The Future of Wholesale
Funding Markets
A FOCUS ON REPO MARKETS POST U.S. TRI-PARTY REFORM

December 2015

Table of Contents
3
6

Executive Summary
The Reliance on Repo within the Wholesale Funding Marketplace
Uncovering the Risks of Repo
The Task Force for Tri-party Repo Infrastructure Reform

12

Conclusions from Research
Safety & Soundness
A. The Impact of Tri-party Reform
B. Regulating Repo Users with Key Ratios
The Fed’s RRP Facility & the Increased Demand for HQLA
A. The Cash-Collateral Concern
B. Money Markets & the Bifurcation of Collateral
Inevitability of Cleared Repo Solutions
A. The Buy-Side Imperative
B. Fire Sale Considerations
C. Potential Marketplace Structure
D. Collateral Connectivity

31

Priorities for Market Participants
Understand the Current Role of Repo in Your Organization
Analyze the Industry LandscapeCreate a Potential Future State around Repo
Achieve a Collateral Management Advantage

34
35

Closing Remarks
Appendix
A Short Analysis of Wholesale Funding
U.S. Repo Market History
Repo Participants & Settlement Mechanisms

38

Glossary

EXECUTIVE SUMMARY
An efficient and effective wholesale funding marketplaceis critical to the proper functioning of the US and global
financial system. The Financial Crisis of 2007-2009 (the “Crisis”
or “Financial Crisis”) exposed weaknesses in the system,
cash providers fundamentally lost confidence in banking
organizations (“banks”) and the wholesale funding marketplaceessentially collapsed. This, in turn, prompted unprecedented
government intervention and the creation of a series of support
programs, many of which continue to this day.
The Crisis brought to light unique risks of the excessive use of
short term wholesale funding and repurchase agreements or“repo”, in particular, to the financing of bank operations andinventory. In short, a combination of the maturity mismatch (i.e.,
the liquidity of short term/ overnight funding used to financelonger term assets) endemic to wholesale funding, tri-party
repo’s settlement mechanism and high reliance on secured
intraday credit created fissures in the system that needed
to be addressed in order to return the market to long term
stability and lessen the risks of a future crisis. Additionally,money funds tended to regard the repo market as equivalent
to a bank deposit from a risk perspective, creating additional
issues in times of crisis, including a potential run on the system.
Throughout the Crisis, this risk manifested when the threat ofseveral funds “breaking the buck” shattered investor confidence
in the money fund market and prompted further government
intervention.
As a result of these factors, wholesale funding reforms becamea cornerstone of U.S. regulators’ post Crisis efforts to reducerisk in the financial system. Much of the change was channeledthrough the Tri-party Repo Infrastructure Reform Task Force (the“Task Force”), which drove direct changes to market operations– partially redefining the value propositions of the bilateraland tri-party settlement mechanisms in the process. In April
2015, tri-party infrastructure providers marked the completionof the largest mandate of Tri-party Repo Infrastructure Reform(“Tri-party Reform”) – the “practical elimination” of secured
intraday credit.1 While Tri-party Reform has a further significant
outstanding directive – the elimination of fire-sale risk – market
participants agree that efforts to date led to a substantial
improvement in the safety and soundness of the system.

As the wholesale funding industry marks a turning point, it isour hope that this paper helps preview a period of continued
reform and market driven change. We, BNY Mellon, believethat our position as both the U.S.’s largest tri-party agent andholder of collateral gives us a unique perspective on this timeof transition. The creation, adoption, and operationalization ofregulations has dominated financial literature since the Crisis.
In addition to progress made through Tri-party Reform, usersof repo – most notably certain Global Systemically Important
Banks (G-SIBs) – are working toward compliance with BaselIII capital and liquidity measures and have largely reachedcompliance at the holding company level. It is important to notethat this paper’s use of the term G-SIB(s) excludes ourselves
and State Street, given the significant differences in businessmodels and relationship with the wholesale funding markets.
Continued retrenchment among the majority of G-SIBs is more
likely to be driven by internal strategy and capital allocations
than by overt regulatory pressure. While regulation and reform
are not complete and will likely continue as mainstays ofwholesale funding, strong market forces and the underlying
structure and profitability of the business will likely begin toaffect repo volumes, participant interactions, and views ofrisks in the system. This leads us to believe that it is time tochange the narrative on wholesale funding away from the puremacro effects of reform to include firm specific strategies for
implementation and the re-emergence of market driven change.
In creating this paper, we conducted in-depth interviews
as well as a broad-based survey, receiving feedback from acomprehensive spectrum of market participants.2 We conducted
this research not only to understand the current drivers of
the use of wholesale funding, but also to explore participants’points of view and strategies for the future. Total interviews
and survey respondents included nearly 100 repo market
participants across the spectrum: large dealers with matchedbooks, collateral providers, cash investors, interdealer brokers,
and potential cleared repo providers. As a result, we drew three
primary conclusions regarding the future of wholesale funding
and the use of the repo markets:

3 | A Focus on Repo Markets

1.	Adopting the recommendations of the Task Force materially
improved the safety and soundness of the system, but
further change is yet to come from regulations affecting
repo users. 75% of surveyed participants agree that thewholesale funding markets are less vulnerable to a future
crisis than before reform. Tri-party Reform simplified the
trading day or processing day, reducing the need for secured
intraday credit provided by the clearing banks. Furthermore,
Tri-party Reform improved trading transparency anddecreased operational risk through process improvements
such as automated three-way deal matching. While Tri-party
Reform drove direct changes to market operations, pending
regulations will likely further affect repo users’ behavior, mostnotably G-SIBs as regulated by the Supplementary Leverage
Ratio (SLR)3, the Liquidity Coverage Ratio (LCR) and the Net
Stable Funding Ratio (NSFR). To become largely compliant,interviewed market participants expect G-SIBs to push theeconomics of these reforms to individual businesses andtrading desks, causing downward pressures on repo activity
in the next 12-18 months. Given certain G-SIB’s traditionaluse of tri-party repo to finance their inventories, we expect
these downward pressures will likely be reflected throughlower overall tri-party volumes, although some new orexisting entities less burdened by regulation are providing
increased liquidity in the space.
2.	Material involvement by the Federal Reserve (the “Fed”)4in the repo market is a near certainty for the foreseeable
future. The effort to increase the safety and soundness of the
global financial sector has materially increased demand forhigh quality liquid assets (HQLA). This is because collective
actions taken since the Crisis (i.e., the regulatory imperative
to clear and collateralize over the counter swaps, therequirement to hold HQLA to meet liquidity standards, andthe increased amount of cash in the system due to stimulus)
create ongoing concerns around the availability of liquid
collateral.5 In short, “collateral is the new cash,” as HQLA
can now be viewed as the financial system’s most importantcommodity. Over 70% of survey respondents agreed that thisincreased demand will lead to a shortage of HQLA in tri-party
repo in the next 12-18 months. To date, the Fed has provided
HQLA to support cash investing needs through its Reverse
Repurchase (RRP) facility. The RRP is now one of the largest
participants in tri-party repo, an effective monetary policy

tool and a buffer to market anomalies. While certain market
developments, such as increasing G-SIB repo volumes post
the expansion of cleared repo, may provide the Fed with aneasy exit from the RRP, interviewees –with near unanimity– feel that conditions will demand its prolonged existence.
One such condition is pending Money Market Reform. These
reforms, which are expected to be implemented in the second
half of 2016, will potentially move up to $1 trillion of cashfrom financing prime securities to government securities, inthe process exacerbating the concerns around the supply of
HQLA and increasing reliance on the RRP.
3.	Expanding the availability of cleared repo in the US isthe clearest path to giving G-SIBs balance sheet relief
and addressing Tri-Party Reform’s largest remaining
concern – fire sale risk.6 77% of our surveyed participants
agree on the need for a robust cleared repo solution, but
this does not come without challenges. To support thisconclusion, we review four relevant points regarding the
adoption and evolution of cleared repo: (A) Repo volumes
have faced downward pressures since the Crisis, with theprospect of more to come. Given this trend, many interviewed
participants see cleared repo as giving some flexibility backinto the marketplace. The participation of cash investors in
a CCP is also key to increasing the size and scope of netting(i.e. the ability to use offsetting positions to calculate asingle balance sheet value7) in the U.S. cleared repo market;
however, cleared repo providers will need to create theappropriate value proposition to attract involvement fromthe buy-side. (B) Secondly, a CCP platform would be in theunique position to provide coordination to dealers andother counterparties in both pre and post-default fire salesituations. (C) Additionally, while there is general agreementon the inevitability of expanded cleared repo services in the
U.S., key questions remain regarding the potential market
structure of the repo industry such as the number of cleared
repo platforms that will be offered and what asset classes
they will clear. (D) Finally, while Tri-party Reform provided
for more efficient movement of cash, we expect the next
market evolution to result in a more seamless movementof collateral, culminating with the linkage of international
central security depositories (ICSDs) and more integrated
global operations of market participants.

4 | A Focus on Repo Markets

The significant structural reform of the repo market is largely
complete, and the changes we see on the horizon do not appear
to be a continuation of the last six years. The equation facing
market participants is now more complicated than that ofsimply addressing the ongoing requirements of regulation.
Understanding and preparing for this more complex futureis essential for anyone participating in or affected by thewholesale funding markets. To help participants prepare forwhat is to come, we developed four priorities in order to beprepared to meet the challenges ahead:
1.	Understand the Current Role of Repo in Your Organization.
Perform a company assessment to provide a deep
understanding of the nature and profitability/ costs of yourrepo and wholesale funding activities. From our discussions
and survey, we found a high degree of variation regarding
the nature, profitability and understanding of the current
business. What are your true margins? How important is thisbusiness to your current client base? Is there an opportunity
for re-pricing current business? Are both your use and mix ofwholesale funding appropriate for your underlying business?
2.	Analyze the Industry Landscape. Conduct a review of
the current regulatory environment, and the structuraland competitive forces affecting wholesale funding.
Market participants have some clear views on where themarketplace is headed. What is less clear is whether thevarious scenarios and the timing of those scenarios havebeen adequately analyzed and modeled. What are some of
the key scenarios you should model? What would the impacts
be of a significant rate rise? What about a collapse in the
Chinese economy and mass selling of Treasuries?
3.	Create a Potential Future State around Repo. Revise
business and operating models to incorporate expectedchanges in the repo landscape. The technology andoperational requirements of complying with Tri-party Reform
have been significant. We, like others in the marketplace,invested significantly in new technology and operational
processes. While these investments will be leveraged in the

future market structure, transformation, understanding andincorporation of cleared repo and collateral connectivity into
existing roadmaps and strategies will necessitate changes
in future plans, budgets and allocation of resources. It will
also likely impact current development and architecture
activities as well as outsourcing and service contracts withkey providers.
4.	Achieve a Collateral Management Advantage. Develop a
strategic roadmap to better coordinate and improve theuses of collateral across your organization. Many firms
have taken important steps to better organize and manage
their collateral. This includes improvements in collateralmanagement technology and operational processes as wellas organizational changes to efficiently manage the needs ofdesks that have collateral requirements (e.g., repo, futures,
swaps, etc.). Going forward, the location and mobility ofcollateral will need to be further analyzed and taken into
account in terms of cleared repo, custodian and collateralprovider selection. This applies to both collateral owners anddealers as well as cleared repo providers.
This is a time of important change in the wholesale funding
markets and calibrating your approach to the fundamental
shifts in the market will be essential. We hope that this paper
provides you with some market insight and understanding as
you develop and execute your strategies moving forward. Let us
thank PwC for their objective perspectives and contributions to
the development of the conclusions within this paper, and weare grateful to our interviewed and surveyed colleagues for theirinvaluable time and industry perspectives.
We welcome and look forward to receiving your feedback
and ideas.

5 | A Focus on Repo Markets

1#

THE RELIANCE ON REPOCHAPTER TITLE
WITHIN THE WHOLESALEFUNDING MARKETPLACE

Leading up to the Financial Crisis, from 2003-2007, market
participants increasingly relied on wholesale funding, as trading
expanded from 15% to 22% of industry revenues.8 This growth
in revenues resulted predominantly from a growth in trading
volumes and made the financial system more reliant on shortterm funding of trading inventories and other assets. Two
specific types of wholesale funding – commercial paper (CP)and repo were used to facilitate the increased funding needs ofbroker dealers and certain other banks.
The Crisis influenced the composition of volumes withinwholesale funding. By 2010, CP had declined to half of its
previous volume. As money market funds found the asset
class more unattractive, and CP issuers found it increasingly
difficult to place paper with investors.9 Since 2012, volumes
have remained constant, but financial CP declined in usage,
while nonfinancial issuances helped to stabilize overall volumes

within this asset class. The total CP market was $987 billion
as of June 2015. Large time deposits (including CDs) are near
their 2005 levels and comprise roughly $1.9 trillion as of Q1
2015. Volumes grew consistently over the last three years, withforeign bank holdings accounting for more than U.S. chartereddepository institutions. The interbank lending market became
an important tool for the Fed to control the excess bank reservesof primary dealers by paying interest on deposits. The Fed’s
participation drove volumes in the interbank market, which grewfrom less than $85 billion in 2007 to over $2.5 trillion today.10
Activity in the repo market dropped over 30% in the wake of the
Crisis.11 In 2010, total repo volumes stabilized, and repo remains
the most material component of the wholesale funding markets(comprising 41%-48% of total volumes over the period). The
U.S. repo market, consisting of tri-party, bilateral, and General
Collateral Finance (GCF) repo was estimated at $3.7 trillion as of
Q1 2015.12

6 | A Focus on Repo Markets

U.S. WHOLESALE FUNDING MARKET ($T)

10

8

6

4

2

-

2003

2004

Commercial Paper

2005

2006

Repo (Est.)

