Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Financial Plumbing of the GCF Repo[R] Service

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Financial Plumbing of the GCF Repo[R] Service

Article excerpt


General Collateral Finance Repo (GCF Repo[R]) is a popular, well-established service for securities dealers. (1) Its structure provides a way for dealers to exchange government securities for cash among themselves in an anonymous way. Further, the Fixed Income Clearing Corporation, which offers the GCF Repo service, provides netting services and acts as a central counterparty. These benefits have led dealers to enter into a large number of GCF Repo contracts; for example, in the first quarter of 2013, average daily trading was almost $500 billion and average daily net settlement exceeded $250 billion.

GCF Repo trades are cleared and settled on the books of the two large clearing banks, JPMorgan Chase (JPMC) and Bank of New York Mellon (BNY Mellon), with each bank using its own tri-party repo settlement platform. During the 2007-09 financial crisis, weaknesses were revealed in both banks' tri-party repo settlement procedures, and thus in GCF Repo. After the financial crisis, regulators and market participants formed the Tri-Party Repo Reform Task Force, with the aim of producing recommendations to improve the stability of the two banks' tri-party repo settlement platforms (Task Force 2010). (2)

Most of the task forces recommendations focused on reducing the settlement systems' reliance on intraday credit to settle trades. Prior to reform, these systems depended heavily on the clearing banks providing unlimited intraday credit to the institutions entering into tri-party repo and GCF Repo contracts. One of the main goals of the reforms was to develop settlement systems where much smaller amounts of intraday credit are provided and where it is provided in a less discretionary way.

The pre-reform systems were worrisome for two reasons. First, as long as a dealer had securities at the clearing bank to serve as collateral, the clearing bank was willing to extend intraday credit to that dealer to settle tri-party repo trades. Given the size of the larger dealers (with tri-party books of easily more than $100 billion), there was potential for each of the clearing banks to extend an enormous amount of intraday credit relative to its capital base. This situation raised the risk that a clearing bank that could not absorb the impact of a failing dealer would itself be destabilized, leading to an interruption of funding and payment services for all of its other clients. The task force recommended that clearing banks limit intraday credit extensions to no more than 10 percent of the value of a dealer's total tri-party book. With these limits in place, market participants and regulators can be more confident that a clearing bank can handle the default of a large dealer on its tri-party repo obligations.

Second, the discretionary nature of the clearing banks' extension of credit was problematic. In times of stress, a clearing bank might be unwilling to take on the risk of extending intraday credit to a troubled dealer. Such a move, however, would effectively push the dealer into bankruptcy because it would lose access to planned-for funds. The task force recommended the removal of this discretion. With the reforms, clearing banks' credit extensions are now committed, capped, and collateralized.

Although the clearing banks have made progress in reducing dealers' reliance on intraday credit, most of the improvements have been aimed at the settlement of tri-party repo trades, and not GCF Repo trades. As a result, GCF Repo trades are still settled under systems that rely heavily on the provision of unlimited intraday credit to function.

In this article, we describe in detail the settlement of GCF Repo and the reliance of the settlement process on intraday credit. First, we provide an overview of how GCF Repos are negotiated and cleared. Then we describe how GCF Repo trades were settled up until the first quarter of 2012, the pre-reform state. Since the first quarter of 2012, however, a number of changes have been made to the settlement process as part of the aforementioned reforms to tri-party repo; and so, lastly, we describe the current settlement process. …

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