Just a stupid question, if the clearinghouses keep encouraging transaction volume and low reserves doesn’t that mean that they are setting the scene to become the counterparties at some point in the future if margin can’t be posted? In other words.... aren’t you on to “Big Short” territory?
Correct me if I’m wrong, but in tri-party repo the clearing house is like an escrow agent ), but is not an insurer of the transaction, so not a counterparty.
I think clearing houses take repayments up front, so in the event of a repo borrower’s insolvency, the clearing house simply completes the transaction on behalf of the insolvent borrower and no one loses money on the deal. But as an escrow agent, the clearing house has no risk, so no incentive to manage the risk for the borrower/lender.
What I THOUGHT I heard, using different terminology, is that the tri-party repo market has essentially transferred risk management to the agent (clearing house) and away from the repo trading partners.
The problem with this is that the clearing house (agent) is incentivized to increase transactions (and fees) and has no incentive to manage risk. So margin limits are set lower to increase transactions, but lower margins allows more leverage--increasing risk. So, basically, tri-party repo risk management is an illusion.
Just a stupid question, if the clearinghouses keep encouraging transaction volume and low reserves doesn’t that mean that they are setting the scene to become the counterparties at some point in the future if margin can’t be posted? In other words.... aren’t you on to “Big Short” territory?
Nope... when you run out of capital you basically haircut other members. Clearinghouses cant lose..
Correct me if I’m wrong, but in tri-party repo the clearing house is like an escrow agent ), but is not an insurer of the transaction, so not a counterparty.
I think clearing houses take repayments up front, so in the event of a repo borrower’s insolvency, the clearing house simply completes the transaction on behalf of the insolvent borrower and no one loses money on the deal. But as an escrow agent, the clearing house has no risk, so no incentive to manage the risk for the borrower/lender.
Is this right?
https://www.bis.org/publ/qtrpdf/r_qt1812x.htm
Have a read
Good article- thank you.
Correct- except it doesnt work anymore. Nickel was one example. Nordic power another. Gilts would have been the same wothout BOE
What I THOUGHT I heard, using different terminology, is that the tri-party repo market has essentially transferred risk management to the agent (clearing house) and away from the repo trading partners.
The problem with this is that the clearing house (agent) is incentivized to increase transactions (and fees) and has no incentive to manage risk. So margin limits are set lower to increase transactions, but lower margins allows more leverage--increasing risk. So, basically, tri-party repo risk management is an illusion.
Is this restatement basically correct?
Yes. I take it a step further and say that it basically guarantees a crisis as the market becomes bifurcated
Thank you
Great reminder piece of the cracks that we have seen but have been papered over.