2007

2008

Deposits

UNCOVERING THE RISKS OF REPO

2009

2010

Interbank Loans

Going into the Crisis, repo markets were mainly of interest to
their participants and the tri-party clearing banks. Primary
dealers dominated repo, principally running “matched book”
businesses. Leverage in the financial system increased
substantially. Additionally, many cash investors werecounterparty focused, with less attention paid to the collateralrisk they took. In addition to generating direct trading revenues,
repo books supported dealer businesses across productareas. Primary dealers provided liquidity to the repo market- acting as buyers and sellers of collateral for clients, who
included governments, sovereign wealth funds, money market
funds, corporates, and other financial institutions. The large
inventories of treasury collateral that dealers acquired assistedwith the liquidity of smooth functioning U.S. Treasury markets,
contributing to the largest and most liquid bond market in
the world.13

2011

2012

2013

2014

2015Q1

Source: PwC Analysis

The increased supply of repo during this period was met by anequivalent increase of demand from cash investors, as bankrisks were viewed as well-diversified and investors had little
concerns about providing banks with increased leverage. At theheight of the market in 2007, repo books ballooned to over an
estimated $5 trillion, with tri-party repo representing nearly halfof the volumes. In a Feb ’13 speech, NY Fed CEO, William Dudley,
succinctly summarized the convergence of supply and demandthat drove this volume increase and ultimately made the risksof repo – most notably the mismatch of maturity and liquidity
between repo assets and their financing – central to the broader
financial community:“On the demand side, it was more profitable to use
shorter-term funds to finance longer-term assets.
On the supply side, such funding was plentiful because
it was viewed as safe and because of the growing
institutionalization of savings with corporations andinstitutional investors in need of deposit-like products
in which to place their cash balances. After all, thefunds were only exposed for a short period of time,and in the case of repo, secured by collateral.”14

7 | A Focus on Repo Markets

AVERAGE ANNUAL TRI-PARTY REPO VOLUMES ($B), 2003 - AUGUST 2015
$3,000$2,500$2,000$1,500$1,000

$500

$0

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Federal Reserve (http://www.newyorkfed.org/banking/tpr_infr_reform_data.html)

Two clearing banks, BNY Mellon and JPMorgan Chase, supported
and controlled the most transparent piece of the repo market
through the tri-party repo settlement process. Given the moreopaque nature of the bilateral repo market, its volumes havebeen notoriously difficult to measure. Because 100% of tri-party
settlements ran through the two banks, tri-party was the mostcentralized and transparent area for regulator involvement.
In addition, regulators and market participants identified
weaknesses in tri-party settlement operations that needed
immediate reform. Tri-party agents lacked risk measurements
and control over the settlement mechanism they oversaw. For
example, the clearing banks often did not know terms for therepos being unwound each day due to the lack of a three-way
trade confirmation. Market participants also depended on
secured intraday credit extended by the clearing banks fortheir use of tri-party, so as trades waited to be settled, tri-

party agents extended secured uncapped intraday credit to
the counterparties. This left the tri-party agent with secured
intraday credit exposure to the broker dealer for 9-10 hours.
Hence, the market functioned on, what was referred to by theFederal Reserve Bank of New York (FRBNY) as, an “excessive
reliance” on secured intraday credit.15 As was later realized,
the extension of secured credit subjected the clearing banks
to risks that could meaningfully impact themselves (due tothe significant volumes relative to their own capital bases)
and markets in times of stress. That is, if a clearing bank was
not able to absorb the impact of a failing dealer or dealers, itwould have a knock on effect of the clearing bank requiring
intervention or even failing itself. These and other pre-2008 risksof the repo market were identified and addressed by Tri-party
Reform.16

8 | A Focus on Repo Markets

THE TASK FORCE FOR TRI-PARTYREPO INFRASTRUCTURE REFORM“A stable and well-functioning tri-party repo market iscritical to the health and stability of the U.S. financial
markets and the U.S. economy.” – FRBNY17
The tri-party repo market underwent substantial changeover the years following the Financial Crisis. At the requestof the FRBNY, the Payments Risk Committee (PRC) founded
the Task Force in 2009.18 The Task Force, made up of various
market participants from clearing banks and hedge funds todealers and the SEC, formed a common platform where triparty market participants and regulators jointly created a setof recommendations to reduce systemic risks in the market.
Implementing these recommendations shaped a distinct period
in the history of tri-party with clearing banks, cash lenders,and collateral providers coordinating efforts to advance andsafeguard the industry.
The Task Force identified three primary risks in the tri-party
market structure, including: 1) the system’s excessive relianceon secured intraday credit provided by clearing banks; 2) the
settlement processes that left credit and liquidity risk largely
unknown to collateral providers and cash lenders; and 3) theinability to ensure against a destabilizing fire sale of collateralfollowing a dealers default.19 Subsequent to this, members of
the Task Force published draft recommendations on specificweaknesses within the infrastructure of tri-party repo including:operational arrangements, liquidity management, margining
practices, contingency planning and transparency of themarket.20 Overall, the Task Force’s recommendations provided
the foundation for the “practical elimination” of secured intraday
credit – defined as 90% reduction of intraday risk related totri-party.21

Tri-party Reform efforts are best viewed and understood
through the changes that occurred in the tri-party trading day
including the introduction of automated collateral substitution(auto-substitution) and three-way deal matching as well as
the change of the daily unwind time. In the years leading up to2008, tri-party repo trades unwound at 8:30am and rebooked
at 3:30pm. Tri-party agents lacked complete trade details, fulllegal terms of trades, and certainty around settlement times. In
the late afternoon (after the close of the Fedwire) dealers would
allocate collateral to trades, using proprietary optimization
tools.22 Overnight (ON) from 6:30pm-8:30am, the clearing banks
locked collateral in cash investor accounts, prohibiting dealer
access. Then, in the morning, the tri-party agent unwound thematerial balance of tri-party repo trades, regardless of maturity
date. Unwinds occurred at 8:30am and secured intraday credit
was extended until the completion of the end of day (EOD)
settlement process at 6:00pm. This process, for example,
exposed [The Bank of New York Mellon] up to 9-10 hours [FN]of credit risk daily (amounting to $1.44 trillion in secured credit
extended daily).23

9 | A Focus on Repo Markets

Trade Terms Agreed between Cashand Collateral Providers; Complete
trade details not received byclearing banks until 3pm

Trade
Terms
Agreed between Cash
Tri-party
Unwindand Collateral Providers; Complete
trade details not received byclearing banks until 3pm

New Trade Instructions
Received/New allocations from
Cash and Collateral Providers

FedwireClosedComplete Trade
Details Received
Intraday Credit Window

FedwireClosedTri-party Unwind Completed

New Trade Instructions
Received/New allocations fromCash
and Collateral
Tri-party
Unwind Providers

Pre-Reform

Complete Trade
Details Received

Official Trade
Settlement

Tri-party Unwind Completed

7:00

8:00

9:00

10:00

11:00

Intraday Credit Window

12:00

1:00

2:00

3:00

4:00

5:00

6:00

Official Trade
Settlement

Overnight
LockupOvernight
Lockup

Pre-Reform
7:00
8:00
9:00
10:00 11:00 12:00
1:00
2:00
3:00
4:00
5:00
6:00
trade instructions with the clearing banks.24 Auto-substitution
Three-way deal matching and auto-substitution provided added
value propositions to the market Overnight
through their efficiencies.
helped replace the need for a full-scale unwind, enabling Overnight
cash
LockupThree-way deal matching helped toestablish that clearing(or another eligible security) to be replaced in term trades Lockup
banks received identical instructions from both dealers andwithout unwinding the entire trade. Moreover, it allowed the triinvestors prior to settling a tri-party repo trade, providing moreparty agent to facilitate the movement of collateral intraday andtransparency to the market and more certainty in settlement.
permitted the agent to keep collateral locked up for the duration
Furthermore, three-way trade confirmation permitted collateralof the day.
Instructions viewable by Tri-party Agent
Trade Terms
providersandAgreedcash investors to submit or confirm tri-party repo
between Cash andCollateral Providers

FedwireClosedTrade Confirmation Target

Intraday Credit Window

Tri-party Unwind
Instructions viewable by Tri-party Agent

Cash Movement: New
Trade Terms
AgreedReceived/
Instructions
betweenCash andNew allocations
from Cash
Collateral
Providersand Collateral
ProvidersTrade Confirmation Target

Official Trade
Settlement
FedwireClosedIntraday Credit Window

Post-Reform
Cash Movement: New
Trade Instructions Received/
New allocations from Cashand Collateral Providers

7:00

8:00

9:00

Overnight
Lockup

10:00

11:00

12:00

1:00 Tri-party
2:00 Unwind
3:00

4:00

5:00

Official Trade
Settlement

Collateral Access through Auto-substitution

6:00
Overnight
Lockup* The industry achieved more than a 95% reduction in intraday credit risk.

Post-Reform

7:00

8:00

Overnight
Lockup

9:00

10:00

11:00

12:00

1:00

2:00

Collateral Access through Auto-substitution* The industry achieved more than a 95% reduction in intraday credit risk.

10 | A Focus on Repo Markets

3:00

4:00

5:00

6:00
Overnight
LockupAuto-substitution allowed the clearing banks to move theunwind to 3:30pm. A standard settlement window was set
from 3:30pm-5:15pm, and cash investors received their cash
proceeds later in the day. Dealers could continue to trade
securities held in either term or overnight deals, which would
not have otherwise unwound until the afternoon. These changes
made by clearing banks streamlined and further automatedcollateral allocation and optimization and also integrated triparty and GCF settlement processes. Looking at this throughthe lens of secured intraday credit risk, tri-party clearing banks
previously extended secured intraday credit for 100% of thedaily tri-party volumes during the trading day. By moving theunwind of maturing tri-party repo trades to 3:30pm, secured
intraday exposure reduced from 10 hours to approximately 2.5hours. With the completion of improvements to the settlement
processes from Tri-party Reform,25 our total volumes of secured
intraday credit extended reduced to 3% of all tri-party repo
collateral.

INTRADAY CREDIT EXTENDED OF U.S. TRI-PARTY REPO COLLATERAL
100%
90%

100%
92%

80%

73%

80%

70%

73%

60%
50%
40%
30%
20%
18%

10%

18%

18%

10%

18%
10%

0%

3Q 2012

4Q 2012

1Q 2013

2Q 2013

3Q 2013

4Q 2013

1Q 2014

2Q 2014

3Q 2014

4Q 2014

Source: FRBNY (www.newyorkfed.org/banking/riskreduction.pdf);
Estimates based on plans or announcements made public by JPMorgan Chase and Bank of New York Mellon. GCF not included.

11 | A Focus on Repo Markets

1Q 2015

3%

3%

2Q 2015

3Q 2015

#
2

CONCLUSIONSCHAPTERTITLE
FROM RESEARCH

While reform is not complete and will continue as a mainstayof wholesale funding, strong market forces – most notably thepost regulatory imperative for cleared repo and the profitabilityof repo – will likely begin to affect repo volumes, participant
interactions, and views of risks in the system. The three primaryconclusions drawn from our research support this thesis that
repo markets are in a time of transition:
1.	Market participants agree that adopting therecommendations of the Task Force materially improved thesafety and soundness of the system. Additionally, pending
regulations on collateral providers and cash investors –designed to increase safety and soundness of the broader
system – will put downward pressure on repo volumes in thenear term.

2.	Continued high demand for HQLA to meet liquidity ratios
and collateralize transactions, implies that “collateral is
the new cash.” The combination of this new dynamic – theshort term downward pressure on repo volumes and likely
developments that will further increase demand for HQLA
(such as Money Market Reform) – implies that involvementby the Fed in the repo market, through its RRP facility, is anear certainty for the foreseeable future.
3.	Expanding the availability of cleared repo services in the U.S.
is the most direct path toward giving G-SIBs balance sheet
relief (through netting) and addressing the Tri-party Reform’s
remaining concern – fire sale risks. This, coupled with thecurrent development of several cleared repo platforms, leads
us to believe that several cleared repo solutions will likely be
introduced into the U.S. market in 2016 and at least one will
be successfully adopted in the near to medium term.

12 | A Focus on Repo Markets

As we look to the future of U.S. wholesale funding, we expect
repo to serve as the circulatory system for broader financial
markets who have become increasingly reliant on the smoothtransfer of collateral. This section addresses the transformationthat is occurring within the industry across reform andregulation, the Fed’s involvement in tri-party, and the likely
expansion of cleared repo in the U.S. While there is a range ofpotential outcomes, some scenarios are thought to be more
likely than others. We address these and more as we consider
the future of the industry.

SAFETY & SOUNDNESS

Adopting the recommendations of the Task Force materially
improved the safety and soundness of the system. 75% ofmarket participants feel that tri-party repo is less vulnerable
to a crisis than before reform. The risk reduction initiativethat encompassed tri-party repo took four years. We provided
approximately a $100 million investment in technology toachieve their “practical elimination” of daylight risk.26 This
reduced our exposure in the tri-party market from roughly $1.4
trillion of uncapped daily credit to less than 10% of our total
tri-party book. Furthermore, it afforded us the opportunity todevelop new and innovative technology solutions for us andour broker-dealer and investor client base as well as the ability
to accommodate any future growth in the repo market. The
implementation was a multi-year collaboration with broker
dealers, regulators, and institutional investors (among others)
and resulted in a more technologically advanced and safer
secured funding marketplace where transactions are settled
efficiently.
The infrastructure of repo was not the only area of the industry
to be impacted by reform. New and pending regulations areaffecting both collateral providers and cash investors. The
SLR, LCR and NSFR have the effect of applying higher capitalrequirements to repo transactions, increasing their cost, andpushing more repo out to term. We expect further downward
pressure on repo volumes in the next 12-18 months from theseregulations as G-SIB’s more stringently allocate capital to thebusiness unit level. Additionally, a surcharge on the SLR, theeSLR, disadvantages the largest US banks versus their foreign
peers, making repo comparatively more attractive outside theU.S.27 There could be some relief on repo volumes from non
G-SIB participants, as they realize opportunities left behind by
the larger dealers. Overall, however, we expect the pressuresfrom regulation on G-SIBs to force tri-party volumes to decline,
at least in the short term.

