Fed official sees benefits in U.S. repo market clearing

By Jonathan Spicer

NEW YORK (Reuters) - Introducing central clearing to tri-party and bilateral repo trading could help reduce "fire sales" and liquidity risks, and add more transparency to sometimes murky U.S. markets, a top Federal Reserve official said on Tuesday.

Fed Governor Jerome Powell, among the U.S. central bank's top financial supervisors, said regulators should be open to more clearing of government and agency-backed debt in particular given the heightened need for banks to hold safer assets.

The comments appeared to lay the groundwork for formal proposals as the Fed and other agencies tackle one of the last areas of reform following the 2007-2009 financial crisis.

"In the right setting central clearing can produce significant benefits including reduced credit and liquidity risks, improved default management and reduced risk of fire sales, greater transparency and improved risk management," Powell, one of five Fed governors, told a conference of bankers, traders and regulators hosted by The Clearing House group.

A clearinghouse stands between parties to trades and fills obligations in the event of default. Regulators globally have ramped up clearing of financial assets following the crisis, in which even the short-term overnight repo markets proved vulnerable to investor panic and runs.

The $1.5-trillion market for tri-party repurchase agreements, where banks or dealers pledge securities to funds for cash, does not have clearing. Nor does the bilateral repo market.

An umbrella U.S. regulator, the Financial Stability Board, has asked agencies to consider expanding clearing in these markets.

"Regulators should be open to emerging clearing solutions where they provide substantial benefits" and can meet certain standards, Powell said, noting regulations "require financial institutions to hold high-quality collateral under the assumption that it can be quickly converted to cash."

He added that not every repo security should be cleared, particularly the less liquid ones. But he said clearing could address the fire sale risk in which counterparties unwilling to hold large positions "strong incentives to sell assets quickly regardless of the price received."

The clearinghouse, he said, would dispose the portfolio of a defaulted member and transfer, hedge or auction off its positions over time.

(Reporting by Jonathan Spicer; Editing by Meredith Mazzilli)

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