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IntroductoryRemarksatWorkshopon"FireSales"asaDriverofSystemicRiskinTriPartyRepoand OtherSecuredFundingMarkets
October4,2013

WilliamC.Dudley,PresidentandChiefExecutiveOfficer RemarksatWorkshopon"FireSales"asaDriverofSystemicRiskinTriPartyRepoandOtherSecured FundingMarkets,FederalReserveBankofNewYork,NewYorkCity


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Goodmorning.Iampleasedtohavetheopportunitytoopenthisworkshopanddiscusskeydevelopmentsin thetripartyrepomarket.Inmyremarks,Iwouldliketogiveabriefoverviewofsomeoftheproblemsthat surfacedinthismarketduringthefinancialcrisisof2008,recognizetheimprovementsthathaveoccurredsince then,andmostimportantly,highlightsignificantvulnerabilitiesthatstillpersistdespitetheprogresswehave made.Whilewecanfeelproudoftheenhancementsthatarecurrentlyunderwayinthetripartyrepomarket, todayIwanttounderscorethefactthatsignificantworkremainstobedone. ThetripartyrepomarketconstitutesavitalcomponentoftheU.S.financialsystem.Itplaysanimportantrolein providingfinancingforbrokerdealersthatmakemarketsinTreasuryandagencysecurities,andisanimportant mechanismthatsupportsdealerintermediationofcredit.Themarketalsoprovidesasecureinvestmentvehicle forthosethatmanagelargeamountsofliquidityandneedaninvestmentvehicletoparkthesemonies.Wecare aboutthehealthandstabilityofthetripartyrepomarketbothbecauseofourinterestinpromotingstableand liquidfinancialmarketsandbecauseweuseittoimplementmonetarypolicy. Therecentfinancialcrisisshowedusthatthetripartyrepomarketwasinherentlyunstableduetodeficienciesin thesettlementinfrastructure.Priorto2008,therewaslimitedrecognitionofthewaysinwhichadverse developmentsinthismarketcouldquicklytransmitrisktootherpartsofthefinancialsystemwithunforeseen consequences.Wenowknow,withthebenefitofhindsight,thatthemarketwasoverlyreliantonmassive extensionsofintradaycreditbytheclearingbankstothebrokerdealers,thatmarketparticipantsdidnot adequatelyappreciatethemagnitudeoftheriskembeddedintheroleplayedbytheclearingbanks,and,asa result,marketparticipantsunderpricedriskinwaysthatunderminedthemarketsresiliencyduringperiodsof stress. Thesevulnerabilitiesweremadeapparentinthespringof2008whentheeventssurroundingBearStearns demonstratedtherunriskthatexistedmorebroadlyinthetripartyrepomarket,promptingtheFederalReserve tointerveneinordertorestoreconfidenceandmarketfunctioning.Thisinterventiontooktheformofthecreation ofaPrimaryDealerCreditFacilityinMarch2008,andasubsequentexpansionofthefacilityinSeptember 2008.Thescopeandscaleofthemarketdisruptionwereclearlyverytroublesome. Asmanyofyouareaware,theFederalReserveBankofNewYorkpublishedawhitepaperinMay2010that highlightedthreecriticalsourcesofinstabilityassociatedwithpracticesinthetripartyrepomarket:(1)the marketsexcessiverelianceonintradaycreditfromtheclearingbanks(2)weaknessesintheliquidityandcredit riskmanagementpracticesofcashlendersandclearingbanksthatleftthemvulnerabletostressenvironments and(3)thelackofamechanismorprocessforliquidatingcollateralduringperiodsofstressinamannerthatdid notdestabilizeothersegmentsofthefinancialsystem. Afterthecrisis,weaskedtheindustrytohelpdevelopaplantoreengineerthetripartyreposettlement infrastructuretomitigatetheserisks.Theindustryrespondedbyidentifyingkeychangesthatcouldbemadeto theplatformtoeliminatemarketrelianceonintradaycredit,therebyremovingakeysourceoffragilityobserved in2008.Thisprocesswaschallengingattimes,andultimatelyrequiredourinterventionasasupervisorto moveforward.Buttheindustrysuccessfullydevelopedaroadmapforreformthatisthebasisforthechanges nowbeingimplemented.Theclearingbanksaremakingsubstantialinvestmentstoreengineertheirtriparty reposettlementprocesses,whilelendersandborrowersaremakingadjustmentstotheirbusinesspracticesand technologiestoensuretheyarereadyforchangesthatareoccurringinthemarket.Whencompletedattheend
