In a speech delivered on November  17, 2015 to The Clearing House Annual Conference, Board of Governors member, Jerome H. Powell discussed the merits of central clearing for repo.  Citing the “several private initiatives for greater central clearing” in the repo market Governor Powell indicated that “repo clearing could potentially bring a range of benefits, including greater opportunities for netting and related reductions in balance sheet costs for dealers affiliated with a bank holding company.”

In addition to the netting benefits Governor Powell set forth the following three additional potential benefits of central clearing of repo:

  1. Orderly Liquidation of a defaulting member’s positions:  A central counterparty could address “fire sale” risk due to their rule based processes for managing a defaulting member’s positions.  Such rule based processes could include transferring positions to solvent dealers or auctioning the securities over time.
  2. Increased Transparency and reduction in Operational Risk:  Aggregate information obtained by the central counterparty could increase transparency into the repo market.  Additionally,  operational risk could be reduced due to the provision of central confirmation of trades and netting of positions.
  3. Risk Sharing:  Transparent rules governing the sharing of losses may provide for a more “predictable process for managing a default.”

Governor Powell includes some cautionary remarks including that “it will not be a simple matter to find a way forward [on central repo clearing] while meeting the heightened regulatory expectations. . .”  Specifically, Governor Powell cited the liquidity requirements of a central counterparty as presenting a “particular challenge” due to the full notional amount of the repo being exchanged.  Lastly, Governor Powell questioned the scale of the potential netting benefits, noting that netting benefits are most present in interdealer markets.  However, he suggested that such netting benefit could arise if “clearing expanded to the bilateral market or if some of the larger end users in the tri-party market, for example money market mutual funds or hedge funds, were able to gain access to the CCP.”

Governor Powell concludes that clearing should be limited “to those assets that are highly liquid and expected to remain so even in severely stressed market conditions.”  Accordingly, Governor Powell suggests that repos with government securities be considered for clearing.

Good Day.   Happy clearing. DR2