Repo a potential threat to financial stability
19 November 2018 Washington DC
Image: Shutterstock
The vulnerability of repos poses potential threats to financial stability, according to a Financial Year (FY) 2018 report released by the Office of Financial Research (OFR).
The report to Congress, released on 15 November, presented the OFRās assessment of the state of the US financial system, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The FY 2018 report stated overall risks to US financial stability remain in a medium range, as it has found for several years.
With regards to repo, the OFR said: ācomprehensive and detailed data are scant for about half of the US repo marketā and also stated ādata gaps persist regarding securities financing transactions, including repos and securities lendingā.
Concerning this, the OFR issued a proposed rule to collect data regarding transactions in the market for repo and said it is also exploring ways to learn more about uncleared bilateral
repos.
The OFR said the repo collection will help to meet the need for a āviable alternativeā to the London Interbank Offered Rate (LIBOR).
The OFR said: āThe attempted manipulation of LIBOR during the financial crisis and ongoing doubts about LIBORās reliability, have led to efforts to devise a reliable, widely accepted, and transparent alternativeā.
It added: āThe OFR worked closely with the Federal Reserve to design a set of three interest rate benchmarks based on data on overnight repos, which may form the basis of a future replacement for LIBOR.ā
The Alternative Reference Rates Committee, an industry group convened by the Federal Reserve Board and Federal Reserve Bank of New York, named the Secured Overnight Financing Rate (SOFR) as its preferred alternative to US dollar LIBOR.
Of this, the OFR said it is ācontinuing to work closely with the Federal Reserve Bank of
New York to oversee the production of the new rates and ensure they accurately represent what they are intended to measure.ā
It also agreed the successful launch of SOFR laid the groundwork for progress on alternative rates.
It stated: āBuilding on this progress, cleared futures referencing the SOFR launched in May 2018, and swaps referencing the SOFR launched in July 2018, achieving important steps in the reference rate committeeās Paced Transition Plan, ahead of schedule.ā
Elsewhere, the OFR found that risks from solvency and leverage remain low, for the most part, even though āsome large banks, insurers, and hedge funds could be vulnerable to severe stressā.
It said, similarly, funding and liquidity risks are low overall, āthanks to favourable borrowing conditions and high liquidity buffers for most banksā.
Based on its research, OFR predicted that if the economy remains healthy, market volatility will āprobably stay lowā but said it could not rule out a shift to very high volatility, because of financial market indicators that are currently high from a historical standpoint.
OFR stated funding and liquidity conditions are generally good with funding conditions from
lenders and markets continue to support corporate borrowing.
The research firm said: āGiven banksā special role in the financial system, we are primarily concerned with monitoring their funding and liquidity risks. For large banks, funding and liquidity risks appear to be low. These banks maintain ample liquidity buffers to survive at least 30 days of stress.ā
OFR also found total hedge fund borrowing increased from $1.9 trillion at the end of 2015 to more than $2.8 trillion by June 2018.
Data indicated that the total amount of hedge fund borrowing is significant, had grown recently, and is mostly concentrated among a few borrowers. The 10 largest hedge fund borrowers account for nearly 40 percent of all hedge fund borrowing, the OFR found.
According to the OFR, derivatives exposures are still a source of ācontagion riskā throughout the financial system āstemming from interconnections among counterparties in financial transactionsā.
It also stated cybersecurity risks remain a concern, to which it said: āThe digital assets are commonly known as cryptocurrencies, although not a concern at this point, is worth monitoring because their use is rapidly growing and evolving.ā
The report to Congress, released on 15 November, presented the OFRās assessment of the state of the US financial system, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The FY 2018 report stated overall risks to US financial stability remain in a medium range, as it has found for several years.
With regards to repo, the OFR said: ācomprehensive and detailed data are scant for about half of the US repo marketā and also stated ādata gaps persist regarding securities financing transactions, including repos and securities lendingā.
Concerning this, the OFR issued a proposed rule to collect data regarding transactions in the market for repo and said it is also exploring ways to learn more about uncleared bilateral
repos.
The OFR said the repo collection will help to meet the need for a āviable alternativeā to the London Interbank Offered Rate (LIBOR).
The OFR said: āThe attempted manipulation of LIBOR during the financial crisis and ongoing doubts about LIBORās reliability, have led to efforts to devise a reliable, widely accepted, and transparent alternativeā.
It added: āThe OFR worked closely with the Federal Reserve to design a set of three interest rate benchmarks based on data on overnight repos, which may form the basis of a future replacement for LIBOR.ā
The Alternative Reference Rates Committee, an industry group convened by the Federal Reserve Board and Federal Reserve Bank of New York, named the Secured Overnight Financing Rate (SOFR) as its preferred alternative to US dollar LIBOR.
Of this, the OFR said it is ācontinuing to work closely with the Federal Reserve Bank of
New York to oversee the production of the new rates and ensure they accurately represent what they are intended to measure.ā
It also agreed the successful launch of SOFR laid the groundwork for progress on alternative rates.
It stated: āBuilding on this progress, cleared futures referencing the SOFR launched in May 2018, and swaps referencing the SOFR launched in July 2018, achieving important steps in the reference rate committeeās Paced Transition Plan, ahead of schedule.ā
Elsewhere, the OFR found that risks from solvency and leverage remain low, for the most part, even though āsome large banks, insurers, and hedge funds could be vulnerable to severe stressā.
It said, similarly, funding and liquidity risks are low overall, āthanks to favourable borrowing conditions and high liquidity buffers for most banksā.
Based on its research, OFR predicted that if the economy remains healthy, market volatility will āprobably stay lowā but said it could not rule out a shift to very high volatility, because of financial market indicators that are currently high from a historical standpoint.
OFR stated funding and liquidity conditions are generally good with funding conditions from
lenders and markets continue to support corporate borrowing.
The research firm said: āGiven banksā special role in the financial system, we are primarily concerned with monitoring their funding and liquidity risks. For large banks, funding and liquidity risks appear to be low. These banks maintain ample liquidity buffers to survive at least 30 days of stress.ā
OFR also found total hedge fund borrowing increased from $1.9 trillion at the end of 2015 to more than $2.8 trillion by June 2018.
Data indicated that the total amount of hedge fund borrowing is significant, had grown recently, and is mostly concentrated among a few borrowers. The 10 largest hedge fund borrowers account for nearly 40 percent of all hedge fund borrowing, the OFR found.
According to the OFR, derivatives exposures are still a source of ācontagion riskā throughout the financial system āstemming from interconnections among counterparties in financial transactionsā.
It also stated cybersecurity risks remain a concern, to which it said: āThe digital assets are commonly known as cryptocurrencies, although not a concern at this point, is worth monitoring because their use is rapidly growing and evolving.ā
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