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ofnextyear,weexpectthatthesechangeswillsubstantiallyimprovethestabilityofthemarket.Indeed,the workcompletedtodatehasalreadyreducedtheamountofactivitybeingfinancedonanintradaybasisfrom 100percenttoabout70percent,andweprojectthatintradaycreditusagewilldeclinetonomorethan10 percentbytheendofnextyear.Byremovingtheclearingbankfromtheroleofsubstantialintradaylender,and makingtripartyrepurchaseexposurestrulybilateral,weexpectthatmarketparticipantswillhavebetter incentivestomanagetheirliquidityandcreditrisksmoreprudently. Whilethesechangesrepresentpositivedevelopmentsthatwillenhancethestabilityofthetripartyrepomarket, animportantchallengeremains.Currentreformsdonotaddresstheriskthatadealerslossofaccesstotri partyrepofundingcouldprecipitatedestabilizingassetfiresales,whetherbythedealeritself,orbythedealers creditorsfollowingadefault.Industryparticipantshaveyettofullyembracetheroletheymustplayinfindinga solutiontothisproblem.Asaresult,Iwouldurgeindustryparticipantstobeginworkonthisissuewithoutfurther delay.Infact,thisisoneofthemotivationsforconveningtodaysworkshoptostartthedialogue. Asseveralofthespeakerswilldiscussingreaterdetailtoday,whenfiresalesoccurtheycanunderminethe stabilityofothermarketsbeyondthetripartyrepomarket.Thetransmissionofinstabilitytypicallyoccursasa consequenceofincreasedmargincallsandmarktomarketlossesthatstrainfirmsliquidityandcapitalpositions andputadditionalpressureonfirmstofurtherdeleverage.Suchscenarioscanhavematerialadverse repercussionsonothermarketsegmentsandmarketparticipants. Itisvitalthatwetakestepstoaddressthisrisknow,duringaperiodwhenmarketsarefunctioningwithout stress,inordertoimprovetheresiliencyofthismarketbeforethenextcrisisoccurs.Thisisespeciallyimportant inlightoftheheightenedthresholdestablishedbytheDoddFrankActforfuturecentralbankinterventionsinthe eventofamarketdisruption.Evenifthisconstraintdidnotexist,theexperienceoftherecentfinancialcrisishas servedtostrengthenourresolvetoensurethatthemarketisstructuredinawaywhereriskisaccuratelypriced andresilienttostressonadaytodaybasis,withouttheneedforofficialsectorinterventionasafirstresort. Asmanyofyouknow,theFederalReservehasbeencallingforactiononthisissueoverthepasttwoyears, andallthreeFinancialStabilityOversightCouncilannualreportshavehighlightedthisasasignificantissue worthyofourattention.However,thediversityofparticipantsinthetripartyrepomarkethasmadeitdifficultto moveforwardquicklywithamarketsolutionthataddressestheriskIhaveoutlined.Industryleadershipis absolutelycriticaltoovercomingthesechallenges.Ifindustryisunabletoplayitsroleinachievingaholistic solution,regulatorsmayfindthemselvesforcedtoemploythespecificpolicytoolsattheirdisposalintheir respectivepurviewstoaddressthefiresalerisk.Whilesuchanapproachmayindeedenhancetheoverall stabilityofthismarket,itcouldalsoleadtounintendedconsequencesthatincludereducingtheefficacyofthe criticalroleplayedbythismarketinsupportingthebroaderfinancialsystem. Iamgladthatyouareallheretodaytoworkwithustobegintoidentifythebestsolutionstotheproblemoffire saleriskinthecontextofthetripartyrepomarket.Iurgeyoutoparticipateactivelyandexpressyourideas candidly.Iamconfidentthatwewillcomeupwiththebestsolutiontothisproblembyworkingtogether.

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