The Present Value

ISDA highlights a selection of research papers on derivatives and risk management         


The Dynamics of the US Overnight Triparty Repo Market

FEDS Notes
By Mark E. Paddrik, Carlos A. Ramirez and Matthew J. McCormick

This note explains the dynamics of the overnight segment of the US triparty repo market by providing an overview of market participants, collateral, intraday trading, pricing and clearing.

A repo transaction involves the sale of assets combined with an agreement to repurchase them on a specified future date at a prearranged price. Triparty repo transactions are bilaterally negotiated and settled through a clearing bank. Overnight triparty repos represent about 80% of daily traded volume of the US triparty repo market across all collateral classes.

The note points out that primary dealers, non-primary dealers and commercial banks account for the majority of cash borrowers, while collective investment vehicles (mostly money market funds), securities lenders and commercial banks represent the majority of cash lenders. Almost all participants act only as either a cash lender or a cash borrower. The Federal Reserve is the only major participant that trades on both sides of the market.

The composition of market participants varies over the course of the day. Among cash lenders, government-sponsored enterprises and securities lenders tend to trade in the first half of the day, while commercial banks make up most of the later trades. Among cash borrowers, non-primary dealers participate only in the first half of the day, while the Federal Reserve’s reverse repo facility has historically made up a large portion of activity during the second half of the day.

In a repo transaction, assets underlying the repo are used as collateral to protect cash lenders against the risk that cash borrowers fail to return the cash. Most overnight triparty repos are collateralized with US Treasury and agency securities. The perceived credit quality and liquidity of collateral plays an important role in intraday trading behavior.

As overnight triparty repos are over-the-counter transactions, trading relationships can impact the terms of transactions. The note demonstrates that participants with more relationships tend to receive more favorable rates and haircuts than participants with fewer relationships.

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Climate Stress Testing

Federal Reserve Bank of New York Staff Reports
By Hyeyoon Jung, Robert Engle and Richard Berner

This paper develops a methodology to stress test the resilience of financial institutions to climate-related risks and introduces a measure of systemic climate risk (CRISK), which is the expected capital shortfall of a financial institution in a climate stress scenario.

Climate change could impose systemic risk to the financial sector through either disruption
of economic activity resulting from the physical impacts of climate change (physical risks) or changes in policies as the economy transitions to a less carbon-intensive environment (transition risks).

The stress testing methodology consists of three steps: 1) measuring the climate risk factor; 2) estimating climate betas of financial institutions; and 3) computing CRISK, which is
a function of a firm’s size, leverage and expected equity loss conditional on climate stress.

The authors apply this stress-testing procedure to estimate the climate risks of 27 large global banks during the collapse in fossil fuel prices in 2020. The study demonstrates a substantial rise in climate betas and CRISKs and finds that banks with a higher loan exposure to the oil and gas industry tend to have higher climate betas.

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On the Market Structure of Central Counterparties in the EU

By Gabrielle Demange and Thibaut Piquard

This paper describes the business models of central counterparties (CCPs) and provides some insights on the market structure of central clearing in the EU.

The authors demonstrate that CCPs in the EU differentiate on several dimensions, including geographic, product line and quality of clearing services. Additionally, CCPs compete based on fees, collateral requirements, access criteria for new members and scope of products eligible for clearing.

The structure of fees differs across CCPs, which are based not only on total amounts, but also on the portion of fixed and variable costs. The quality of the insurance provided against counterparty risk results from collateral requirements, access criteria for new members and the scope of products. Increasing the scope of products attracts new transactions and directly affects the opportunities for cross-netting provided by CCPs.
The paper also analyzes how pairs of dealers choose which CCP to clear a given transaction. The analysis shows that CCP choice is affected by transaction size, fees, the riskiness of CCPs and market volatility. The authors argue that collateral costs don’t determine the choice of CCP.

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