BK Bank of New York Mellon Corporation

By Katy Burne 

A dispute over technology could pose a new threat to Wall Street's plumbing by severing a link that allows big banks to borrow freely from one another, according to market participants.

A unit of Depository Trust & Clearing Corp., the dominant processor of repurchase agreements, or repos, between securities dealers, has told traders it will stop facilitating certain interbank repos as of July 15. The roadblock affects an estimated $45 billion in daily repo loans, short-term loans through which banks and other financial firms exchange cash and securities to raise funds for their trading activities.

A clearing bank confirms the identity of parties to a trade and their terms, before processing the transaction. In settlement, a third party ensures the quantities agreed upon in the trade are transferred.

The suspension would mean the DTCC unit couldn't match up trades between dealers that have cleared their interbank repos through Bank of New York Mellon Corp., a large clearing bank, and dealers that clear through BNY's distant competitor in repo clearing, J.P. Morgan Chase & Co. Since a unit of DTCC will no longer bridge the divide, dealers will only be able to trade with firms that process their trades through the same clearing bank.

A handful of dealers have already scheduled some monthslong repos to expire before the cutoff, in a bid to insulate themselves from changing conditions as the break ripples through that corner of the roughly $3 trillion U.S. repo market, according to people with knowledge of the contracts.

The shift "will further bifurcate" the repo market at a time when it is already under pressure from regulation, said Josh Galper, managing principal at consultancy Finadium. The change, which would have to be signed off by the Securities and Exchange Commission, also would likely lead to the adoption of different repo rates for Bank of New York Mellon and J.P. Morgan clients, said Joseph Abate, an analyst at Barclays PLC.

The trades that would be affected by the suspension are repos between dealers that cross clearing banks and are backed by Treasurys, mortgage bonds and agency debt in trades known as "general collateral finance." Those GCF trades account for about $45 billion, or 15% of the $300 billion in daily interdealer repo trading.

The decision is the latest twist in a long-running struggle by bankers and the Federal Reserve to reduce risk in repos. Regulators accelerated those changes after the 2008 financial crisis exposed structural flaws. Under the overhaul, BNY and J.P. Morgan rejiggered settlement times and virtually eliminated the amount of intraday credit they have extended to dealers in some repos, moves lauded by the Fed.

Last year, the Federal Reserve Bank of New York said the industry had met several repo-overhaul milestones but that settlements of interdealer GCF repos across clearing banks remained out of sync with other repos. It called the misalignment a "potential source of market instability in periods of stress."

In an effort to align interdealer GCF trades and other repos, BNY, J.P. Morgan and DTCC set out to build new technology for swapping information about the cash and securities being exchanged between clients of the clearing banks.

J.P. Morgan completed a series of enhancements and the DTCC unit completed the majority of its own, but BNY determined that the technology work would have taken too much time and resources, people familiar with the situation said. At the same time, BNY asked a unit of DTCC to accept new limits on a credit facility the bank provides to the settlement firm.

When they couldn't resolve their differences, the DTCC unit, called Fixed Income Clearing Corp., chose to suspend its interbank GCF repo services.

Repo volumes already have been shrinking in response to new rules targeting banks. The planned suspension has traders and the Fed on watch for further disruptions, participants said. The New York Fed, which has overseen the repo reform efforts, hasn't intervened in the standoff, said people familiar with the matter.

"In a world where everyone is concerned about lack of liquidity, why take this away?" one large dealer complained of the planned suspension.

The activity across clearing banks was suspended by DTCC once before, between 2003 and 2008, but at that time the business was divided more evenly between clearing banks. Now, BNY Mellon has a roughly 85% share of the dealer client base in such repos.

Changing clearing banks is operationally taxing and few are expected to do so.

Some traders said the suspension could leave J.P. Morgan and its clients--which people familiar with the matter said include units of Credit Suisse Group AG, Royal Bank of Scotland Group PLC and HSBC Holdings PLC--disadvantaged, with fewer trading partners in a panic, and could potentially complicate any attempts to resolve firm failures. Representatives of those firms declined to comment.

Others said that dealers on the J.P. Morgan side tend to have more cash than securities, but they may have to pay more to transact than BNY Mellon clients under the change. J.P. Morgan already has an account at BNY and could expand its own capabilities, said one person involved in the talks between the banks.

One industry idea under discussion is a new repo clearinghouse that could solve the issues across the clearing banks, but the mechanisms are complex and unlikely to be ready by July 15.

(END) Dow Jones Newswires

January 31, 2016 19:18 ET (00:18 GMT)

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