Somewhat
Disagree7%

As a result of Tri-party Reform,
75% of surveyed market participants
view the wholesale funding markets
as less vulnerable to a future crisis

Strongly
Disagree
7%
Strongly Agree28%

Neither Agreenor Disagree
11%Somewhat Agree47%

13 | A Focus on Repo Markets

A. THE IMPACT OF TRI-PARTY REFORM
Tri-party Reform achieved its goal of the “practical elimination”
of secured intraday credit and dramatically improved the triparty repo settlement processes. Its settlement mechanism
has become much more streamlined, tightly controlled, andmonitored, largely by the internal risk and compliance checksof the two tri-party agents, JPMorgan Chase and ourselves. In
aggregate, Tri-party Reform measures drastically reduced theamount of securities requiring intraday credit and provided
the tools to ultimately reduce and cap secured intraday credit
usage. The two banks capped dealer credit to less than 10%of their entire tri-party repo book. Additionally, the reduced
secured intraday credit time window allowed the banks toreview trade confirmations and other parameters ahead of
the unwind. Improvements were not only attributable to thetri-party agents, but also improvements provided dealers withnew tools and functionality (linked to the systems of tri-party
agents). Lastly, the centralization and restructuring of collateralmanagement along with algorithmic improvements facilitated amore efficient allocation of capital and better risk management.
One of the key Tri-party Reform areas of focus – fire sale risk– has not been resolved by actions to date. Surveyed market
participants recognized this systemic risk, as 56% agreed thisis the biggest outstanding risk to tri-party repo participants.
Interviewed market participants reiterated this risk, andmany expect a natural mitigant to emerge through cleared
repo (discussed in detail in the Inevitability of Cleared Repo
Solutions section).

Repo users and providers agree the system is safer, butinterviewed participants’ thoughts on the effects of reform on theease of day to day operations were mixed. For collateral providers,collateral is available through the auto-substitution mechanism,
which increases collateral liquidity but augments pressure on
the collateral management mechanisms for banks and broker
dealers. On the cash investor side, cash is not available until theend of day unwind, forcing cash investors to carefully manage
their end of day cash movements. These changes also pose a
problem for market participants looking to trade across repo
markets, as timing schedules, trade pairing and intraday cash
movements (e.g., deadlines, timeframes, when money hits an
account) differ depending on the particular repo market. For
example, although GCF and tri-party repo unwind at 3:30pm,
new funding may not occur with GCF until 4:30pm, which leaves
a funding gap of one hour. On the positive side, investors are notas exposed to tri-party agents since deals remained locked until
3:30pm. Finally, investors have greater transparency regarding
collateral through online reporting and can better specify whichcollateral they would like for a transaction. Cash and collateralproviders improved trade security through deal matching,which helped to establish the correct implementation of trade
parameters. Despite the mixed effects on ease of operations,overall interview and survey feedback on the success of reforms
was resoundingly favorable with regard to the improved safety
and soundness of the tri-party repo settlement mechanism.
Finally, surveyed market participants agreed that the top threebenefits of Tri-party Reform were: (1) reduced reliance on tri-party
clearing bank’s secured intraday credit, (2) three-way automateddeal matching, and (3) dealer improvements to liquidity risk
management and planning.

14 | A Focus on Repo Markets

CASE STUDY:
THE EFFECTS OF THE “PRACTICAL ELIMINATION”
OF INTRADAY CREDIT

In May 2013, The FRBNY published an analysis on the risk of fire sales
in tri-party repo27, which helps demonstrate the material change insafety and soundness of the system brought about by the “practicalelimination” of secured intraday credit.
Before the crisis, the largest tri-party portfolios
averaged roughly $200 billion in total exposure(both overnight and term). With the clearing
banks extending secured intraday credit for
the full value of the portfolio, they would takeownership of the securities after a credit event.
The FRBNY estimated an amount of eachsecurity class that could be liquidated in a day
without depressing the market price and usedthat amount to calculate the days necessary
to liquidate each asset class. Then, applying
a historical average volatility, they calculated
a 99% confidence interval VaR for a tri-party
agent, respective to their largest clients.
In the event of a largest dealer default, uniform
application of the 97% reduction in secured
intraday credit reduces the $6 billion expected
loss to less than $200 million. This material
benefit raises the question, what were thetrade-offs for this increase in security? Did repo
become less liquid and/or more expensive as
secured intraday credit was removed from thesystem? BNY Mellon’s Repo Index28 (a weighted
average of repo rates for the three largest triparty asset classes) shows a decrease in the
spread between U.S. Treasury repo rates and 6
month Treasury bill rates in May 2015, as market
participants processed the insecurities createdfrom the implementation of reduced intraday
credit and capped dealer credit facilities;
however, this spread soon returned to priornorms.

Portfolio
Value (B)

Share ofPortfolio

Daily
Liquidation
Amt (M)Days toLiquidate

99% VaR(M)

U.S.
Treasuries& Strips

$71

35.3%

$7,5009$679

Agency
Debt

$11

5.3%

$2,0003$69

AgencyMBS and
CMO

$88

44.2%

$4,00022$2,385

Corporate
Bonds

$7

3.4%

$250

Equities

$11

5.5%

ABS

$4

1.9%

$4

4.4%

$200

100.0%

Asset Class

All other
Total

27

$627

$500

22

$2,550

$125

30

--

-$6,310

Expectedpre-reform
loss by aclearingbank afterlargestdealerdefault

BNY MELLON TREASURY REPO INDEX VS. 6 MONTH US TREASURY BILL
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
Jan-15

Feb-15Mar-15

Treasury Repo Index

15 | A Focus on Repo Markets

Apr-15May-15Jun-15

6 Month UST

B. REGULATING REPO USERS WITH KEY RATIOS
While addressing fire sale risk is the outstanding material
element of Tri-Party Reform, new and pending regulations
affecting both collateral providers and cash investors will likely
affect repo volumes in the near to medium term. Stemming fromBasel III, regulations (most notably SLR, LCR, and NSFR) areleading banks and broker dealers to reduce their balance sheets
and streamline operations, which includes optimizing posted
collateral and allocating capital more stringently to businesslines. On the other hand, small and mid-sized participants could
realize opportunities left behind by the larger dealers in the triparty repo market. This is also likely in the more opaque bilateralmarket, with over half (53%) of those surveyed seeing greaterliquidity coming from this space. We review the main regulations
affecting repo users as well as their near term influenceon absolute volumes and relative volumes in the following
paragraphs.

ABSOLUTE VOLUMES
Regulations and reporting requirements will indirectly force
repo volumes to decline in the near term. The impact on G-SIB
repo activity is different for each regulation and includes
applying leverage-based capital to the balance sheet and offbalance sheet exposures. Hence, more capital will need to beheld against repo (SLR), the amount of HQLA held against shortterm funding will need to increase (LCR), and the cost of shortterm funding will rise (LCR and NSFR). Each regulation will likely
have a negative effect on repo volumes. A summary of theseregulations, their expected effects on repo, and their respective
implementation schedules can be found in the corresponding
table:

Supplementary
Leverage Ratio (SLR)

Liquidity Coverage
Ratio (LCR)

Net Stable Funding
Ratio (NSFR)

Tier 1 CapitalHigh Quality Liquid Assets

Available Stable Funding

Total Leverage Exposure

Net Cash Outflow over a 30 day Stress Period

Required Stable Funding

REGULATION

SLR

LCR

NSFR

GENERAL EFFECT (G-SIBs)

EFFECT ON REPO

IMPLEMENTATION–– Limits supply of balance sheet–– Increases Tier 1 capital–– Reduce off-balance sheet exposures–– Cost of holding cash becomes more
expensive–– Grosses up the balance sheet–– Increases capital needed against
repo transactions–– Likely impacts capital allocatedto repo–– 2015, disclosure began–– 2018, banks must be compliant
to SLR and eSLR–– Increases supply of liquidity tosurvive a short-term (one month)stress scenario–– Requires banks to holdunencumbered HQLA–– Cost of holding cash becomes
more expensive–– Reduces the supply of HQLA
collateral–– Limits amount firms can assume
as automatic or rollovers–– Makes short term funding more
expensive due to corresponding
HQLA requirement–– Pushes repo out from overnightto term–– U.S. banks fully compliant by 2017–– Phase-in transition with 80% by
2015, 90% by 2016, and 100%by 2017–– Increases supply of liquidity tosurvive a long-term (one year)
scenario–– Pushes repo out to longer term–– Increases the cost of repo–– Discourages matched books–– Rule has not been proposed in
the U.S.; although international
standards mandate complianceby 2018

16 | A Focus on Repo Markets

While G-SIBs are making changes to comply with these metrics
at the holding company level, their effects on banks and repo
users are not fully realized (as illustrated by the SLR graphbelow detailing requirements and ratios). G-SIB management
is currently more focused on retrenchment, efficiency, andcompetitive advantage than revenue growth. This has led tothe development of much more rigorous and accurate capital
allocation programs. Compared to other trading desks or
products, the post-Crisis economics of repo are difficult toisolate. As such, it is likely that repo will be subsidized by otherdesk’s use of bank capital. In addition, the economics of repo asa stand-alone business (i.e., matched books) are not favorable– especially considering the SLR and NSFR. As a previously
almost capital free business, repo is specifically affected by
the introduction of leverage based capital. While difficult toscope, several interview participants agreed that this will put a
downward pressure on their volumes.

1%

le
an

In
or

ga

n

St

p,
M

o&

ou
Gr

GS

y

c.

.
Co

c.
rg

.
e&
as
Ch
M
JP

Source: SNL Financial LLC

Total Assets

Our analysis focuses on SLR because it most directly affects the
economics of repo. 80% of market participants surveyed see the
SLR contributing to reduced repo market liquidity. Additionally,
the SLR is the most direct driver of capital held against repo
positions, and 75% of surveyed participants view capitalconstraints as the biggest impediment to volume growth andprofitability. Declines in G-SIB tri-party volumes (14% decline
from 2013 through Q2 2015) directly reflect banks activities toreach SLR compliance, as reduced repo activity is an immediate
and effective method for reducing leverage. With banks working
toward compliance at the holding company level, we predict that

0%

Co

e
iss

pA

it
ed

iC

re

di

Su

tS

AG
p
Un

Cr

c
Pl
Gr

UB

S

ou
Gr

S
RB

SLR Threshold

ou

p

c
Pl

nk

ys
la

Ba

rc

SA
De

ut

sc

he

as

Ba

gs
in
BN

P

Pa

rib

ld

Ho

BC

HS

Ch

in

aL

td

td
aL
in
Ch

AB

of
nk
Ba

0

0%

SLR%

1%

rp

0

2%

500

tig

500

3%

1,000

2%

In

3%

Ci

1,000

4%

Fa

4%

5%

1,500

Co

1,500

6%

2,000

ls

5%

7%

el

6%

W

7%

2,000

8%

2,500

fA

2,500

9%

3,000

up

8%

ro

9%

Bo

3,000

Millions

Millions

Q2 2015 SLR THRESHOLD FOR NON-US BANKS VS. eSLR THRESHOLD FOR U.S. BANKS (TOTAL ASSETS VS. SLR %)national/regional SLR implementations will likely affect repo
volumes in two ways:
1.	Changes to final rules may make the SLR more restrictive.
As this paper neared publication, a salient example emergedwith Switzerland’s announcement that it will require a 5%
SLR for Swiss G-SIBs.29 Repo will most likely see further
global volume declines if higher capital thresholds, suchas the proposed Swiss or U.S. rules, are put in place.
Furthermore, a potentially more material effect would be if
national/ regional rules bridge the current gap between the

17 | A Focus on Repo Markets

eSLR, which uses daily average balance sheet reporting, andthe SLR, which uses each month end for its quarterly averagecalculation. In its current state, the SLR allows for quarterend “window dressing”’ – the elimination of which would
create material downward pressure on non-Fed tri-party
volumes (10%-15% if uniformly applied outside of the US).
2.	Advances in capital allocations will expose repo to theeconomics of a stand-alone business. Before Basel III, repo
was an almost capital free business as the predominance ofhigh quality assets and overnight contracts allocated little
risk weighted capital to the business. Post-Crisis, firms havebeen seeking to understand the economics of their individual
businesses (down to the trading desk level) and to more
stringently allocate capital than before.
We expect the effects of compliance to be felt in G-SIB
operations and further downstream on client’s repo volumes.
Through the release of specific statements or general
presentations, G-SIBs have reported that they are phasing incompliance with LCR. Dealers were also materially compliant
with the NSFR as early as 2013,30 despite it being the last of thethree ratios to be finalized by the Basel Committee on Banking
Supervision (October 2014) and it not yet being proposed in
the U.S. The primary effect on repo of LCR and NSFR will be ashift to term, as HQLA and/or dedicated financing must be held
against shorter term or riskier repo transactions. We see further
nuances in the effects of these ratios as follows:
1.	LCR will affect investor cash and costs to the end client.
(1) Post-Crisis, firms are increasingly less willing to accept
investor cash because of the increased costs of holding it
and the difficulty employing it in a low rate environment.31
LCR treats cash held by dealers from entities such asalternative asset managers (as opposed to retail deposits)32
more punitively. We expect a continued downward pressure
on repo volumes from this requirement; however, effects will
be firm-specific and dependent on how the economics ofholding cash and executing repo are pushed to the end client.
(2) Financing of non-HQLA will be penalized more under LCR
than prior regulations. For example, in a repo transaction
financing a corporate bond position for 30 days or less, thedealer must also hold HQLA equivalent to the value of thecorporate bond being financed.

2.	NSFR will push overnight repo to term and increase
operational burdens. Short term liabilities will receive a morepunitive Available Stable Funding (ASF) score, requiring
a longer term funding mix or assets with a less onerous
Required Stable Funding rating. In addition to pushingtransactions to term, we expect increased operational
complexity with repo from NSFR. The RSF metric requires
transaction standards to adjust to different counterparties,
with financial and non-financial counterparties requiring
different treatments. As a result, G-SIBs will need to adapt
their operational infrastructure to these counterpartyspecific requirements.
As a result of these and other changes, the vast majority ofmarket participants postulated that non G-SIB dealers may
increase trading volumes, filling the gap left by G-SIBs. We
reviewed this hypothesis and found that, indeed, non-GSIBs had
indeed increased volumes roughly 20% from January 2014 to
mid-September 2015. For some perspective, the overall change
in volumes was +3%.33 Non G-SIBs may be subject to domestic
regulations (e.g., stressed capital in both the US and Europe);
however, they are not covered by the most stringent balance
sheet and capital restrictions. This provided an opportunity for
non G-SIB participants to take additional volumes.
Other potential regulations affecting repo market participants
include the G-SIB surcharge in the United States andcounterparty credit limits. The Fed recently finalized the G-SIB
surcharge in the U.S. Unlike the Basel Committee’s G-SIB
surcharge framework, the U.S. rule has an additional factor for
reliance on wholesale funding. This wholesale funding factor
increases the G-SIB surcharge to 1.0% to 4.5% under the U.S.
rules, up from a range of 1.0%-2.5% under the Basel framework.34
Additionally, U.S. regulators are considering counterparty credit
limits, which would limit the exposure a dealer can have to asingle counterparty or a group of connected counterparties (i.e.,
restricting how much exposure G-SIBs can have with anotherdealer). This rule also follows a final Basel Committee framework
limiting exposures among counterparties.35

18 | A Focus on Repo Markets

RELATIVE VOLUMESAs repo users can attest, each clearing mechanism has distinct
features that provide benefits for specific trading strategies orcollateral uses. In the most general sense, tri-party provides
operational efficiencies, bilateral offers more bespoke
qualities, and GCF provides netting benefits and the ability toface a central counterparty (CCP). Each has compelling value
propositions, however, we expect changes in absolute volumes
over the next 12-18 months to be unequally distributed between
these three markets. G-SIBs are the dominant collateralproviders in tri-party, and as such, it is not a surprise thatmarket participants expect the decline in absolute volumes
to be caused by retrenchment in tri-party. 57% of surveyed
respondents expect tri-party repo volumes to decline in thenext 12-18 months. A plurality of respondents (43%) expect anincrease in bilateral volumes while GCF repo volume predictions
were largely mixed, with 25% of respondents predicting an
increase versus 38% for a decrease. In the paragraphs that
follow, we explore the rationale behind these expectations inmore detail.

