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Capital market activities (repo, market making…): regulatory impacts and future trends - Economic and monetary challenges

Financial Stability Risks in SFTs: Start with the data gaps

By Berner Richard - Director, Office of Financial Research, U.S. Department of Treasury

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After the financial crisis, the Financial Stability Board recommended oversight of securities financing transactions (SFTs), including markets for repos (repurchase agreements), securities lending, and margin lending activities. The crisis revealed three types of vulnerabilities in these markets: (1) leverage and liquidity transformation risks by market intermediaries, (2) weaknesses in the market infrastructure, and (3) the risk of runs and asset fire sales.

Regulators have taken important steps to address some of these vulnerabilities, but more remains to be done. For example, no comprehensive mitigant is available for the significant risk of fire sales. In addition, a lack of good data prevents us from adequately monitoring these markets, identifying new trends, and assessing their vulnerabilities.

To help address these gaps, the OFR and the U.S. Federal Reserve System launched data collection pilots this past year with input from the U.S. Securities and Exchange Commission. The first pilot, which is complete, focused on the U.S. bilateral repo market. A second, ongoing pilot is focusing on securities lending.

Nine large bank holding companies voluntarily provided snapshots of their bilateral repo activity at the end of three reporting days in the first quarter of 2015. Over those days, participating dealers lent an average of $1.6 trillion and borrowed an average of $1 trillion. These trades accounted for about a half of the total U.S. bilateral repo market on those days.

We found that about 81 percent of the repo trades and about 61 percent of the reverse repo trades, in which dealers provide cash to their clients, used U.S. government securities as collateral. Equities backed 15 percent of the repo and 21 percent of the reverse repo trades by market value. The OFR recently published a research brief discussing the findings in more detail.

The pilot was limited in scope, excluding smaller market participants, cross-border repo activities, and trades outside the United States. For these reasons, the results do not offer a complete picture of market interconnectedness or allow us to track any migration of activities away from the primary dealers that participated in the pilot.

On the other hand, the pilot uncovered some key requirements for future data collections. First, common data standards are essential. For example, the lack of standardized counterparty information makes analyzing market interconnectedness difficult for market supervisors and market participants. Although the use of a legal entity identifier (LEI) would help to resolve this issue, the pilot found that adoption of the LEI standard among repo market participants is low.

A lack of good data prevents us from assessing their vulnerabilities.

Second, participating firms must consistently identify entities by industry sector to assure data quality. Third, the pilot found the need for a consistent and uniform approach to grouping collateral securities to analyze the U.S. SFT market.

Fourth, the internal reporting systems of firms in SFT markets should be able to produce granular data at the enterprise level to track risk within the firm and across the financial system. The pilot found that internal systems are disjointed, presenting problems for regulators and the firm’s own risk monitoring efforts. For example, data elements specific to a trade might be kept in one trading system while counterparty data might be kept in a separate system.

We will apply these valuable lessons during permanent data collections in collaboration with the Fed, the SEC, and our global counterparts. In these collections, we will require the use of data standards such as LEI. We will also collaborate in other data collection efforts in the United States and Europe. These efforts will be consistent with the principles of in the Financial Stability Board’s multi-year plan on global SFT data collection and aggregation. Our goal is to promote coordination on data standards and cross-border sharing. Success will give us a clearer picture of the global SFT market and developments that may present emerging risks to financial stability.