Common use of Opacity Clause in Contracts

Opacity. Lack of data on aspects of the repo market, including rates and volume, added to uncertainty during the crisis. Subsequently, the Fed and the Office of Financial Research (OFR) have attempted to gather more comprehensive data. The Fed has long published data on repos involving primary dealers (large Treasury security dealers), and in 2010 began publishing data on triparty repos. In 2019, OFR issued a rule to collect data on repos cleared by FICC. Since 2018, the Fed has published data on key repo rates, such as the Secured Overnight Financing Rate. Regulators still do not collect comprehensive data on all types of repos, however. Under EPR, large banks are subject to new liquidity rules. Some, but not all, of the securities dealers active in repo markets are owned by large banks. Certain rules already implemented make large banks less reliant on short-term borrowing. However, the Net Stable Funding Ratio rule— which would directly limit their use of repos—has not been regulation changed how repos were netted when a failing G-SIB is resolved to maintain its value. The Fed also intervenes in repo markets to conduct monetary policy. Called open market operations, the Fed uses repos and reverse repos to affect overall liquidity and target the federal funds rate, its primary monetary policy target. Traditionally, the Fed’s repo counterparties have been the primary dealers. In 2013, the Fed created a standing facility called the Overnight Reverse Repurchase Operations Facility to expand its operations to more counterparties. (At this facility, the Fed is the cash borrower.) The Fed also provides reverse repos to foreign official institutions as part of its services to them. During the financial crisis, the Fed intervened heavily in repo markets to restore overall liquidity. Because of the severity of the crisis, this intervention alone could not restore liquidity for all firms, and the Fed was forced to lend directly to securities dealers and others. Changes following the crisis in how monetary policy is conducted had ended the Fed’s use of repos (but not reverse repos). However, the Fed has regularly used repos again since a spike in repo rates in September 2019. Repos remain an inherently unreliable source of funding in a crisis, even if large banks are less reliant on them following postcrisis reforms. The Fed can intervene in repo markets to restore overall market liquidity, but it cannot ensure all nonbank borrowers individually have access to liquidity because it does not provide repos directly to borrowers on demand. Nevertheless, borrowers may rely more heavily on repos because they believe the Fed will step in during a crisis, which economists call moral hazard. A more specific source of systemic risk is a scenario where a major securities dealer involved in the repo market faces a liquidity crisis. This could cause a fire sale of the dealer’s assets if the dealer tried to raise cash or if the dealer failed and its repo counterparties sold its collateral to recoup cash. Fire sales could impose losses on unrelated investors holding similar assets, spreading financial instability. The greater reliance on triparty and cleared bilateral repos since the crisis reduces overall risk but increases the systemic importance of the firms at the heart of those transactions—BoNYM and FICC, respectively. Were either firm to fail, it could destabilize financial markets because their role in repo markets could not easily and quickly be replaced. Policymakers debate whether enhanced prudential regulation has successfully contained the systemic risk posed by the banks and FMUs subject to it. Repos are not uniformly regulated—the market itself is not regulated and the different types of participants face varying requirements governing their borrowing and lending. This complicates systemic risk regulation and transparency. Most recent reforms to repo practices were voluntary (e.g., penalties for fails) and thus potentially calibrated from a user—instead of a policy—perspective.