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Shadow banking: Repo CCPs, anyone?

Recommendation 10 of the Financial Stability Board’s Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos instructs local authorities to "evaluate, with a view to mitigating systemic risks, the costs and benefits of proposals to introduce CCPs [central counterparties] in their inter-dealer repo markets where CCPs do not exist. Where CCPs exist, authorities should consider the pros and cons of broadening participation."

US repo markets have not yet embraced CCPs; rather participants can trade bilaterally or via the $1.5 trillion tri-party market, where custodian clearing banks JPMorgan and Bank of New York Mellon intermediate between counterparties handling collateral selection, payment and settlement, custody and management during the life of the transaction. These commercial bank clearers have proven themselves susceptible to runs during aggregate shocks, and US regulators continue to express concern about the risk of contagion from fire sales.

Meanwhile, European repo markets have already made extensive use of CCPs, with up to 40% of the market being cleared with CCPs since 2008, according to a 2012 International Capital Markets Association report, although the real number in terms of turnover might be closer to 50% as most electronically cleared trades roll off overnight and are not captured by the Icma survey.

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