JPMorgan repo retreat shows cost of rule changes
US bank winds down GCF business; concern over BNY Mellon dominance.
JPMorgan’s decision to wind down its government securities settlement business for certain broker dealers and banks in the US – part of which includes settling repurchase agreements known as general collateral finance, or GCF, repos – could leave the GCF repo market almost entirely controlled by just one bank: Bank of New York Mellon.
GCF repos make up around 9% of the wider $1.6 trillion tri-party repo market and differ from other tri-party repo arrangements because the trades are centrally cleared. Broker dealers and banks use the GCF repo market for short-term funding by pledging high-quality assets as collateral – typically US treasuries or agency bonds.
While JPMorgan’s move, announced in July, will not affect all of its clients, its effective retreat from this nook of the repo market underscores a broader dilemma: that tougher regulatory rules introduced in the wake of the financial crisis are prompting banks to quit low-risk but capital-intensive businesses that are vital for keeping cash flowing around the system.
“It’s almost a no-brainer for banks to look to reduce their systemic importance and one way would be to get out of things like the GCF repo market, assuming the profitability of that business is less than the cost of capital,” says Pri de Silva, a senior analyst at CreditSights.
Dominance a deterrent
The leverage ratio requirement makes the relative cost of capital too high for low-margin activities such as repos because all assets are treated the same. The systemically important bank buffer, which US regulators use for total loss-absorbing capacity (TLAC) purposes, is another factor because it means big banks need to hold more debt as well as more capital.
BNY Mellon’s repo market dominance is also a deterrent for other providers to step in. The bank’s market share was already roughly 80% to 85% before JPMorgan said it would exit its government securities settlement business.
“There have been multiple attempts over the last 10 years by different groups to think about setting up a new tri-party activity or a new clearing business for repo, but none of this has happened,” says Josh Galper, managing principal at Finadium, a research and advisory firm. “The reality is it will be very difficult for a new repo clearing group to come in and compete with BNY Mellon on the GCF platform.”
That is making some people uncomfortable. A lack of competition in the GCF market could push trading costs higher, but it also emphasizes systemic concerns about BNY Mellon’s dominance in the wider tri-party repo market.
“If BNY Mellon were ever to experience any grave operational problems leaving it unable to be the main US tri-party agent then that could significantly affect the funding operations of the majority of broker dealers, not just in US but worldwide, as well as the investment activities of all repo investors, which includes every money market fund,” says Galper.