EXPECTED CHANGE IN REPO VOLUMES (12-18 MONTHS)
70%
60%

57%

50%
43%

40%

38%
30%

29%

30%

25%

25%

20%
13%

10%
0%

Tri-party
Increase

GCF
No impact

Bilateral
Decrease

29%

We expect volumes to be more resilient than some believe. NonU.S. G-SIBs moving to daily average balance sheet reportingfor SLR calculations would drive roughly a 15% decline in
non-Fed tri-party volumes. However, in the short term, thepotential for coordinated regulatory movement (nationally or
regionally) seems unlikely. Also, as previously discussed, we
expect continued downward pressure on volumes from capital
allocations. These pressures on repo volumes are more difficult
to scope, as they are more firm specific than national/ regional
leverage ratio changes. In aggregate, we expect non-Fed triparty volumes to not likely decrease by more than the 20%
predicted by some.
While repo users recognize downward pressure in tri-party
volumes, tri-party repo has advantages and disadvantages,some of which are increasingly notable post Tri-party Reform.
1.	Tri-party provides for economies of scale. Once links
have been established with a tri-party clearing bank, theinfrastructure for tri-party becomes more automated. This
automation and economies of scale are more valuable post
Tri-party Reform, as collateral optimization across a bank’s
portfolio has taken on greater importance to minimize
balance sheet and related capital usage.
2.	Tri-party allows for auto-substitution. If a security needs tobe returned through substitution, only the delivery instruction
is required, and the tri-party agent’s system is able toperform the necessary logistics, pulling the security back andsubstituting it with cash (or another eligible security) without
unwinding the trade, which would necessitate additionalliquidity.
3.	The main disadvantages for tri-party include less control over
specific collateral types and rigid adherence to the tri-party
settlement schedule. Collateral is given up to the tri-party
agent who facilitates the clearing and settlement of the
trade. Given the number of CUSIPs that flow through tri-party
clearing banks, tri-party repo requires strict schedules in thetiming of unwinds and cash payments.

19 | A Focus on Repo Markets

52% of respondents anticipate doing more bilateral businessover the next 12-18 months, but volume figures remain
infamously opaque.
1.	Bilateral is a more bespoke process, providing the ability tochoose collateral by CUSIP. Interviewed dealers, specifically,
preferred the ability to choose collateral for reverse repo aswell as determine haircuts and maturity structures, which
can be customized between the two parties. Moreover, ourinterviews suggested that a material portion of bilateralvolume is driven by broker dealers looking for specificsecurities to close short positions (i.e., “specials”).
2.	Bilateral provides more flexibility in the timing of cash flows.
The return of cash on the maturity date can be earlier in the
day than with tri-party. Thus, if a market participant is time
sensitive, bilateral repo would be a preferred option.
3.	The disadvantage of bilateral is its significant operationalburden. The manual nature of collateral value calculations
and cumbersome operational CUSIP identification requiresignificant time and overhead. This manual process makes
substitutions more difficult and requires a full unwind of
the trade. These disadvantages continue to present a cost
to dealers as well as a barrier to entry for some market
participants.
Client to client strategies in the bilateral market may eventuallydisintermediate primary dealers; however, adoption of thesestrategies has been slow. Thus far, these transactions have only
been executed by the most mature market participants.36 Given
that most primary dealers typically finance their securities
through tri-party, dealer disintermediation would mean a movein relative volumes toward bilateral. However, to date, thistrend has been negligible, as sourcing the right collateral andappropriate counterparty has significant hurdles.

Market participants expect GCF volumes to remain flat tomoderately down in the short term, with 38% expecting adecline in volumes. GCF repo comprises a small subset of therepo market, as it is a dealer to dealer clearing platform. GCF
processes roughly $200 to $235 billion of Fed-eligible collateralin net repo transactions daily, placing GCF transactions at 5% of
the roughly $3.7 trillion US repo market.37 GCF volumes dropped
nearly 33% over the past 5 years, which we believe is driven by
the broader reduction in dealer balance sheets. Similar to triparty repo, we expect GCF volumes to experience declines, as
G-SIB capital constraints further affects their use of repo.
In addition to impacting absolute and relative volumes, postCrisis, the profitability equation for broker dealers is more
complicated as a result of reform and regulation. Specificallyfor repo transactions, the introduction of leverage based capital(SLR) and liquidity measures (LCR, NSFR) to the profitability/
financing equation means that profitability is more nuanced
than before reform. For example, increased capital requirements
mandate larger capital bases, as these companies becomesafer, financial markets will likely require lower costs of funding.
While Tri-party Reform did not affect capital requirements,
it simplified the trading day for repo users by mitigating
operational burdens. Increased costs of liquidity, as secured
intraday credit was capped, nonetheless, give Tri-party Reform
an inconclusive effect on repo user profitability. Despite thesenuances, surveyed market participants (56%) agree that
repo profitability is under significant pressure from capitalconstraints.

20 | A Focus on Repo Markets

PROFITABILITY
CapitalRequirement

Risk Appetite

Reliance on
WholesaleFunding

Cost of Funding

Cost of
Operations2RoE

Tri-party Reform

=

=

+/-

=

=

+/-

SLR/ eSLR

+

+

=

+/-

=

+/-

Basel III: LCR/
NSFR

+

-

-

+

+/-

-

Regulatory
Changes1

n (+) Increasing Effect n (-) Decreasing Effectn (=) Not Affectedn (+/-) Affected Inconclusively
Source: “Overview of the potential implications of regulatory measures for banks’ business models”; European Banking Authority; 09 Feb 2015 and PwC Analysis38(1) For costs, a positive sign denotes a decrease (e.g. a lower cost of funding or lower cost of operations), for all others a positive sign denotes an increase in theflow or ratio(2) Excludes the cost of implementing the regulatory measures“Requiring that banks hold much higher capital andliquidity and rely less on wholesale short-term debt
has raised funding costs. Regulation has also raised
the cost of funding inventories through repurchaseagreement (repo markets). Thus, regulation may havemade market making less attractive to banks.”- Governor Jerome H. Powell, Federal Reserve
Board Governor, August 3, 201539

THE FED’S RRP FACILITY & THE
INCREASED DEMAND FOR HQLA

While there has been a reduction in dealer leverage andcollateral provided to the market, the buy-side remains awash
with cash after the easing of recent years, creating concerns
about the availability of collateral available for repo. The Fed’s
RRP facility mitigates these concerns by supplying collateral,
predominantly to money market funds. Additional reforms,
however, affecting cash investors, specifically Money Market
Reform, risk disrupting what most feel is a tenuous balance. In
this section, we review these important dynamics
and expectations for market participants in the near to
medium term.

21 | A Focus on Repo Markets

U.S. TRI-PARTY REPO COLLATERAL VALUE ($B)

$1,716$1,804$1,591$1,608$1,591$1,608

2013

2014

2015

2013

2014

2015

$1,716$1,500$1,000$1,000
$500

$500
0

2012
Source:0 NewYorkFed.org

2012
Source: NewYorkFed.org

TRI-PARTY REPO VOLUMES G-SIBS & THE FED VS.
NON-GSIBS
100%

TRI-PARTY REPO VOLUMES G-SIBS & THE FED VS.
NON-GSIBS
80%
100%
60%
80%
40%
60%
20%

2
20
13
il
20
Ju 13
ly
20
13
Oc
t2
0
Ja 13
n
20
14
Ap
ril
20
Ju 14
ly
20
14
Oc
t2
0
Ja 14
n
20
15
Ap
ril
20
15

Ja
n

Ap
r

2

01

01

Oc
t2

20
12

ly
2

Ju

Ap
r

Ja
n

20%

il

20
12

40%
0

G-SIB
Source: BNY Mellon

22 | A Focus on Repo Markets

FED

Non G-SIB

FED

Non G-SIB

01
3
Oc
t2
0
Ja 13
n
20
14
Ap
ril
20
Ju 14
ly
20
14
Oc
t2
0
Ja 14
n
20
15
Ap
ril
20
15

20
13

ly
2

ril

n

Ja

Ap

Source: BNY Mellon

Ju

2
20
13

01

2
01

G-SIB

Oc
t2

ly
2

Ju

Ap

ril

20
12

0

20
12

The Fed’s activity in the tri-party repo market increases at quarterends (both overnight and term) as non-U.S. G-SIBs restrict activity
for reporting. While seemingly a nuance in the definition, the Basel
III leverage ratio calculates its denominator based on the quarterly
average month end totals of on-balance sheet assets. The U.S.
eSLR, however, also requires quarterly reporting, but on a daily
average basis of on-balance sheet assets, and off-balance sheet
items use month end averages. As might be expected, the effectof these different calculations places considerable pressure on
the distribution of quarter end collateral. As shown in the graphon page 23, the take up of the Fed’s RRP facility at quarter ends
greatly exceeds its intra-quarter volumes.

$1,804$2,000$1,500nCash investors, largely buy-side investors, and other approved
counterparties (banks, GSEs, etc.) are able to turn to the Fed’s RRP
facility, which provides both a return on cash invested and theability to reverse repo against a zero risk weighted counterparty.42
Structured as a daily auction, participants can submit one bid
to the FRBNY’s Open Market Trading Desk with a minimum of $1
million and a maximum of $30 billion (and an indicative interestrate). Bids are pooled together and interest rates determined bya daily auction, with lower interest rate bids given priority accessto the $300 billion daily pool. Currently, the daily limit is $300
billion. Additionally, the Federal Open Market Committee (FOMC)
uses term RRP operations as an additional supplementary federal
funds policy tool, typically at quarter ends. Size limits for term RRP
operations are determined on a case by case basis, but have ahistorical take-up of $200-250 billion.43$2,000U.S. TRI-PARTY REPO COLLATERAL VALUE ($B)

Ja

A. THE CASH-COLLATERAL CONCERN
Through the recent past, the Fed intermittently provided aliquidity buffer to tri-party markets. From 2008-2010, the
FRBNY established the Primary Dealer Credit Facility (PDCF)
and the Term Securities Lending Facility (TSLF) for times ofmarket stress, which served as a cushion to the tri-party repo
infrastructure. In this capacity, the Fed was, indeed, the “lenderof last resort”40 to tri-party repo. Subsequent to the PDCF and
TSLF, the Fed’s RRP facility went online in September 2013 “asa supplementary policy tool to help control the federal funds
rate.”41 Since its inception, the RRP has been the most significant
change in the mix of tri-party market participants, filling muchof the volumes forgone by primary dealers. While repo markets
show material declines from 2012-2015 (as G-SIBs prepared forleverage and liquidity ratios), non-Fed tri-party volumes dropped
by a larger degree of magnitude with the Fed stepping in to
replace lost volumes and control short term rates.

BNY MELLON DAILY TRI-PARTY VOLUMES BY REGION
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

1/2/2014

4/2/2014

7/2/2014

10/2/2014
APAC

Non SIBThrough the RRP facility, the Fed established a tool to manage
the short end rate environment. Without the RRP, excess
cash would most likely put downward pressure on short term
rates, effectively turning rates negative. As the Fed considers
its first rate increase since the Crisis, it has stated a desire
to raise short term rates while keeping long term rates low,which will likely put increased reliance on the RRP. In June
2015, the Fed announced it would “allow aggregate capacityof the ON RRP facility to be temporarily elevated to support
policy implementation and will use other tools, such as term
operations, as necessary.”44
The Fed’s RRP facility, however, provides more to markets thanmanaging front end rates, it gives the Fed a tool to address thecollateral challenge.45 Decreases in broker dealer repo volumes,
excess cash with the buy side, and Money Market Reform(described in the subsequent section) suggest that the Fed mayneed to maintain and/ or provide additional collateral to market
participants over the short to medium term. The Fed’s current
balance sheet is around $4.5 trillion in assets,46 which suggeststhat the RRP facility could have room to grow.

