Market participants must recalibrate business and operational models if they are to accommodate and benefit from fundamental changes within wholesale funding markets, according to a new BNY Mellon research paper published in conjunction with PwC Financial Services.
The newly released paper – The Future of Wholesale Funding Markets: A Focus on Repo Markets Post US Tri-Party Reform – concludes that, while regulation and ongoing reform will continue to shape wholesale funding, strong market forces combined with the underlying structure and profitability of the business are set to impact repo volumes, participant interactions, and views of risks in the system.
The research takes as its starting point the modernization initiative to address the systemic risks inherent in the US repo market infrastructure that flowed from recommendations issued in 2009 by the Tri-party Repo Infrastructure Reform Task Force, sponsored by the Federal Reserve Bank of New York's Payments Risk Committee. The four-year collaboration that followed – involving BNY Mellon, its broker dealer clients, regulators, CCPs and institutional investors – saw the goal of the 'practical elimination' of intraday credit met.
The paper notes that 75% of surveyed participants agree that the wholesale funding markets are less vulnerable to a future crisis following the tri-party reform initiative, which reduced the need for secured intraday credit provided by the clearing banks and also improved trading transparency and decreased operational risk through process improvements, such as automated three-way deal matching.
The paper highlights three key future drivers that will shape the US market, which remains one of the world's most important funding markets:
- Pending regulations on repo users will likely dampen repo volumes in the near term, most directly through the allocation of capital and liquidity ratios to the desk level;
- The increased demand for high quality liquid assets, and a potential further increase brought about by Money Market Reform, indicate that the Fed will likely maintain its Reverse Repurchase facility for the foreseeable future;
- Expanding cleared repo services in the US is now considered an imperative, given the need to address 'fire sale' risk and the search by Global Systemically Important Banks (G-SIBs) for balance sheet relief.
The paper notes that each of these developments raises multiple considerations for market participants, but that the incentives in addressing these considerations vary greatly across collateral providers, cash investors, matched books, interdealer brokers, and regulators.
"This complex array of priorities increases the importance of a comprehensive collateral roadmap to guide firm strategy through interactions with market participants," says Brian Ruane, CEO of Broker-Dealer Services and Tri-Party Services at BNY Mellon. "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 their collateral capabilities around this changing environment."
To date, the Fed has provided high-quality liquid assets to support cash investing needs through its Reverse Repurchase (RRP) facility. "The RRP is now amongst one of the most important participants in tri-party repo, an effective monetary policy tool and a buffer to market anomalies," says Ruane. "While certain market developments, such as increasing G-SIB repo volumes following the expansion of cleared repo, may provide the Fed with an easy exit from the RRP, there was near unanimity across the firms we interviewed that conditions will demand its prolonged existence."
While regulation will continue to shape the evolution of the markets, Christopher Pullano, Partner at PwC, says that a focus on collateral management and cleared repo is expected to be at the forefront of change, helping markets and clients alleviate pressures from risk, regulation, and operational burdens.
"As a result of this research, repo participants will better appreciate the value of collateral connectivity and benefits that an integrated view of their accounts would provide to their organizations, particularly when combined with the ability to post collateral across current boundaries (CSDs and countries)," he says. "The research clearly supports the conclusion that collateral connectivity is one of the most notable and identifiable long term trends in the repo market that firms should begin to understand and plan for now."
The potential fragmentation of asset mobility should be a primary focus for the industry at this time, adds Ruane. "Collateral is the new cash – the ongoing shift from the old uncollateralized world, particularly in the derivatives space, means demand for collateral and its mobility is outstripping all other asset types," he says. "The ability to mobilise collateral across legal entities and countries is becoming as important today as payment systems have been in the past. Any friction or blockages only creates risk, so when it comes to moving collateral around, enhanced global connectivity is key."
Given the critical importance of wholesale funding in Europe and Asia-Pacific, Ruane believes the impact of the US reforms will inevitably ripple out across other financial markets. "The wholesale funding market in the US is taking on increased importance, and the US tri-party business is, in reality, global in terms of participants," he says. "So it will be interesting to see how these US reforms around credit and intraday exposures will play out in those regions. For instance, in the US, clearance and collateral management are intertwined, and that is not the case in Europe – yet. When that happens, we can expect new competitors to emerge."
The new research paper can be found at here.