A pillar of U.S. regulators' plans to curb risks in the $2 trillion bond-lending market known as repo has been stuck in limbo for more than two years, forcing a key Wall Street utility to speed up alternative plans that would only address a fraction of participants.
Depository Trust & Clearing Corp., which operates a central hub used by banks and brokerage firms to finance their bond trades, is discussing a draft proposal with the Securities and Exchange Commission that would allow pension funds and insurance companies to join as cash providers, a person with knowledge of the matter said.
The DTCC's effort is seen as a stopgap, since the SEC has taken no action on a separate October 2014 proposal to include a much larger pool of cash providers: money-market funds run by behemoth asset managers like Fidelity and Federated Investors (FII) . The DTCC system, known as a clearinghouse, is the only one of its kind in the U.S.; it functions as a central counterparty, essentially guaranteeing the repo loans that are processed through it.
The financial crisis of 2008 exposed the risk that a large firm's default could roil the repo market, triggering a fire sale of liquidated collateral that could send bond prices into a tailspin, in turn saddling more banks and investors with devastating losses. Both the international Financial Stability Board and Federal Reserve Governor Jerome Powell have suggested that greater use of clearing in the market could mitigate systemwide risks by providing a mechanism to gradually wind down a failed firm's bond trades with minimal disturbance.
In clearing, a central hub like the DTCC takes over as the main counterparty for all transactions, assuming the responsibility of collecting additional payments from individual participants when their trades go south. The clearinghouse is set up so that any losses from the default of a single trader are shared among all members, and it also assumes the responsibility for liquidating any collateral that's seized.
"Central clearing has been a regulatory priority to reduce risk, but at the same time regulators have put up unintended obstacles to making this a reality," said Josh Galper, a repo-market expert at Finadium, a consultancy in Concord, Mass.
The repo-clearing initiatives are further clouded by President-Elect Donald Trump's pledge to dismantle some banking regulations enacted following the financial crisis. A rollback could reduce incentives for banks to trim their balance sheets, a key benefit of clearing.