US

1/2/2015

4/2/2015

EU

Fed RRP Facility

7/2/2015

10/2/2015

There is consensus among market participants that the RRP
will continue to play a steady role in the market moving forward
and could even increase in size. Interviewed repo users believethat short term repo usage and regulatory trends provide little
opportunity to wind down the program. In our survey, 56% ofparticipants expect rate normalization to have no impact on triparty volumes, and roughly a third (35%) expect repo volumes toincrease as a result.47
B. MONEY MARKETS & THE BIFURCATION OF COLLATERAL
While the majority of post-Crisis press coverage and regulation
focused on banking organizations, the Crisis also brought
to light risks of the buy-side, which are being addressed byregulators. The most notable illustration of buy-side risks was
the $62 billion Reserve Primary Fund “breaking the buck” (i.e.,
when its net asset value fell below $1), and the subsequent
run on seemingly safe investments. In 2010, the U.S. Securities
and Exchange Commission (SEC) implemented rules for money
market funds through Rule 2a-7. Initial SEC rulings requiredmoney market funds to reduce the weighted average portfolio
maturity to less than 60 days and applied more stringent
restrictions on credit rating allocations. In addition, regulation

23 | A Focus on Repo Markets

applied daily and weekly mandates on liquidity as well as
restrictions on credit terms, diversification of securities,
operational enhancements (e.g., stress testing), and reporting
requirements. The SEC proposed further amendments in 2014,
adopting improvements to Rule 2a-7, which will come into effectin October 2016. These included floating net asset values (NAVs),
liquidity fees, and redemption gates. For the repo market, thenew definitions for government and institutional prime money
market funds will have a fundamental impact on how funds
structure themselves and the collateral acquired throughrepurchase agreements. Government funds will be able to havea stable NAV (as opposed to institutional prime funds that are
required to maintain a floating NAV) and will not be subject
to liquidity fees and redemption gates. Generally, these terms
make government funds more attractive to investors.
Investments currently in institutional prime funds will be
re-designated to government funds, bifurcating the market
for collateral and creating additional demand for government
securities. For cash investors in repo, Money Market Reform willlead to significant changes in the choices fund companies offer.
Many fund companies already announced product offerings
for new government funds as well as conversions of existing
funds from prime to government.48 The industry belief is thatmost institutions would prefer a stable NAV albeit with a lower
yield compared to incrementally higher yields and a floating
share price. As a result, we expect Rule 2a-7 to remove funding
from the market for non-government securities while further
saturating the cash supply in government security financing,leading to potential imbalances in both markets. Over half (58%)

of those surveyed see Money Market Reforms decreasing overallliquidity to the market, and 49% believe these reforms havedecreased the availability of HQLA. Additionally, some estimatethat $1 trillion in assets could move to government securities.49
If migration to government funds becomes significant, thenfurther demand for HQLA may push repo rates negative, making
government assistance through the RRP even more imperative
to control short end rates.
Money Market funds are already the largest counterparties of
the RRP, suggesting that the relationships and infrastructure
exist for further reliance as assets shift from prime togovernment funds. As of Q2 2015, 90% of the take up of bids
for the RRP facility came from money market funds. Money
market funds seek repo collateral from the RRP, as it is both asound counterparty for investments and a provider of short term
(overnight) liquidity. Many funds require overnight investments
to address possible redemption requests and SEC liquidity
restrictions; however, their traditional repo counterparties are
funding more in term investments to mitigate balance sheet
costs and implications of the NSFR. Additionally, money markets
can only invest with rated counterparties, which further limits
the supply of collateral and number of counterparties available.
Over the past couple years, this symbiotic relationship has
become more well-established, with the RRP continually adding
new reverse repo counterparties. As such, we expect an evengreater reliance on the Fed’s RRP facility to provide liquidity anda source of portfolio returns as the money market industry takes
on reform of its own.

TAKE-UP BY THE FED’S RRP FACILITY (OVERNIGHT)
$350
$300
$250
$200
$150
$100
$50
$0

9/24/2013
Banks

12/24/2013

3/24/2014

Government-Sponsored Enterprise (GSEs)

6/24/2014
MMFs

Primary Dealers

24 | A Focus on Repo Markets

9/24/201412/24/2014

3/24/2015

Source: Federal Reserve Bank NY

INEVITABILITY OF CLEAREDREPO SOLUTIONS

believe that repo rates and spreads will need to increasesignificantly to make an acceptable return on capital.

Like most members of the financial community, repo
participants are optimistic that post-Crisis challenges
are drawing to a close, regulations are nearing complete
implementation, and the next wave of industry change will
be market driven. As repo market participants emerge withstronger clearing and settlement processes and compliant
with the new reforms and regulations, finding ways to increase
profitability in the new environment is at the forefront of theiragendas. Repo’s traditional low risk/ high leverage structure
makes change impacting the bottom line most likely to come in
the form of a unique cleared repo solution for the U.S. market.
G-SIBs look to such a solution as the most likely path to shrink
balance sheets, reduce capital, and/ or, perhaps, to increase
repo volumes without changing allocated capital. Moreover, in
the absence of a clearing solution (and if leverage based capitalis directly allocated to the repo desk), interviewed participants

The overwhelming majority of market participants interviewed
and surveyed (77%) believe the US repo market would benefit
from an increased availability of CCP services. With increased
balance sheet restrictions, netting has become a significant
value proposition for G-SIBs, giving them the ability to reduce
exposures and improve portfolio liquidity especially under stressconditions.50 Our surveyed market participants provided input
on the services of a CCP through their knowledge of the U.S. GCF
CCP platform. Netting was favored by a third (33%) of surveyed
market participants as the most value added service that a
CCP could provide. Additionally, 32% believed an increased
participant base would improve the current GCF CCP model.
Finally, many also expect a CCP to increase market stability by
mitigating fire sales and by offering services such as uniform
haircuts and better transparency of price and counterparty
exposures.

Somewhat
Disagree
5%77% of surveyed participants believe
repo market would benefit from anincreased availability of CCP services
over the next 3-5 years.

Strongly
Disagree
2%

Neither Agreenor Disagree
16%Strongly Agree37%

Somewhat Agree40%

25 | A Focus on Repo Markets

Given the needs of the market, a CCP could have been an organic
outcome, so why has one not emerged? We see three reasons
behind the absence of a CCP in the U.S. market:
1.	Lack of incentive for market participants. Before leverage
restrictions, there was little opportunity cost associatedwith expanding balance sheets; hence, dealers lacked acuteincentive to seek out relief from netting. Also, post-Crisis,
the aforementioned reforms and regulations required thetime and resources of the majority of repo participants.
Additionally, U.S. buy-side firms are necessary to expand the
cash base for a cleared repo solution. Potential cleared repo
providers have only recently become amenable to finding
solutions for buy-side mutualized loss restrictions.
2.	Lack of incentive for cleared repo providers. Launching acleared repo platform involves a centralization of risks that
requires sophisticated understanding and metrics. Withhigh barriers to entry, most institutions lack the regulatory
credibility, industry relationships, and risk management
capabilities to provide the services needed for cleared repo.
Pre-Crisis, the services of a CCP were more of an added
benefit, and the substitute of leverage was easily available tomarket participants.
3.	Potentially limited collateral base. To be viable commercial
ventures, clearinghouses require standards-based
calculations for haircuts and initial margin. Costs may beprohibitively high for cleared repo of less liquid asset classes,
as standards based (i.e., VaR) calculations of initial margin
could prove uneconomical compared to market based triparty or bilateral haircuts.
A unique cleared repo solution is a growing industry imperative,
leading market participants to search for viable commercial
clearinghouse models. Multiple global clearinghouses are
exploring models for the U.S. market.51 Some potential
providers are engaging regulators to look at the structure andrisk profiles of proposed CCPs, focusing on their ability towithstand a stress event. Costs associated with protecting a
CCP from such an event, nevertheless, make this business lesseconomically viable. Specifically, if the costs of contributing toa default fund outweigh the commercial benefits of netting, themembers of a CCP may not be compelled to participate. In thefollowing sections, we explore this as well as the advantages
and disadvantages to market participants of a unique cleared
repo solution emerging in the U.S. and cleared repo’s potential
to address fire sale risk. We raise key questions and briefly
discuss what the U.S. repo market will look like with a cleared
repo solution. Finally, we introduce the concept of “collateralconnectivity,” which, we believe, will ultimately help the global
market resolve its collateral challenges.
A. THE BUY-SIDE IMPERATIVE
The increased importance of cleared repo to the U.S. market
centers on the benefits of netting to minimize leverage andcapital costs. To expand the pool of available cash, the market
needs to develop a cleared solution that allows for both buy
and sell-side participation; however, the benefits of netting
to the buy-side are not as significant. Buy-side participationis necessary, nonetheless, because the bulk of dealers’
repo activities involve supplying collateral to the market. As
such, buy-side participation is viewed uniformly by market
participants as the logical and intuitive way to expand available
liquidity and increase netting.
A CCP structure, however, faces some buy-side challenges:
first in attracting participants, then in providing the necessary
features to encourage participation. That is, attracting thebuy-side requires appropriate value propositions. Principally,
propositions include: (1) appropriate risk sharing, (2) increased
collateral availability, (3) decreased liquidation risk, and (4)flexibility around timing of cash flows.
1.	Appropriate risk sharing. There is little overt economic
value to a buy-side firm being a full CCP member given they
do not receive the same benefits from netting as G-SIBs.
Additionally, many buy-side firms are restricted fromparticipating in mutualized risk models due to covenants.
Furthermore, as the provider of cash, the buy-side brings
little to no risk to the table compared to a levered collateralprovider. Potential solutions involving a tiered membership
structure with appropriate risk sharing and limited liability tocash providers would make CCP membership more attractive.

26 | A Focus on Repo Markets

2.	Increased collateral availability. Declines in industry leverage
have materially reduced collateral available to cash investors(as addressed in the RRP section). Cleared repo has thepotential to increase the available collateral through two
effects. Firstly, G-SIBs will feel balance sheet relief throughnetting, which will allow allocated capital to more efficiently
support repo volumes. Secondly, an expanded cleared repo
offering may attract some traditional bilateral volumes withthe ease of sourcing collateral, increasing visibility into
collateral in the system.
3.	Decreased liquidation risk. A benefit to some buy-side
participants is the decreased risk of an immediate liquidationof a large amount of collateral resulting in a fire sale. Other
participants, however, would value the opportunity toliquidate collateral in trades given that most repo is highquality collateral that appreciates in crises. Mutual funds rely
heavily on providing investors with liquid assets and a stable
NAV. Any collateral accepted via reverse repo into a fund’s

portfolio would contribute fundamental risk to the portfolio.
Hence, mitigating this risk is essential.
4.	Flexibility around timing of cash flows. With access to vast
amounts of collateral and cash, a CCP could provide more
flexibility around timing to cash investors. The importanceof the timing of cash flows extends to returning cash toinvestors.
	The unique features of the U.S. market require formal stayprovisions. These will likely be necessary to give a CCP
adequate time to liquidate trades and return cash to thebuy-side. Buy-side funds, however, require highly liquid
instruments that must be able to meet withdrawal requests
on a daily basis. Extended liquidation periods increase thechance of a run in these markets. As such, initial proposals forformal stays have had lukewarm reception from the buy-side,
but shortening the liquidation window is a key – and most feela surmountable – hurdle for buy-side participation in a CCP.

WHO WOULD YOU EXPECT TO BECOME MEMBERS IN A CCP?
100%

82%

80%
60%

53%

44%

47%
32%

40%
20%
0%

Money Market
Funds

Real Estate
Investment Trusts(REITs)Hedge Funds“...82% of surveyed market
participants expecting money
market funds to become membersof a CCP.”

Pension Funds

Sovereign Wealth
Funds

14%
Other

	Provisions concerning appropriate risk sharing, specifically
via liquidation stays, received resistance from the buy-side
and are currently being revisited. Market participants expect
cleared repo providers to reach solutions to these issues,
with 82% of surveyed market participants expecting money
market funds to become members of a CCP.

27 | A Focus on Repo Markets

B.

FIRE SALE CONSIDERATIONS“Current reforms do not address the risk that a
dealer’s loss of access to tri-party repo funding could
precipitate destabilizing asset fire sales, whether by
the dealer itself, or by the dealer’s creditors following
a default.” - William C. Dudley, President and Chief
Executive Officer of the FRBNY, October 4, 201352
Fire sale proposals address the mitigation of fire sales both
pre and post dealer default. Pre-default fire sales are definedby the FRBNY as a dealer’s “loss of access to secured funding”
requiring the dealer to sell assets, while post-default fire sales
are defined as the rapid sale of collateral by counterparties
following a dealer default.53 Proposals to mitigate fire salerisk pre-default include laddered term funding, which would
spread the risk of larger repo transaction out over smaller
denominations and set maturity out over consecutive dates.
Proposals also include providing for access to both regular andemergency “lending authorities” such as the discount window
and the PDCF. Post-default fire sales proposals provide forliquidation rules, sources of liquidity, and allocation of possible
losses. While regulators have said that the creation of an entity
to provide these services may not be required, we believe aunique cleared repo solution would be in the best position toprovide these services to the market.
A cleared repo solution would be in the unique position to provide“collective action”54 to dealers and their counterparties in both
pre and post-default fire sale situation. Interviewed market
participants felt with near unanimity that an expansion ofcleared repo in the U.S., if adequately margined and capitalized,
would be the most effective way to address fire sale risk. With afocus on collateral, a CCP could address the initial issues related
to a fire sale by mediating the preemptive and future risks to the
cash lender and collateral provider.

Post-default, a CCP utility would also be in the systemicallyimportant position of managing the organized liquidation ofcollateral of a market participant default as well as absorbing
any losses through its waterfall structure. As a member of a
CCP, each investor would share in the mutualization of risk andlosses and hence, the CCP would act as a liquidity buffer intimes of market stress. Through an organized sale of depressedcollateral, the CCP would absorb cash investors’ losses andfacilitate auto-substitution through a clearing bank into a
non-defaulting member’s account. Additionally, this waterfall
structure would function through a participant-funded default
fund, which would further help to mitigate losses.
Pre and post dealer default terms and “collective action”
measures of a clearinghouse is not a fait accompli. A cleared
repo solution should also require a continuous analysis of
the risk of each asset class allowed on the CCP platform. One
benefit of the repo market is that it is predominantly comprisedof Treasury and agency securities, which are liquid, low risk, and,most importantly, tend to be negatively correlated with otherasset classes in times of stress. Thus, incorporating a majorityof these assets would not only provide alternative sources offunding or securities to auto-substitute in times of stress, butalso they would provide stability to the CCP.
C. POTENTIAL MARKETPLACE STRUCTURE
Infrastructure providers and market participants seek a broad
range of solutions from deciding which products and services
will initially be launched to how the industry will eventuallymature. Adding complexity to the mix, multiple market
participants are looking to offer cleared repo solutions. While
the market will likely evolve towards an optimal cleared repo
structure over time, open questions remain regarding what thestructure will look like now, as it evolves, and as regulators andmarket participants adapt.

