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The Fixed Income Clearing Corp. plans to seek regulatory approval to include investment companies in the central clearing of government-related debt repurchase agreements to minimize the risk of fire sales, according to a person familiar with the matter.
To address Federal Reserve concern that systemic risks remain that could exacerbate a financial crisis, the FICC wants to extend a limited membership to registered investment companies as early as next week, said the person, who asked not to be identified since the request is not finalized. The FICC clears tri-party repos of government-related securities with the central bank’s 22 primary dealers.
Market participants have sought to reach a solution to what the Fed has identified as the final reform needed in the $1.6 trillion-a-day market for short-term funding. Officials want to remove the risk that questions about a dealer’s liquidity could lead to wholesale dumping of assets that causes a crisis of confidence in the financial system. New York Fed President William Dudley has stressed over the last two years that such fire-sale risk must be stamped out.
Prodded by the Fed, industry groups with the support of dealers, banks and investors have been working to come to an agreement on a method to initially to guarantee the most-liquid types of collateral used to borrow money in repurchase agreements, or repos. Money market mutual funds and other asset managers are among those firms, the primary lenders of cash in the tri-party repo market, that would be granted the limited membership, the person said.
The guarantee would cover securities such as Treasuries and mortgage securities backed by Fannie Mae and Freddie Mac, which make up to about 85% of daily repo transactions.
Bari Trontz, a spokeswoman for New York-based DTCC, which owns the FICC, declined to comment on the likelihood of them filing any regulatory proposal.
Repos are transactions generally used by primary dealers, consisting of Wall Street’s biggest banks including Morgan Stanley and Bank of America Corp., for their day-to-day financing needs. In one type of repo agreement, a dealer borrows money from a money-market fund in return for collateral, often Treasury bills or notes.
The dealer agrees to repurchase the securities as soon as the next day for the principal value plus interest. The collateral itself in the tri-party market is held on behalf of investors by JPMorgan Chase Co. and Bank of New York Mellon Corp., which serve as the designated clearing banks.
The repo market accelerated the fall of both Bear Stearns, which was taken over by JPMorgan in 2008 after an emergency bailout orchestrated by the Fed, and Lehman Brother Holdings, whose collapse in September of that year plunged financial markets into their worst crisis since the Great Depression.
Investors who perceived the firms might not pay repo loans or be able to post adequate collateral because of their exposure to the plunging value of subprime mortgages demanded more and higher quality assets and refused to finance new repos.
In a tri-party arrangement, a third party, one of two clearing banks, functions as the agent for the transaction and holds the security as collateral. JPMorgan Chase Co. and Bank of New York Mellon Corp. serve as the industry’s clearing banks.