A safe and sound tri-party repo market is critical to the stability of the U.S. financial system. In an effort to strengthen the resiliency of the tri-party repo infrastructure, the Federal Reserve’s Payments Risk Committee (“PRC”) created the Tri-Party Repo Infrastructure Reform Task Force in 2009 and asked the industry to develop a solution that would reduce reliance on intraday credit and increase risk management practices. The Task Force’s goal is to enhance the repo market’s ability to navigate stressed market conditions by implementing changes that help better safeguard the market. DTCC has worked in close collaboration with the Task Force on their reform initiatives.
GCF Repo is a service offered by the Fixed Income Clearing Corporation (FICC), a subsidiary of The Depository Trust & Clearing Corporation (DTCC). The GCF Repo Service enables members to trade in general collateral repurchase agreements, or “Repos,” based on rate, term, and underlying product, throughout the day without requiring intra-day, trade-for-trade settlement on a delivery-versus-payment (DVP) basis. Net settlement occurs at the end of the day for all transactions thus creating a highly liquid market. Because GCF Repo uses the tri-party infrastructure, DTCC needed to identify systemic changes within the GCF Repo settlement process that would reduce risk and integrate seamlessly with other industry changes to meet the goals of the Task Force. Once the tri-party reform enhancements are fully implemented by the clearing banks, GCF Repo settlement will be reduced by approximately 76% on average, with a potential for over a 92% reduction on certain days. This large reduction in settlement of both cash and securities reduces systemic risk related to tri-party settlement.
Brian Disken is DTCC’s Director of Fixed Income Product Management. He recently sat down with @DTCC to answer some questions regarding the changes to the GCF Repo end-of-day settlement processing and its impacts.
In understanding the new changes better, can you talk about the current process for GCF Repo end-of-day settlement?
The end of day settlement process for GCF Repo today settles on a gross basis. What that means is that each day there is an unwind of obligations from the prior day and rewind of the new obligations on the current day. Each day we run a net settlement process for the GCF Repo service in which we determine what the GCF Repo settlement obligations will be for each firm. We then generate those obligations at 3:15 p.m. EST each day and send that information to our customers and clearing banks. Our customers have until 4:30 p.m. EST to pledge collateral to FICC to satisfy their delivery obligation and FICC will forward that collateral to the dealers with receive obligations. The next day that process completely unwinds and then the process starts over again at 3:15 p.m. EST. where there is new obligation output sent to the clearing banks and our customers for settlement.
What are the changes being made and why is the new process better?
Ultimately what will happen over the coming months with the clearing banks is, rather than those settlements occurring on a gross basis, they are going to settle on a net basis. We will take your return obligation from the previous day and net it against your new obligation for the current day, reducing the amount that needs to settle from day to day. When modeling and analyzing this “Net of Net” solution, we observed an average reduction of 76% in GCF Repo settlement, with the potential of exceeding 90% on certain days. This reduction will dramatically reduce the amount of intra-day credit extended by the clearing banks. Intra-day credit extensions were one of the main concerns identified by the Task Force that needed to be addressed by the industry.
Can you explain how this change will mitigate systemic risk and align with the recommendations of the Tri-Party Repo Infrastructure Task Force?
The main goal of the Task Force is to reduce the amount of systemic risk caused by the amount of credit extended by the clearing banks to their customers. So, by ensuring that we are netting our settlement and not processing a gross unwind and a gross rewind, we are substantially reducing the amount of credit extended by the clearing banks in order to settle GCF Repo obligations.
Were the Task Force recommendations the impetus for this change?
The reason for the change was primarily a result of the Task Force recommendations. DTCC participated in the Task Force discussions and worked towards solutions for the industry in reducing the amount of credit extended by the clearing banks, resulting in lower risk within the financial system. The creation of the Task Force was prompted by the financial crisis of 2008 and its main purpose was to address systemic risk concerns associated with the tri-party repo market infrastructure.
What is the status of the implementation process and are the clearing banks on-board?
Yes. We work closely with the clearing banks and meet with them on a regular basis. While several enhancements have been implemented, there are additional enhancements that are well into the design phase and implementation timelines have been communicated. We actually have one clearing bank running part of the process that will support the “Net of Net” settlement. The other clearing bank is still in the process of designing how exactly the “Net of Net” settlement process will work and integrate with the tri-party changes that each bank is making.
Who benefits from this change?
The industry as a whole is the beneficiary by reducing the amount of credit extended by the clearing banks, and by reducing the amount of cash and collateral moving through the system. When will the benefits be seen?
The benefits are already being seen. Each bank has been implementing changes to their tri-party settlement model thus beginning to reduce the amount of credit extended. More work still needs to be done, with a goal in mind to cap dealer credit at 10% of their tri-party repo portfolio.
How will clients experience the change to the GCF Repo Service?
The main changes they will see are the collateral substitution capabilities, the next day unwind moved to 3:30 p.m. EST, and GCF Repo trading deadline moved to 3 p.m. EST. The majority of the dealers are supportive and pleased with the functionality that is now available to them. In terms of future changes – with respect to the implementation of the “Net of Net” settlement, there will be no systemic changes required by our customers but there will be behavioral changes with respect to the manner in which the repo desks fund their positions on a daily basis.
Listen to Brian talk about the improvements to GCF Repo end-of-day settlement processing in this DTCC Podcast: Watch Video @