Dermot Turing

Mr.Manmohan Singh

Changes to the regulatory system introduced after the financial crisis include not only mandatory clearing of OTC derivatives at central counterparties and margining of uncleared derivatives, but also prudential measures, including notably a “Liquidity Coverage Ratio” which obliges firms to set aside high-quality liquid assets (HQLA) as a stopgap against anticipated cash outflows. We examine factors which may affect the demand for HQLA in a severely stressed market following a hypothetical default of a major clearing member. Immediately following a major default, the amount of HQLA demanded by the whole market would spike. We estimate the size of the spike and draw conclusions as to whether the depth of the market is adequate to absorb it.

The Morning After--The Impact on Collateral Supply After a Major Default

In recent years, many money and repo rates in the United States have been between zero and 25 basis points. As Fed’s liftoff approaches, the question of the level of these rates (and the markets that determine them) becomes increasingly important. The paper discusses (i) whether the Fed can control short–term rates as it starts to tighten; and (ii) what are the advantages and disadvantages of using asset sales versus a large reverse repo program (RRP). A large RRP by the Fed will deprive the financial system of the money pool (i.e., GSEs and money market funds) as the Fed will directly absorb the money on to its balance sheet. This will rust the financial plumbing that connects the money pool to collateral suppliers. Some asset sales may be preferred to a large RRP as this will result in a market-determined repo rate and will allow the Fed to reach its monetary policy liftoff objectives with minimal footprint on market plumbing. We also discuss cost of issuing short tenor T-bills relative to a large RRP in a rising rate environment.

Mr.Manmohan Singh

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