from the New York Fed
General Collateral Finance Repo (GCF Repo) is a popular, well-established service for securities dealers. Its structure provides a way for dealers to exchange government securities for cash among themselves in an anonymous way. Further, the Fixed Income Clearing Corporation, which offers the GCF Repo service, provides netting services and acts as a central counterparty.
These benefits have led dealers to enter into a large number of GCF Repo contracts; for example, in the first quarter of 2013, average daily trading was almost $500 billion and average daily net settlement exceeded $250 billion.
GCF Repo trades are cleared and settled on the books of the two large clearing banks, JPMorgan Chase (JPMC) and Bank of New York Mellon (BNY Mellon), with each bank using its own tri-party repo settlement platform. During the 2007-09 financial crisis, weaknesses were revealed in both banks’ tri-party repo settlement procedures, and thus in GCF Repo. After the financial crisis, regulators and market participants formed the Tri-Party Repo Reform Task Force, with the aim of producing recommendations to improve the stability of the two banks’ triparty repo settlement platforms (Task Force 2010).
Most of the task force’s recommendations focused on reducing the settlement systems’ reliance on intraday credit to settle trades. Prior to reform, these systems depended heavily on the clearing banks providing unlimited intraday credit to the institutions entering into tri-party repo and GCF Repo contracts. One of the main goals of the reforms was to develop settlement systems where much smaller amounts of intraday credit are provided and where it is provided in a less discretionary way.
The pre-reform systems were worrisome for two reasons. First, as long as a dealer had securities at the clearing bank to serve as collateral, the clearing bank was willing to extend intraday credit to that dealer to settle tri-party repo trades. Given the size of the larger dealers (with tri-party books of easily more than $100 billion), there was potential for each of the clearing banks to extend an enormous amount of intraday credit relative to its capital base. This situation raised the risk that a clearing bank that could not absorb the impact of a failing dealer would itself be destabilized, leading to an interruption of funding and payment services for all of its other clients. The task force recommended that clearing banks limit intraday credit extensions to no more than 10 percent of the value of a dealer’s total tri-party book. With these limits in place, market participants and regulators can be more confident that a clearing bank can handle the default of a large dealer on its tri-party repo obligations.
[click on image below to continue reading]
Source: https://www.newyorkfed.org/medialibrary/media/research/epr/2015/epr_2015_primer-on-the-gcf-repo-financial-plumbing_lo.pdf?la=en