28 | A Focus on Repo Markets

Questions regarding market entrants and products
1.	How many platforms will be launched? Several existing
service providers, across markets are exploring either
expanding existing services (e.g., GCF) or launching new
platforms in the U.S. in 2016. With the potential for multiple
clearing platforms to emerge, the market may become
overcrowded. It should be noted, however, that while CCPs
segmented by collateral pools would provide benefits
in terms of diversification of risks, multiple CCPs may
diminish the economies of scale of both cost and netting –the principal value propositions of a CCP. In the long term,
we expect the industry to consolidate into two or threeplatforms.
2.	What products will they clear? Many feel that cleared repo
should initially trade in only Fedwire securities, leaving large
collateral pools of corporate bonds and mortgage backed
assets in the tri-party and bilateral repo markets. Equity
clearing as a singular cleared repo asset class is emerging
as well; however, volumes in this market are much smaller
than government securities.55 As such, we anticipate that
initial cleared repo platforms will be narrowly focused or evenasset class specific and will potentially later evolve to clear
across the asset class spectrum via a pure central clearing
counterparty.
3.	How will they be structured? There are a variety of CCP
structures being utilized today in different markets – fromliquidity agent to fully novated counterparty. Among the
known potential cleared repo providers, GCF proposed
an expansion of its existing service to include buy-side
members, while other platforms are reviewing their proposed
structures with U.S. regulators.56 With that said, users of repo
will potentially be drawn to different structures by participant
types (e.g., G-SIBs, other broker dealers, Money Markets, etc.)
according to their specific needs. Cleared repo platforms,
therefore, will be keen to develop services suitable to various
participant types (and not just collateral types).
Questions regarding services and service providers
4.	What services will they provide? In a pure CCP, the services
should include: risk management, netting, default funds,

100% principal guarantees, coordinated transfers andsettlement with a clearing bank, general electronic
counterparty ledger, bespoke haircuts, and collateralclassifications. While there are existing tri-party agent
services that will naturally be leveraged by a CCP, it is also
possible that a clearinghouse may expand services into
existing tri-party offerings such as clearing, settlement, andcollateral optimization.
5.	What is the existing tri-party service providers’ role inthis new marketplace? With the world’s largest tri-party
platforms, clearing banks could become a natural part of thecleared repo infrastructure. There are operational advantages
within tri-party that can be applied to a CCP model such as:
high speed margining, asset valuation and asset mobilization.
In addition, mature trade pairing, which rests within the triparty infrastructure, further augments the netting process.
As capital markets businesses become better collateralized,
the need for collateral pooling and optimized collateralmanagement increases. Coordination with a tri-party agent
to provide collateral optimization services would help
differentiate the services of a CCP by providing additionalrelief to broker dealer’s cost of capital.
Question regarding regulation
6.	Finally, how will regulators deal with concentration and otherrisks created by CCPs? A CCP derives the vast majority of its
risk through its counterparties and the assets provided ascollateral. Mitigating factors to these risks would include
analyzing correlations between the pools of collateral held,
netting benefits, and portfolio diversification benefits. A
significant amount of focus has been given to counterparty
risk; however, concentration and fire sale risk are also
considerations for the collateral being margined. Focus
should be given toward a risk-weighted collateral-driven
model, with margin adequately accounting for the possibility
that in a liquidation scenario the cash investor would notreceive the full value of the repo collateral. Moreover, in an
ideal state, participants in the market should understandtheir risk from both the perspective of the effort and time ittakes for collateral to be converted into cash as well as fromthe counterparty.

29 | A Focus on Repo Markets

As the market evolves past the 3-5 year mark, we expect the
majority of the aforementioned questions to be resolved. In
resolving these questions, users of repo may look to placefurther demands on infrastructure providers to help facilitate
the sourcing and movement of collateral.
D. COLLATERAL CONNECTIVITY
With Tri-party Reform, we saw a more efficient movement ofcash, but with greater demands being placed on collateral,
there is an increased need for its efficient movement between
providers and users across platforms and geographies.
Collateral connectivity will likely come in two phases. The firstphase will require an aggregation of collateral pools to view thecollateral available, and the second phase will involve linking
ICSDs for the movement of collateral between platforms. In thetarget state, a cash investor or collateral provider would have aholistic view of cash or assets available for repurchase across
ICSDs, geographies, and legal entities. Through linked systems,
the cash investor or collateral provider would be able to reachin and have access to an available pool of global collateral
as well as the ability to mobilize it and use it among different
products. To facilitate the efficient and effective movement of

HIGHLIGHT:
THE BENEFITSOF COLLATERALOPTIMIZATIONTECHNOLOGIESGiven the scarcity of HQLA
in the marketplace, thebenefits of financial
technology in collateralmanagement are becoming
more sought after. 70% of
market participants surveyed
expect a further shortageof HQLA over the next
12-18 months.

collateral, technology systems and bridges should be put inplace, risk management protocols will need to be agreed uponand standardized, and new processes and personnel will needto adapt to a common framework.
Longer term, we believe linkages and movement between
collateral pools will become essential to the wholesale funding
markets and broader financial system. Regulators’ push toclear transactions with some asset classes (e.g., swaps) may
be felt in the repo market if a centralized, risk-driven model
doesn’t develop through market participant initiatives. A fearof concentration risk would make it more likely that more than
one cleared repo solution will ultimately be successful in the US
market. As mentioned though, the existence of multiple CCPs
reduces the netting benefits through diminished economies ofscale. Because of this, longer term, we expect the market willdevelop solutions across cleared repo platforms (e.g., crossproduct and cross platform netting). These solutions will require
even greater collateral visibility and mobility, making the ability
to seamlessly move collateral from one account to another,across collateral pools and geographies, and at any point in timea key development in the next generation of the repo markets.

The tri-party mechanism provides
operational support for dealers incollateral transactions. Collateral
optimization opportunities provided
by tri-party agents help minimize
balance sheet usage. Although difficult
to quantify, the growth of collateralmanagement will boost familiarity withand demand for tri-party repo services,
furthering the value proposition of triparty repo and supporting its volumes.
Collateral optimization involves anefficient and cost effective use of assets
without impacting the balance sheet.
Given the demand for HQLA in themarketplace, financial technology incollateral management will further help
to optimize the balance sheet. With many
dealers realizing the limitations placedby regulations, optimizing balance sheet
collateral will help to alleviate some ofthe pressure on the repo market and
30 | A Focus on Repo Markets

this fundamental source of funding.
Collateral optimization facilitates a more
efficient and timely method of allocating
collateral to trades. Additionally, it takes
into consideration business preferences,changing market conditions, cost of
carry, and cross-margin to optimize
the portfolios of market participants.
Moreover, significant economic savings
can be achieved with lower funding costs
and reduced balance sheet collateralrequired. Less collateral can also be
required to receive the same amount offunding, additional, high quality collateralcan be deployed for other uses within thecompany, and automating the allocation
process frees up human resources tofocus on higher value-added activities
within the organization. There is little
downside to the development of thistechnology, which is likely to support
not only tri-party services but also theindustry’s evolution into cleared repo.

#
3

CHAPTERTITLE
PRIORITIESFORMARKET PARTICIPANTS

While reform and regulation will continue to affect the market,
firms must also understand market driven changes – suchas cleared repo – to refresh their strategies around repo andremain competitive. Reviewing the following four priorities
should be a beneficial exercise to help market participants
better understand, prepare for and coordinate their goals
regarding the market changes discussed in this paper.

UNDERSTAND THE CURRENT ROLE
OF REPO IN YOUR ORGANIZATION

Given the changing economics of repo, some repo desks mayneed to be viewed as providing financing and liquidity for otherdesks instead of as stand-alone profit centers. Repo can be
profitable as a stand-alone asset class to the market, however,by one of two ways: growth as an industry or the creation ofcustomer value. As we have seen in our earlier discussions,the repo industry is no longer in a growth phase, so businesses
should focus on improving their value propositions while
managing costs to drive profitability. The creation of customer
value requires an understanding and careful managementof a customer’s willingness to pay versus its costs. Access tosophisticated tools such as auto-substitution and tri-party
collateral management mechanisms will likely also provide
for increased value. For cash investors, liquidity management
procedures and the management of the timing of cash flows
should be a focus to increase yield. Cash investors benefitted
from having a relatively risk free counterparty through the RRP
for the past few years. As interest rates normalize, yield andthe market supply of liquid collateral may be easier to comeby, but an early focus on efficiency, process and procedure
management should likely pay further dividends as theinvestment environment changes.

31 | A Focus on Repo Markets

ANALYZE THE INDUSTRYLANDSCAPE

While regulators maintain a neutral stance, repo faces thetangible prospect of regulated central clearing similar tothe swaps industry, which would likely significantly increase
the compliance and regulatory reporting burden on market
participants. Identifying obstacles and developing long termplans around compliance and regulatory concerns could
ensure that any forthcoming regulatory structure is proactively
managed and/ or mitigated. The more preemptive industry
participants are about managing risk and setting compliancegoals the stronger the social infrastructure becomes for theindustry and, in turn, less direct regulation could be necessary.
While industry participants may need to come together toprovide additional reform measures or a common dialogue tomitigate things such as fire sale risk, participants also need torecognize that they are doing their part to proactively strengthen
their firms internal risk and compliance policies and procedures.
Lastly, repo participants can engage in dialogues with regulatorsand other stakeholders to identify concerns and ultimately
shape the industry’s regulatory dialogue and potential future
requirements.
Industry trends and drivers could have competitive implications
to how market participants align themselves or respond to
threats. For example, the market could see disintermediation of
repo trading desks with the emergence of a CCP, with the buyside finding a natural platform to be able to transact with similar
entities. To continue to provide repo solutions, dealers could
look to optimize collateral posted in repo transactions to drive
profitability. As previously discussed, many expect cleared repo
to play an increasing role. With the potential emergence of acleared repo solution, market participants are now questioning
not only how they will respond, but also how their market peers
will respond. How much would a CCP rely on tri-party services?
How much will services be built in house or outsourced to
FinTech players?

CREATE A POTENTIAL FUTURE
STATE AROUND REPO

Integrating potential changes into future target operating
models requires a comprehensive assessment of one’s business,with repo collateral management becoming more refined andtechnology-driven. Even though repo could be viewed as a utility,
its ability to fill the gap of core activities across the spectrumof market participants will drive the industry toward stronger
proprietary risk management and collateral optimization models
associated with repo. For users of the tri-party settlement
mechanism, we anticipate technology to allow increased
functionality and provide a platform for repo that will become
more bespoke and similar to bilateral in nature. With cleared
repo solutions and the interconnectedness of technology andoperational platforms becoming more apparent, collateralmanagement and transparency are likely to become a focus formarket participants.
Many participants across various aspects of the value chain
are investing in new technologies and refining operational
processes, but these changes are far from complete.
Participants still see some systems as antiquated and in needof linkages with other platforms or industry participants. While
Tri-party Reform helped considerably to simplify the tri-party
settlement process, further action needs to be taken to makethe industry more transparent. Cleared repo is a step in theright direction, but ultimately, an understanding of collateralconnectivity and mobility will help industry participants create
collateral management roadmaps. These plans guide theimplementation of corporate strategy, ensuring repo is used
for its ideal purpose – efficiently filling the gaps in corporate
funding while minimizing both systematic and firm-specificrisks.

32 | A Focus on Repo Markets

ACHIEVE A COLLATERALMANAGEMENT ADVANTAGE

Firms have increased the sophistication and efficiency ofcollateral management; however, a comprehensive collateralmanagement roadmap can bring competitive advantages. A
roadmap should help firms be aware of and understand thegeneral expectations of other constituents. To help mitigate theeffects of LCR and NSFR, firms need to better understand thetypes of securities and transactions that are driving markets(i.e., what’s good collateral for a 30 or 60 day trade is not thesame as for a longer maturity trade). To address this, roadmaps
should include regulatory considerations (e.g., the potential
for more restrictive final rules of Basel ratios), potential
optimization challenges, an understanding of the impacts of
the Fed’s RRP program on a firm’s use of repo, and the potential
influence of centrally cleared repo.

Collateral management technology, operational processes,
and organizational structures are evolving to improve how
repo desks function and how tri-party agents service theirclients. These changes risk being myopic if they merely service
immediate client needs and demands. 78% of repo market
participants are looking for collateral optimization solutions.
These technologies need to evolve and be able to adapt toforward-looking market innovations. Collateral transformation,
trade optimization, and custom term repos (i.e., under one day)can be incorporated into a roadmap to provide user flexibility as
well as helping to further reduce risk to the market as a whole.
As we look to the future of repo, the location, mobility, andconnectivity of collateral will be a paramount concern acrossrepo participants. Overall, the evolution of these products andservices require robust collateral management process withsystems and analytics that are iterative and adaptable to a newand changing market structure.

33 | A Focus on Repo Markets

#4

CHAPTERREMARKS
CLOSING
TITLE

While post-Crisis reforms made tri-party repo safer, importantchanges face the industry and its participants. This paper
highlighted three of the most significant developments we
expect to come to pass: (1) pending regulations on repo users
will dampen repo volumes in the near term, most directly
through the allocation of capital and liquidity ratios to the desk
level; (2) the increased demand for HQLA and potential further
increase brought by Money Market Reform indicate that the
Fed will likely maintain the RRP facility for the foreseeable
future; and (3) expanding cleared repo services in the U.S. is now
considered an imperative given the need to address fire sale risk
and G-SIBs’ search for balance sheet relief.
Each of these developments raises multiple considerations
for market participants. The incentives in addressing these
considerations vary greatly across collateral providers, cash
investors, matched books, interdealer brokers, and regulators (e.g.,
netting is a driving concern for G-SIBs and of minimal importanceto money markets). This complex array of priorities increases theimportance of a comprehensive collateral roadmap to guide firm
strategy through interactions with market participants.
The change we see coming to the wholesale funding markets
and broader financial industry is profound. Institutions must

review their current position, understand the industry, revise
business and operating models, and organize collateralcapabilities around this changing environment. Regulation willcontinue to shape the safety of the markets, but we expect
a focus on collateral management and cleared repo to be at
the forefront of change, helping markets and clients alleviatepressures from risk, regulation, and operational burdens. In
closing, we believe repo participants should understand theconcept of collateral connectivity and the benefits that bothan integrated view of custody accounts and the ability to post
collateral across current boundaries (CSDs and countries) would
provide to their organizations. While development of thesecapabilities will likely be driven by institutions with material
global operations, we believe collateral connectivity is the mostnotable and identifiable long term trend in the repo market thatfirms should begin to understand and plan for now.
We hope this paper was insightful, and helped you, our clients,
colleagues, and repo market participants better understandthe changes coming to the industry. We thank PwC for theirinstrumental contribution to the production of this paper, andwe are grateful to our interviewed and surveyed colleagues fortheir invaluable time and insight.

