The hidden pipes of finance may be furring up

JPMorgan’s pullout of tri-party repo market shows impact of banks reshaping their business models

Gillian Tett .

A decade ago JPMorgan Chase looked like a financial octopus: its tentacles reached into almost every part of the Wall Street money machine. But some of those tentacles are now being trimmed.

Take the tri-party repurchase (repo) market — the corner of modern finance where banks and others raise short-term loans backed by collateral while entities such as mutual funds use it to park their cash.

Until now, JPMorgan has been a linchpin of this $1.6tn sector, since it settled and cleared these deals, acting as a bridge between clients. Its only rival was the mighty Bank of New York Mellon. But a couple of weeks ago JPMorgan bankers revealed that they plan to withdraw from this market by the end of 2017 to focus on more profitable activities. This leaves the crucial tri-party repo sector almost exclusively in the hands of Bony; John Pierpont Morgan might be spinning in his grave.
Nobody outside Wall Street has yet paid much attention. To most people the tri-party repo sector is akin to household plumbing — deeply unglamorous and easy to ignore unless the system breaks down and creates a mess.

But, just like plumbing, it matters a great deal whether or not tri-party repo works. When the market seized up in 2008, this created panic among banks, investors and the companies that rely on it for funds. And right now there are at least three reasons why we should pay attention to JPMorgan’s move.

First, and most obviously, it underscores the pressure on all investment banks — including even the supposedly successful ones — to rethink their business models as financial reforms bite and interest rates sink ever lower. A decade ago it would have been hard to imagine a world where JPMorgan abandoned tri-party repo — just as it was hard to picture Goldman Sachs creating a retail bank. Now all manner of taboos are tumbling on Wall Street.

Second, the move also raises questions about the structure of tri-party repo itself. Since JPMorgan announced its withdrawal, US regulators have been trying to reassure financiers and company treasurers that Bony will be able to manage the transition in a calm, orderly way and that it is aware of its systemic responsibilities.

Perhaps so. Bony appears to be a strong bank. But it looks odd to have such an important corner of finance organised as a monopoly in the hands of a private-sector bank. After all, Wall Street is supposed to promote free-market competition and regulators are supposed to dislike concentrations of risk.

So, if nothing else, this shift calls for a wider debate. In the wake of the 2008 financial crisis, the New York Federal Reserve introduced reforms to make the market function more effectively. It should go further and ask whether it is time to use a big industry-owned utility to settle and clear trades instead, such as the Depository Trust & Clearing Corporation; alternatively, it could encourage new entrants or look at other solutions.

But the third crucial point that JPMorgan’s move highlights is the degree to which some of the hidden pipes of finance may be furring up as the banks reshape their business models. The US repo market (of which the tri-party piece is one part) is $2.2tn, according to a review by the Securities Industry and Financial Markets Association, with a similarly large market in Europe. That sounds impressively big. However, daily turnover is about half the level of a decade ago partly because there is less demand for credit, but also because of a reduction in the numbers of brokers and others who organise deals or provide inventories of collateral.

That might not matter immediately; the market is functioning fairly smoothly. But the Bank of England has just published a sobering piece of research suggesting that, if another financial shock hits, it may be hard for the industry to obtain enough high-quality collateral to borrow funds. This, in turn, might cause the wider financing channels in the repo world and elsewhere to freeze in potentially dangerous ways. Models suggest this tipping point is reached if the Vix index — a gauge of investors’ expected volatility — remains at 44 per cent for three months.

Thankfully, there is no sign that this is imminent. The Vix is extremely low, and funding is flowing through the financial channels smoothly, in the tri-party repo world and elsewhere. But it is better to do a safety check on a plumbing system before a crisis hits rather than when there is a nasty blockage.

JPMorgan’s move could be a perfect excuse for regulators and bankers on both sides of the Atlantic to start a wider debate about the repo world. They should use it.

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