BK Bank of New York Mellon Corporation

By Katy Burne 

J.P. Morgan Chase & Co.'s retreat from a mundane but crucial settlement role in the $13 trillion U.S. Treasury market poses a fresh challenge for regulators seeking to bolster the market's capacity to withstand shocks.

The New York bank's decision, announced July 21 and due to be complete next year, leaves rival Bank of New York Mellon Corp. as the lone firm handling the settlement of U.S. government debt for big bond brokers.

Having just one firm in the business of making sure traders deliver cash and securities as expected will pose a fresh test for a sprawling market whose functioning has come under scrutiny since the financial crisis. Many analysts already worry that liquidity, the capacity to trade quickly without moving prices, has been falling when markets come under stress.

Following J.P. Morgan's exit, Bank of New York will settle transactions including the majority of Treasury debt sold at U.S. government auctions, the majority of Treasurys traded in the secondary market and most U.S. government debt exchanged in the overnight "repo" market, a key source of funding in which financial institutions use the bonds as collateral for cash loans.

Officials at both banks said they had been in touch with the Federal Reserve and the Treasury Department to reassure them the moves wouldn't disrupt trading in U.S. Treasurys or the $2.2 trillion daily market for repos. But the move could inflame concerns that there already weren't enough options for traders, potentially exposing the market to a shutdown in the event of an outage at a large settlement firm.

"You have all your eggs in one basket here, and if you're the Fed, that has to be a little disconcerting, because you don't want any hiccups in this market," said Ray Stone, a former New York Fed researcher and head of Stone & McCarthy Research Associates.

The change, deep in Wall Street's financial plumbing, reflects pressure from new regulations as well as banks' efforts to cut back less-lucrative activities.

There were about half a dozen providers of settlement services in the Treasurys market before consolidation whittled the market down to two in the 1990s.

But for more than a decade, banks that operate as "primary dealers" in the Treasury market have only had two options for settling trades -- Bank of New York and J.P. Morgan.

Bank of New York is prepared to work with dealers that want to move to its platform and expects to be able to handle the extra volume, spokeswoman Cheryl Krauss said.

J.P. Morgan said it would continue to provide other related services, like managing government bonds as collateral for client trades.

The Treasury is "confident that Treasury securities will continue to settle and trade in the usual manner," a Treasury spokesman said.

The Fed and others have been concerned for more than a decade about Bank of New York's large market share -- now 85% -- for settlement in a $1.6 trillion part of the repo market.

The central bank worried as far back as 2006 that concentration could present systemwide risks and considered forming a utility as a backup, people briefed on the matter said. J.P. Morgan's announcement may restart those discussions, the people said.

The Fed also is holding Bank of New York to higher operating standards due to its share of the market.

"A single provider of settlement services -- or a new entrant, should there be one -- will be expected to operate in a safe and sound manner that supports market functioning and that is resilient to stress," said Darren Gersh, a spokesman for the central bank in Washington.

One concern is damage to infrastructure. The 2001 terror attacks, for example, hit Bank of New York's telecommunications lines close to the World Trade Center, causing payment disruptions. Since 2001, the bank has strengthened and diversified its disaster recovery procedures, said Ms. Krauss, the bank's spokeswoman.

"If they have a technical glitch, what happens if the collateral can't be sent back or the money can't be sent? That's wild business," said Bruce English, who ran the repo desk at Aubrey G. Lanston & Co., which previously was a primary dealer.

Bank of New York has $29.5 trillion in assets under custody or administration. It already handles settlement for all but four of the 23 primary dealers that trade bonds directly with the Fed.

Primary dealers handle the majority of bonds sold in U.S. government auctions. Most subsequent trades in the market also involve primary dealers, and settle at either J.P. Morgan or Bank of New York, although smaller dealers and alternative providers do exist.

Citigroup clears trades of government securities for clients such as hedge funds. BMO Harris Bank, a Chicago based unit of BMO Financial Group with $104 billion in assets under management, is considering expanding its government securities settlement and custody services to broker dealers.

"We think there's further opportunity," said Scott Ferris, head of the financial institutions group at BMO Harris.

Write to Katy Burne at katy.burne@wsj.com

(END) Dow Jones Newswires

July 31, 2016 16:25 ET (20:25 GMT)

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