34 | A Focus on Repo Markets

#5

CHAPTER TITLE
APPENDIXA SHORT ANALYSIS OF WHOLESALEFUNDING

While wholesale funding does not have standard definition, it
is broadly defined as the use of deposits, federal funds, andshort-term liabilities (e.g., repurchase agreements) to service
the financing, operational, risk or liquidity management needsof a bank or other financial institution.57 This type of funding
includes commercial paper, overnight and term repo, non-retailtime deposits, and interbank loans.58 The market segments
into either unsecured or secured funding. Unsecured funding(CDs, commercial paper, term, call and overnight deposits) is
typically across a term of up to one year;59 secured funding(repo and asset backed CP) is also short dated but seen in
longer maturities. Due largely to their short-term nature,these instruments provide flexible and affordable short-term
financing.
Banks and dealers rely on wholesale funding liquidity, but theimportance of this market to asset managers, corporates, hedge
funds, pension funds, and institutional investors among others
also remains significant. Cash investors use wholesale funding

instruments to gain yield on very short term investments, and,especially in the persistent low rate environment, their appetite
for these investments remains strong. For example, money
market funds invest generally across the spectrum of wholesalefunding given their investment mandates. While the different
types of wholesale funding share liquidity profiles and risks,
they are used for different purposes. Repo and CP are used tofinance broker dealer operations, but the decline in CP issuanceby financial firms has left repo as the material form of wholesalefunding used in financing broker dealer activities.
As now a material portion of wholesale funding, interbank
lending grew significantly since 2008 in volume due to theincrease in excess bank reserves. The interest rate on excess
reserves (IOER) provides a beneficial risk/reward profile fora large short term loans. It is important to note that excess
deposits at the Fed are included in SLR calculation as partof Tier 1 capital, so there is little incentive to deposit excess
reserves tied to Basel III or other regulation. Looking forward,
however, it is difficult to determine what reserves may flow into
other areas of wholesale funding and the impact this will have.

35 | A Focus on Repo Markets

U.S. REPO MARKET HISTORYIn the 1970s, the bilateral repo market introduced tri-party agentsto the bilateral repo trade to eliminate the “double” financing
charge imposed on dealers.60 Double charges occurred whensecurities pledged to a cash lender were returned too late in
the day to be redelivered as collateral to a new cash lender. At
this time, the trade settlement was a very manual process andsubject to high levels of operational risk. Following multiple dealer
defaults in the 80s, dealers approached the clearing banks for“safekeeping” arrangements, where the clearing bank acted as a
joint custodian (or limited agent for both parties in the repo). In thelate 1980s, the clearing banks made investments to automate thesettlement process and reduce risk.
From 2005 to 2008, new laws, the rise of prime brokerage
activity, and market participant activity contributed to thegrowth of tri-party repo. The Bankruptcy Abuse Prevention andConsumer Protection Act of 2005 expanded the exemption fromautomatic stay to a wider range of collateral to be used for repo
transactions. It is estimated that prime brokerage activity also
increased during this time and provided an efficient way forprime brokerage customers to finance against non-government
securities. In a response to an increased demand, clearing banks
invested in infrastructure advancements that allowed dealers
and cash investors to optimize their use of the platform.61
Throughout Tri-party Reform, clearing banks’ initiatives
phased in risk reduction initiatives through a series of further
operational and technology changes and improvements. The
clearing banks worked closely to coordinate with market
participants to complete the recommendations. In 2012, wereduced 15% of our risk by eliminating approximately $270
billion of exposure to the Depository Trust Company (DTC)
sourced collateral from unwinds and substitutions. In December
2013, we exceeded our 70% risk reduction goal, achieving
an 80+% risk reduction by eliminating exposures associatedwith FRBNY sourced collateral. And in May 2014, we exceeded
the 90% risk reduction goal set forth in the Target State andachieved 92-95% risk reduction, with the implementationof rolling settlements of GCF interbank collateral. Finally, as
of April 23, 2015, we fully transitioned to committed credit,
eliminating discretionary credit, and committed credit wascapped, thus achieving a 97% reduction in risk.
The U.S. repo market, as a whole, is currently estimated to bearound $3.7 trillion. The U.S. tri-party market was approximately$1.6 trillion as of June 2015,62 and the US bilateral repo market,
based on overall primary dealer volumes, was estimatedby the Federal Reserve to be around US$1.9 trillion as of
October 2014.63 On average, U.S. Treasuries and agency debt
comprise the majority of tri-party repo volumes (36% and 46%
respectively, over the past five years). Agency debentures andMBS shrank by approximately 25% (by $200 billion) over thisperiod. Equities have experienced the fastest growth rate, having
more than doubled (from $78 billion to $167 billion).

REPO PARTICIPANTS & SETTLEMENTMECHANISMS

At a high level, repo market participants can be segmented into
two major groups: collateral providers (cash borrowers) andcash investors (collateral takers). More diversified participants
can be classified as broker dealers/matched books whoboth invest and finance, interdealer brokers (IDBs) and theFederal Reserve. Banks and broker dealers use repo to financeinventories of their own securities as well as to provide on
demand liquidity to clients (e.g., corporates, pension funds,
high net worth individuals, etc.), facilitating market-making
purposes. Collateral providers use repo to finance short-term
funding gaps. Conversely, cash investors (e.g., mutual funds,
pension funds) look to invest cash and enhance returns on theirportfolios. IDBs typically broker transactions between cash
investors and collateral providers. Finally, the role of the Fed has
become substantial in the repo market through both overnight
and term RRP operations.

36 | A Focus on Repo Markets

THE REPO CONTINUUM

Bilateral
Repo

Tri-party
Repo–– GMRAs and CRMAs
DOCUMENTATIONTRADE EXECUTION–– Individual GMRAs–– Clearing bankagreements–– Collateral eligibility defined by cash lender–– Trade details: repo term, haircut, and interest charged

Clearing
House Lite–– GRMAs, clearing bankagreements

Centrally
Cleared
Repo–– Clearing house rules–– Membership agreements–– CCP membershipagreements–– Anonymous counterparty–– OTC platform–– Repo term and interest
determined by cash
lender–– Determined bycounterparties (e.g., tenorof trade)–– Collateral is restricted toFed-eligible securities–– Ability of the CCP toreliably price–– Netting of collateral andcash–– Netting of collateral and
cash

TRADE
CONFIRMATION–– Back offices confirm
to cash and collateralproviders–– Three-way deal matching

COLLATERALMANAGEMENT–– Substitution is allowed
but cumbersome–– Repos segregated until
unwindCLEARING /SETTLEMENT–– Counterparties executeon a Delivery vs. Payment(DvP) basis–– Clearing bank segregates securities, manages the transfer of cash/collateral andunwind–– Auto-substitution of collateral–– CCP hedges and canretain positions into the
future–– Cash lender must liquidate the collateral on the open
market–– Clearing house facilitatesliquidation–– Cash lender exposed to a loss if the haircut/ collateralincorrectly valued–– Participant-funded
default fund

RISK MANAGEMENT–– Cash/collateral providers
each responsible forcounterparty collateralmonitoring–– Clearing bank monitors
pledged collateral withdaily revaluations andmargin management–– Counterparty risk remains –– Trade novated by CCP,
between collateral
mitigating individual
provider and cash lendercounterparty risk

PARTICIPANTS–– Predominantly broker
dealers and their prime
brokerage (PB) clients–– Governments, broker
dealers (BDs), MMFs,
alternatives, corporates,
other financial
institutions–– Broker dealers & theirclients (PB clients) otherfinancial institutions,
MMFs, alternatives

LIQUIDATION

Repo settlement mechanisms can be looked at as a continuumof activity, with bilateral at one end of the spectrum, followed by
tri-party repo (clearing banks), then various “clearing house lite”
models, and finally, a pure CCP at the other end. This illustrates
the particular settlement mechanisms of the U.S. repo markets:bilateral and tri-party and the direction in which the market
is likely to evolve. Furthermore, the continuum shows thevalue chain of activities of repo from pre-trade documentationand settlement to post-trade processing and liquidation
management (in the case of default). The main function and–– Participant-funded
default fund–– Broker dealers &expanded clearing
house members (MMFs,
alternatives)

value proposition of tri-party agents is to coordinate settlement
between collateral providers and cash lenders. Furthermore, thetri-party agent maintains custody of the collateral securities,
processes payment and delivery between the cash borrower andthe cash investor as well as provides other services such as thesettlement of cash and securities, the independent valuationof collateral, and the optimization of collateral allocation. The
clearing house lite model provides risk mutualization and loss
waterfalls without full novation.

37 | A Focus on Repo Markets

#6

CHAPTER TITLEGLOSSARY

BNYM Repo Index: The indices represent a volume weighted
median of repo rates negotiated between cash and collateralproviders for the three largest tri-party asset classes. They
provide daily overnight interest rates on U.S. tri-party repo
transactions collateralized by U.S. Treasuries, agency mortgage
backed securities (agency MBS), and U.S. agency debt.64
Commercial Paper (CP): Commercial paper is an unsecured
debt instrument issued by corporations to help with shortterm financing needs. Short term financing typically includes
accounts receivable, inventories, and other short-term liabilities.
Maturities, correspondingly, are short term and generally lessthan 270 days.65
Fedwire Eligible: Fedwire is a payment and securities transfer
system operated by the United States Federal Reserve Banks,
where financial institutions can electronically transfer funds
among Fedwire participants.66 Fedwire eligible securities
are repo eligible securities for transactions with the Fed andinclude: U.S. Treasuries (and STRIPS), agency debt, agency MBS,and agency collateralized mortgage obligations (agency CMOs).67

Financial Commercial Paper: Commercial paper issued bydomestic and foreign firms including: financial companies,
banks, insurance, securities, and industrial firms.68
DTC Eligible: DTC Eligible refers to non-Fedwire eligible repothat can be transferred to or from the Depository Trust Company
into a repo allocation.69
DTC sourced collateral: This includes equities, municipal andcorporate bonds, commercial paper, asset-backed securities,
and non-agency mortgage-backed securities.
Delivery Repo: Repo transaction where collateral moves fromthe account of the seller into the buyer’s account. The collateralis under the buyer’s control for the term of the repo.70
General Collateral (GC) Repo: GC repo refers to transactions
where the repo seller has discretion on which collateral to deliver,with the buyer specifying only the general type (e.g., government
bonds). GC makes up the bulk of repo traded in the U.S. and isdriven by the need to borrow or lend cash rather than collateral.71

38 | A Focus on Repo Markets

General Collateral Finance (GCF): The GCF market is blindbrokered and solely trades with Fed-eligible collateral.
High Quality Liquid Assets (HQLA): Per Basel III, HQLA is defined
as “assets considered liquid in markets during times of stressand in most cases eligible for use in central bank operations.”
Furthermore, HQLA has been divided into two levels (the second
level having two additional sub levels) based on liquidity: level 1(cash, central bank reserves, sovereign-backed securities), level
2A (GSE debt, government securities, covered bonds, corporatedebt), and level 2B (MBS, equities, lower rated corporate debt).
Liquidity Coverage Ratio (LCR): The LCR requires that banks
must have enough liquid assets such that the LCR minimum
is ratio is 1 or 100%. This regulation ensures that banks havesufficient liquidity to survive a short term stress scenario lasting
one month. As such, banks are required to hold unencumberedhigh quality liquid assets. It is defined by HQLA divided by thenet cash outflow over a 30 day stress period.
Matched book: Matched book refers to the reverse-in of
securities and the simultaneous repo-out of the same securities
where the terms to maturity of the agreements are identical.72
Maturity mismatch: The use of short term/ overnight funding tofinance longer term assets.
Net Stable Funding Ratio (NSFR): The NSFR will look to ensurethat banks have sufficient stable funds to survive a long term
stress scenario lasting for 1 year. It is defined as the amountof Available Stable Funding divided by the amount of Required
Stable Funding. The ratio should be equal to at least 100%.
Non-Fedwire Eligible: Repo not eligible for transactions with
the Fedwire include ABS, private label CMOs, corporate debt,
equities, money market instruments, collateralized debt
obligations, international securities, municipal debt, andwhole loans.73
Nonfinancial Commercial Paper Issuers: Nonfinancial issuers
include public utilities, and industrial and service companies.74
Repurchase Agreement (repo transaction): Repos financeinventories, earn short term interest, provide necessary liquidity,
facilitate the movement of cash and securities, and service

other needs. Fundamentally, a repo transactions consists of asale of securities (i.e., the collateral) paired with an agreement
for the seller to buy back the securities (to “repurchase” them)from the buyer at a future time/ date.75 That is, a cash lenderprovides funds against collateral to a borrower who agrees torepurchase the assets plus interest at a confirmed later date.76
The interest rate on the transaction (also known as the reporate) is the spread between selling price and the repurchaseprice. Other terms of a repo transaction include: the collateral,the haircut (adjusted collateral value), the term or maturity date,
and the counterparty.
Specials: Repo collateral that rapidly gains in popularity anddrops in yield as a result. This occurs when the repo transaction
is driven by a need to borrow a certain type of collateral rather
than gain a return on cash invested.77
Supplementary Leverage Ratio (SLR): The SLR (and eSLR)
requires the largest banking organizations to hold more Tier 1
capital, particularly to support leverage and off-balance sheet
exposures, which may pose greater risks during periods ofstress. It is defined by Tier 1 capital divided by total leverage
exposure. The eSLR is applicable to U.S. based Systemically
Important Financial Institutions (SIFI) and requires SIFI banks tomaintain a buffer on top of the SLR of more than 2%; hence, thisrequires SIFIs to maintain an SLR in excess of 5%.78
Term Repo: A term repo contract extends beyond one day, andhas been a more favored product as banks and large dealers
look to spread their funding risk over longer time periods.79
Time horizon: Short term is defined as less than 18 months;
medium term is defined as 18 months to 3 years; and long-term
as greater than 3 years.
Tri-party agent: A tri-party agent performs post-trade
processing for tri-party repo transactions, which typically
includes: collateral selection, settlement, payment processing
and custody.80
Overnight Repo: An overnight repo agreement consists of a
1-day tenure, where cash is lent out overnight and repaid (withinterest) the following day. While cheaper than term repo, it
exposes borrowers to the risk of not being able to financethemselves in times of market or firm-specific stress.

