Antoine Martin and Susan McLaughlin of the Federal Reserve Bank of New York recently published a short two-part series discussing the history of the tri-party repo market.
As discussed in the articles, the tri-party repo arrangement was pioneered in the late 1970s by Salomon Brothers and its Treasury securities clearing bank, Manufacturers Hanover, as a means to reduce inefficiencies (i.e., costs) associated with financing Salomon Brothers’ positions in Treasury securities. The tri-party arrangement allowed Salomon Brothers and its lenders to settle the transfer of securities and cash directly on the books of Manufacturers Hanover, without the use of Fedwire. During the mid-1980s, a series of dealer defaults on repo contracts under a “hold-in-custody” arrangement (a different arrangement that was developed to reduce inefficiencies associated with delivering collateral) caused large losses for repo lenders and led to the widespread adoption of the tri-party arrangement. Subsequent operational developments, including the Bank of New York’s automation of settlement that provided for nearly simultaneous transfers of cash and securities, created further efficiencies in the tri-party repo market, and, as a result, enhanced liquidity in Treasury securities.
Tri-party repos arrangements were eventually expanded beyond Treasury securities to include agency mortgage-backed securities, asset-backed securities, corporate bonds, equities and other asset classes. Together with certain legal changes and financial innovation in the mid-2000s, the tri-party repo market grew nearly four-fold between 2002 to its peak in 2008. Martin and McLaughlin argue that tri-party repos backed by riskier assets increase the risk of fire sales in the repo market and, along with their colleagues Brian Begalle and Jamie McAndrews, have published a staff paper that more specifically discusses the risks and risk management of fire sales in the tri-party report market. Importantly, as mentioned in our previous post on market reforms, the FRBNY recently cited the risk of fire sales as a remaining policy concern.
The two-part series can be found here: Part One and Part Two.
Good Day. Interesting History. DR2.