by James Conmy

Current rules, which have been in place since early 2003, limit FICC customer engagement in GCF repo transactions to other customers that clear at the same bank.

A bifurcated market

FICC’s Government Securities Division initiated its GCF Repo service in 1998 in conjunction with its clearing banks – Bank of New York (BONY) and JPMorgan Chase. The service, which allows dealers to trade GCF repos throughout the day on a blind basis with interdealer broker-netting members, quickly achieved high volumes.

“While the current rules were put into effect to deal with certain risk issues that came up in the payments system, they also created a bifurcated market,” said Murray Pozmanter, DTCC managing director, Clearance and Settlement Product Management. “Different rates were quoted for dealers at BONY than those quoted at Chase, which resulted in an inefficient market with limited liquidity.”

Keeping business intra-bank

By early 2003, volume had risen so much that it began to create payment system risk problems in the movement of cash between the two prime clearing banks. In response, FICC initiated the rule that transactions could only take place if both parties were able to settle the transactions at the same clearing bank.

In effect, Pozmanter said, this restriction cut the market into two segments, reducing overall liquidity and volume. Now, to overcome the problems that led to this restriction, FICC has drawn up a new set of rules and procedures governing the mechanics of the transactions.

Single fund movement

Instead of requiring the banks to transmit funds in the morning when overnight repos are “unwound,” and then transmit funds again in the evening when new repo transactions are settled, FICC and the clearing banks have come up with a plan that allows the two fund movements to be netted into a single interbank movement of money at day’s end.

Meanwhile, in place of making the funds payments, the interbank dealers at the net borrowing bank will give FICC an interest in each of the securities and deposit accounts they maintain at the bank. FICC, in turn, will give the other bank, which was supposed to receive the funds, an interest in this collateral.

FICC steps in

“FICC is more or less stepping into the middle of the intraday process in order collateralize the exposure between the two clearing banks, thus reducing the intraday risk,” Pozmanter said. “Then, at the end of the day, when the fund transfers between the two banks can be netted, the collateral holds against the dealers can be released. Both banks have partnered with FICC to make this process work.”

To protect against the possibility of an intraday default of one of the GCF repo participants, FICC also has proposed imposing a premium on any participant’s clearing fund deposits that are related to GCF repos. DTCC’s Risk Management group will receive periodic reports summarizing customers’ holdings by asset type at the banks involved in order to determine the rate for the GCF premium.

More liquidity

“By allowing the market to function between the banks rather than solely within the banks, we’re substantially broadening the liquidity and trading opportunities for all the participants,” Pozmanter noted.

“The timing for implementation of the proposed new payment methodology will be determined in conjunction with the clearing banks upon approval of the rule filing,” Pozmanter said. Both the banks and FICC will have to undertake some development in order to roll out the new functionality. @

[To learn more about the GCF Repo service, contact Murray Pozmanter, DTCC managing director, Clearance and Settlement Product Management, at 212.855.7522, or by email at mpozmanter@dtcc.com. For questions about the rule filing, contact Nikki Poulos at 212.855.7633 or by email at npoulos@dtcc.com.]