- All regulated financial institutions should have access to Fed liquidity, including: money market funds, banks, broker-dealers, FCMs, and even hedge funds.
- The Fed can haircut the funding based on the type of institution and it’s capital. A small hedge fund might have access to Fed funding with a 5% haircut on U.S. Treasurys and a double A-rated global bank might only have to pay a 0.25% haircut.
- The allowable collateral for Fed funding should be greatly expanded and the haircuts adjusted accordingly.
4. Repo/Funding Market Reorganization
There’s a growing problem in the Repo/funding markets because they’re fragmented – there are multiple CCPs (FICC and LCH.Clearnet), multiple tri-party clearers, clearing banks, and still many trades done direct. The solution is to move funding onto an exchange. Imagine a central execution and clearing exchange where cash providers and collateral providers meet? Say a hedge fund needs financing for investment grade corporate bonds, they could access that funding through the exchange. The cash provider (money market fund) is on the other side of the transaction, but the exchange stands in the middle.
Exchange traded funding is two steps beyond current central clearing counterparties. Not only is funding centrally cleared, but it’s also centrally executed and all market participants have access.
The Repo/funding trades, futures contracts, stocks, and bonds could also be cross-marginable. Think of it like “portfolio margining” for bank funding. By adding funding into a central exchange, not only would it create a more efficient market, but also be another financial instrument to offset risk, not to mention the benefits of having an exchange counterparty for regulatory capital charges. Being short a 2-year note in the Repo market can partially offset any number of long futures contracts.
Of course, for collateral to trade on an exchange, pricing must be more standardized, so there needs to be a global securities pricing system . . .
5. Global Mark-To-Market Pricing
These days, liquid and exchange traded financial instruments are easy to price. The pricing problem arises with lower grade paper or securities with complicated structures – like CDOs. If all CCPs, clearing banks, and exchanges could accept a wide variety of collateral for Repo/funding purposes and for margin pledging, there must be a standardized pricing service. In addition, consider the benefits to regulators from a continuous global pricing system. Here’s how it’s done:
- Securities pricing becomes a rolling cycle – meaning there’s no end-of-day. With all the advancements in computerization and trade processing systems, there’s no need for the day to end. Once a time zone, like Asian the markets, close they continue to submit prices into the global pricing system.
- Regulators, exchanges, CCPs and clearing banks collect margin and run reports continually during the global cycle. For example, if markets move in Asia early in their business day, U.S. banks would be required to deliver margin within a specified time period, perhaps within 2 hours.
- Underwriters would be required to price all securities they underwrite and submit the prices to the global pricing network throughout the day. For securities not on the global pricing system, there would be increased regulatory capital charges and much larger haircuts for pledging them as margin.
- Securities in the global pricing system then could be completely fungible as margin held at exchanges and CCPs. Both the collateral and haircuts could be standardized, something like 0.25% for AAA-rated sovereigns and 2% for investment grade equities. This would also eliminate much of the anticipated problems being created by regulatory demand for higher grade collateral.
I hope you find these ideas interesting and I welcome your comments.