39 | A Focus on Repo Markets

1	Please note that JPMorgan Chase completed their secured intraday credit risk reduction and capped credit facilities goal (excluding GCF) as of March 2014.
“Tri-Party Repo Infrastructure Reform.” NewYorkFed.org. Federal Reserve Bank of New York. Web. November 2015.

2

	The key objective of the research conducted by BNY Mellon was to gauge the opinions of senior wholesale funding industry leaders on the possible future shape of
the U.S. wholesale funding industry. The themes included were: repo market trends, current market risks, data and analytics, liquidity, central clearing, industry/market reforms, fire sales, and market disruptions. BNY Mellon’s Market Research & Client Insight group distributed and analyzed this survey. The survey wasdeveloped in collaboration with PwC subject matter experts. The target population was senior heads of repo desks and of institutions across the wholesalefunding landscape. A total of 57 surveys were completed from senior respondents across cash investors, collateral providers, matched book intermediaries, andadvisors, with average repo books ranging from less than $10B to greater than US$100B. The survey was live during a four week period from August 5th to August
31st 2015.

3

	We refer to all national/ regional implementations generally as the SLR. Where appropriate, we refer to the U.S. final rule as the eSLR while other national
implementations retain the SLR designation.

4

	The majority of oversite of the repo industry (including the implementation of the Reverse Repurchase facility) has been conducted through the Federal Reserve
Bank of New York; however, we use a more general term to account for influence from other parts of the Federal Reserve System.

5

	“Collateral Management: A Review of Market Issues.” BNYMellon.com. BNY Mellon, October 2015. Web. November 2015.

6	GCF integration with the full tri-party repo settlement process also remains incomplete according to the reform proposals laid out by the Task Force. “Update on
Tri-Party Repo Infrastructure Reform.” NewYorkFed.org. Federal Reserve Bank of New York. Web. November 2015.

7	“Netting Definition.” investopedia.com. Investopedia, 24 November 2003. Web. 19 November 2015.

8	Includes trading revenue for all US and EU G-SIBs (excluding State Street and BNY Mellon). Source: Capital IQ

9	Adrian, Tobias, Karin Kimbrough, and Dina Marchioni. “The Federal Reserve’s Commercial Paper Funding Facility.” NewYorkFed.org. Federal Reserve Bank of New
York. Web. November 2015.

10

	The interbank lending market before the 2007-2008 Financial Crisis, interbank lending was made up mostly of transactions between financial institutions - i.e.,banks with excess reserves loaned to those with short-term funding shortfalls. At the same time, a small amount of bank excess reserves (<$75b) was left with theFed, earning no interest. Post 2007-2008 Financial Crisis and as part of its effort to stabilize the economy, the Fed began paying interest on these excess reservebalances (IOER). The volume of excess reserves grew to $2.5 trillion as of Q1 2015. This $2.5 trillion is included as part of the total interbank lending volume andfunctions as a series of short-term loans that the Fed pays interest on. However, this financing is a source of risk-free return for banks, and may not be consideredfunding. Interbank lending in its traditional form still exists, but is dwarfed by the volume of funds held at the Fed (~$400B vs. $2.5T).

11	Bilateral repo numbers are estimated based on overall primary dealer volumes.

12	“Financial Accounts of the United States.” FederalReserve.gov. Board of Governors of the Federal Reserve, 18 September 2015. Web. 19 November 2015.

13“Has U.S. Treasury Market Liquidity Deteriorated?” Liberty Street Economics. Federal Reserve Bank of New York, 17 August 2015. Web. November 2015.

14	Dudley, William C. “Fixing Wholesale Funding to Build a More Stable Financial System.” NewYorkFed.org. Federal Reserve Bank of New York, 1 February 2013. Web.
September 2015.

15

	“New York Fed Releases White Paper On Tri-Party Repurchase Agreement (Repo) Reform.” NewYorkFed.org. Federal Reserve Bank of New York, 17 May 2010. Web.
November 2015.

16
17“Tri-Party Repo Infrastructure Archive.” NewYorkFed.org. Federal Reserve Bank of New York. Web. November 2015.
“Tri-Party Repo Infrastructure Reform.” NewYorkFed.org. Federal Reserve Bank of New York. Web. November 2015.

18

	“The Payments Risk Committee is a private sector group of senior managers from U.S. banks that is sponsored by the Federal Reserve Bank of New York.”“Payments Risk Committee.” Ny.frb.org. Federal Reserve Bank of New York. Web. November 2015.

19

	“New York Fed Releases White Paper On Tri-Party Repurchase Agreement (Repo) Reform.” NewYorkFed.org. Federal Reserve Bank of New York, 17 May 2010. Web.
November 2015.

20

	Jaswal, Anshuman. “Triparty Repo in the US Well Begun But Far from Done.” Celent (2011). Web. 9 June 2015.

21

	“As a result, the share of triparty repo volume that is financed with intraday credit from a clearing bank has dropped markedly, from 100 percent as recently
as 2012, to a level averaging 3 to 5 percent today (as compared with the Task Force’s original target of no more than 10 percent).” “Update on Tri-Party Repo
Infrastructure Reform.” NewYorkFed.org. Federal Reserve Bank of New York, 24 June 2015. Web. November 2015.

22

	Most clients used proprietary optimization tools of Bank of New York Mellon. In addition, some clients used their own and some allocated manually.

23“BNY Mellon Achieves Significant Milestone in Tri-Party Repo Risk Reduction Initiative.” Bnymellon.com. BNY Mellon, 11 May 2015. Web. September 2015.

24	Please note this excludes the full alignment of GCF repo settlement with the tri-party settlement process.

25	Overall implementation of the reforms, inclusive of eliminating intraday credit represented a significant investment by Bank of New York Mellon and JPMorgan.
Roughly two thirds of the costs of implementing Tri-party Reform were borne by the clearing banks. From this, we approximate that clearing banks spent a
combined $120 million, resulting in an industry spend of roughly $180 across cash investors and collateral providers. Jaswal, Anshuman. “Triparty Repo in the US
Well Begun But Far from Done.” Celent (2011). Web. 9 June 2015.

26

	Clarke, Kevin, Charles Andrews, and Steve Pearson. “Ten Key Points about the New US Supplementary Leverage Ratio.” PwC Financial Services/ Regulatory
Services. PwC, 9 April 2014. Web. 19 November 2015.

27

	Bigalle, Brian, Antoine Martin, Susan McLaughlin and James McAndrews. “The Risk of Fire Sales in the Tri-Party Repo Market.” NewYorkFed.org. Federal Reserve
Bank of New York, May 2013. Web. November 2015.

28

	“U.S. Tri-Party Repo Indices and Related Futures Products from BNY Mellon and CME Group to Provide Investors with Powerful New Interest Rate Risk
Management Tools.” BNYMellon.com. BNY Mellon, 20 November 2014. Web. 20 November 2014.

29	Voegeli, Jeffrey. “Switzerland Said to Impose 5% Leverage Ratio on Big Banks.” Bloomberg.com. Bloomberg, October 2015. Web. October 2015.

30

	Cooper, Jonathan. “Repo and the Net Stable Funding Ratio: The Push Toward Long-Term Funding.” secfinmonitor.com. Securities Finance Monitor, June 2015. Web.
June 2015.

40 | A Focus on Repo Markets

31	Chung, Juliet, and Sarah Krouse. “Big Banks to America’s Firms: We Don’t Want Your Cash.” Wall Street Journal 18 October 2015. Print.

32

	Chung, Juliet, and Sarah Krouse. “Big Banks to America’s Firms: We Don’t Want Your Cash.” Wall Street Journal 18 October 2015. Print.

33

	Source: BNY Mellon Tri-party Repo Volumes

34

	“Federal Register.” Gpo.gov. Federal Reserve, 14 August 2015. Web. November 2015.

35

	“Supervisory Framework for Measuring and Controlling Large Exposures.” Bis.org. Bank for International Settlements, April 2014. Web. November 2015.

36

	Liz Capo, McCormick. “Money-Market Funds Finding New Repo Partners as Dealers Retreat.” Bloomberg.com. Bloomberg, 10 June 2015. Web. June 2015.

37

	“Finadium: Realities of Repo Clearing for the Buy-side.” Secfinmonitor.com. Securities Finance Monitor, 18 June 2015. Web. June 2015.

38

	Please note that this table follows the EBA Report on the Overview of the potential implications of regulatory measures for banks’ business models. This reportreferences an increase in risk appetite for banks under the leverage ratio as they opt for higher risk, higher margin activities given their decreased ability to use
leverage. The risk appetite for the NSFR/ LCR will decline, however, given the pressure on banks to increase their HQLA.

39

	Powell, Jerome H. “Structure and Liquidity in Treasury Markets.” FederalReserve.gov. Board of Governors of the Federal Reserve System, 3 August 2015. Web.
November 2015.

40

	Dudley, William C. “Fixing Wholesale Funding to Build a More Stable Financial System.” NewYorkFed.org. Federal Reserve Bank of New York, 1 February 2013. Web.
September 2015.

41

	“Overnight Reverse Repurchase Agreements.” FederalReserve.gov. Board of Governors of the Federal Reserve System. Web. November 2015.

42	Furthermore, HQLA has been divided into two levels based on liquidity: level 1 (cash, central bank reserves, sovereign-backed securities), level 2A (GSE debt,
government securities, covered bonds, corporate debt), and level 2B (MBS, equities, lower rated corporate debt).

43	On September 22, 2015, the Federal Reserve Bank of New York announced the latest term RRP at quarter end with an offer amount of $250billion. “Statement
Regarding Term Reverse Repurchase Agreements.” NewYorkFed.org. Federal Reserve Bank of New York, 22 September 2015. Web. September 2015.

44

	“Part 2: Monetary Policy.” FederalReserve.gov. Board of Governors of the Federal Reserve System. Web. November 2015.

45

	“Collateral Management: A Review of Market Issues.” BNYMellon.com. BNY Mellon, October 2015. Web. November 2015.

46

	“Quarterly Report on Federal Reserve Balance Sheet Developments.” FederalReserve.gov. Board of Governors of the Federal Reserve System, August 2015. Web.
September 2015.

47	53% and 65% of participants expect rate normalization to have no impact on bilateral and GCF volumes respectively. Over a third (37%) expect bilateral repo
volumes to increase as a result of rate increases, whereas only 26% expect GCF volume increases.

48

	Burne, Katy. “Money Funds Clamor for Short-Term Treasurys.” Wall Street Journal October 2015. Print.

49

	Burne, Katy. “Money Funds Clamor for Short-Term Treasurys.” Wall Street Journal October 2015. Print.

50

	“Collateral Management: A Review of Market Issues.” BNYMellon.com. BNY Mellon, October 2015. Web. November 2015.

51

	Devasabai, Kris. “Grim Repo: Clearing Touted as Saviour for Shrinking Market.” Risk Magazine, February 2015. Print.

52

	“Introductory Remarks at Workshop on ‘Fire Sales’ as a Driver of Systemic Risk in Tri-Party Repo and Other Secured Funding Markets.” NewYorkFed.org. Federal
Reserve Bank of New York, October 2013. Web. November 2015.

53

	Bigalle, Brian, Antoine Martin, Susan McLaughlin and James McAndrews. “The Risk of Fire Sales in the Tri-Party Repo Market.” NewYorkFed.org. Federal Reserve
Bank of New York, May 2013. Web. November 2015.

54

	Bigalle, Brian, Antoine Martin, Susan McLaughlin and James McAndrews. “The Risk of Fire Sales in the Tri-Party Repo Market.” NewYorkFed.org. Federal Reserve
Bank of New York, May 2013. Web. November 2015.

55

	“Quadriserv to Build Equity Repo Platform with OCC as CCP.” Secfinmonitor.com. Securities Finance Monitor, 20 December 2012. Web. September 2015.

56

	King, Joseph. “Enabling Buy-Side Firms to Become Members of GSD Will Increase Efficiency, Transparency in U.S. Government Securities Market.” DTCC.com.
DTCC Connection, 25 February 2014. Web. September 2015.

57

	“2015 FSOC Annual Review.” Treasury.gov. Financial Stability Oversight Council, 2015. Web. November 2015.

58	Babihuga, Rita, and Marco Spaltro. “Bank Funding Costs for International Banks.” Imf.org. International Monetary Fund, April 2014. Web. September 2015.

59

	“Funding.” db.com. Deutsche Bank. Web. 1 November 2015.

	“Financial Innovation: The Origins of the Tri-Party Repo Market.” LibertyStreetEconomics.NewYorkFed.org. Federal Reserve Bank of New York. Web. September 2015.

60

61

	“Financial Innovation: The Origins of the Tri-Party Repo Market.” LibertyStreetEconomics.NewYorkFed.org. Federal Reserve Bank of New York. Web. September 2015.

	“Financial Innovation: The Origins of the Tri-Party Repo Market.” LibertyStreetEconomics.NewYorkFed.org. Federal Reserve Bank of New York. Web. September 2015.

62

63

	“Finadium: Realities of Repo Clearing for the Buy-side.” Secfinmonitor.com. Securities Finance Monitor, 18 June 2015. Web. June 2015.

64

	“U.S. Tri-Party Repo Indices and Related Futures Products from BNY Mellon and CME Group to Provide Investors with Powerful New Interest Rate Risk
Management Tools.” BNYMellon.com. BNY Mellon, 20 November 2014. Web. 20 November 2014.

65

	“Commercial Paper Definition.” Investopedia.com. Investopedia, 19 November 2003. Web. 20 November 2015.

66

	“Fedwire® Services.” Frbservices.org. Federal Reserve Bank Services. Web. November 2015.

67	Copeland, Adam, Darrell Duffie, Antoine Martin, and Susan McLaughlin. “Key Mechanics of the U.S. Tri-Party Repo Market.” NewYorkFed.org. Federal Reserve Bankof New York. Web. November 2015.

68

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41 | A Focus on Repo Markets

72	Baklanova, Viktoria, Adam Copeland, and Rebecca McCaughrin. “Reference Guide to U.S. Repo and Securities Lending Markets.” Financialresearch.gov.
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74	Hahn, Thomas. “Instruments of the Money Markets.” Richmondfed.org. Federal Reserve Bank of Richmond, 1998. Web. November 2015.

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78

	The eSLR, applicable to SIFI banks only, requires SIFI banks to maintain a buffer on the SLR of more than 2%, on top of the minimum of 3%.This will require banks
to maintain an SLR in excess of 5%.

79

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80

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42 | A Focus on Repo Markets

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