Clearstream and ICE Clear Europe launch tri-party collateral management partnership


When time is of the essence, as in real estate transactions or where disbursements are required after an initial agreement.

Cash and Tri-Party Escrows


To protect against this situation, parties can enter into a tri-party control agreement to ensure that the Independent Amount is retained in a segregated account by a custodian third party. In fact, the Dodd-Frank Act will require dealers and major swap participants in the case of non-centrally cleared derivatives to notify their counterparties that they have the right to require segregation of collateral. As a result of these requirements, tri-party control agreements are expected to become much more common.

Tri-party control agreements typically entitle the non-defaulting party to access collateral held by the custodian on the occurrence of specified events of default. For example, if the "secured" party is in default, the party that posted the collateral Pledgor would usually have a right to access the collateral. Alternatively, if the Pledgor is in default, the secured party may have that right.

Before it can access the collateral, the non-defaulting party must, under the terms of the tri-party control agreement, deliver a notice to the custodian certifying certain matters and notifying instructions for transfer of the collateral. The Notices published overnight by ISDA are templates designed to facilitate the negotiation of the form of such notices by the parties to the relevant tri-party control agreement.

While a great deal of focus is appropriately on the clearing banks, given their pivotal role in the settlement process, the active engagement of all market participants is critical to reaching the goal of material risk reduction.

To this end, the largest securities dealers affiliated with bank holding companies have recently been asked to submit to the Federal Reserve detailed execution plans and timelines for the necessary changes to systems and processes. At the same time, the Federal Reserve is pressing them to work with lenders to achieve more-timely and more-accurate trade confirmations, which are critical to ensuring that the coming process changes are effective in reducing the use of intraday credit, and thus risk.

On another front, the Federal Reserve is working with regulators of other important market participants. As I described earlier, there are a wide range of participants in the triparty repo market, only some of whom are subject to direct Federal Reserve oversight.

A particular strength of the task force process was the involvement of essentially all important classes of market participants and their regulators. With that process now concluded, the Federal Reserve is committed to finding other ways to continue and expand these interactions. Such an inclusive approach is essential if key changes to the settlement process that require adjustments in the behavior of all market participants are to be effectively implemented.

Not only securities dealers affiliated with bank holding companies but also other broker-dealers as well as cash lenders, such as money market funds, must modify systems and protocols consistent with the requirements of the target state. To this end, engagement with the Securities and Exchange Commission has been and will continue to be particularly important given its role as the primary regulator of broker-dealers and many cash lenders, notably money market funds.

In addition, the Federal Reserve is committed to providing information on its initiatives related to the triparty repo market. With these aims in mind, the Federal Reserve Bank of New York recently launched a website that will serve as a portal for a range of information related to the triparty repo market.

The Problem of Fire Sales While eliminating the daily unwind and reducing reliance on intraday credit will materially reduce the potential for a recurrence of many of the problems evident during the financial crisis, other vulnerabilities will remain.

A particular concern of the Federal Reserve, and also reflected in the Financial Stability Oversight Council's most recent annual report, involves the challenge of managing the collateral of a defaulting securities dealer in an orderly manner. As I noted earlier, the situation could be further complicated by the fact that many cash lenders are highly risk averse, subject by regulation or prospectus to stringent limitations on their portfolio holdings, and may have limited operational capacity to manage collateral.

As a result, they would likely be inclined to quickly liquidate securities that they had obtained from a failed dealer, creating the potential for a fire sale that could destabilize markets and propagate shocks across the financial system. A solution to this fire sale problem likely requires a marketwide collateral liquidation mechanism.

The challenges in designing and creating a robust mechanism--which would almost certainly need the capacity to fund a significant volume of collateral for some period of time--are appreciable, and include assuring adequate liquidity resources even under adverse market conditions and developing rules for the allocation of any eventual losses across market participants. Such capabilities typically exist today in the context of clearing organizations that have a formal membership structure, which allows for capital assessments and the sharing, or "mutualization," of potential losses.

How this model might be adapted to a market more loosely organized around clearing banks, particularly in which certain less-liquid collateral types continue to be funded, remains unclear and will surely need to be the focus of much additional study. Conclusion Given the importance of the triparty repo market and the vulnerabilities that were so evident during the financial crisis, enhancing the market's resiliency and its settlement system is an important regulatory and financial stability priority.

Building on the work of the task force, we believe that supervisory efforts will yield substantial progress in eliminating the reliance of the triparty repo market on intraday credit, although perhaps not as quickly as many of us had hoped, and in improving risk-management practices across a range of market participants.

A significant remaining challenge, however, is the development of a process to liquidate in an orderly fashion the collateral of a defaulting dealer that would operate reliably in the context of a settlement system organized around clearing banks. Thank you once again for the invitation to appear before you today to share the perspectives of the Federal Reserve on these important issues.

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The Fed was looking for broader reform, perhaps an overhaul of the entire tri-party system. Reducing the intraday credit extension by the clearing banks was really just shifting risk from the clearing banks back to the cash investors and collateral providers. In the end, no one particular group was willing to agree voluntarily increase their share of the credit risks. The recommendations by the Task Force, though helpful, were not the complete overhaul of the system that the Fed had in mind.

The Fed disbanded the Task Force at the end of By February of , the Fed let it be known they were still unhappy about the lack of progress in tri-party reform. They informed the market they were considering placing restrictions on the tri-party market and for much of the Fed asked dealer banks to voluntarily reduce their use of tri-party financing.

The Fed has a point. It is a risk. However, remember the cash investors receive a haircut on the value of the securities and those securities are priced by an independent source, the clearing bank. The haircut is supposed to take into account the volatility and liquidity of the underlying collateral. All in all, the Fed has identified risks inherent in the tri-party infrastructure and market participants are adopting reforms to address the risks, but the end result will be just shifting risks from one group of participants to another.

Remember, during each progression and attempt to eliminate the risk for one group, that risk is not disappearing , it is just shifting from one group to another. The risk of the cash investors should be priced in the haircuts taken as margin on the trades. In essence, the Fed is saying the money funds are not pricing their haircuts correctly.

It would be a better reform to require larger haircuts on illiquid and hard to price securities than to force a whole market into a tri-party Repo CCP with the taxpayers ultimately guaranteeing it.

The regulators need to help make the markets free, efficient and transparent, rather than take the inefficiencies of few and force others to share them. An additional side benefit will be that this will delever a highly levered financial system. It did have several major drops followed by a very mild recovery just above the recession line. Japan is in the same boat, but to a lesser extent.

It maybe a stale year to slightly negative for global economy.