## 1usaea2020006 ## Source details **Canonical URL:** [1usaea2020006](https://www.imf.org/-/media/files/publications/cr/2020/english/1usaea2020006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1usaea2020006.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1usaea2020006.pdf.json) --- ### Overview - The heterogeneity of the United States (U.S.) financial markets and complex regulatory and supervisory institutional setup underscore the importance of enhancing systemic risk oversight and building effective macroprudential tools. - An effective framework would: - ensure interagency sharing of information; - identify possible emerging regulatory gaps; - obtain an overview of systemic risks; and - develop a cooperative framework to address identified threats to financial stability. - The Technical Note reviews these processes in the United States and examines systemic liquidity. - Analytical work was largely carried out before the global intensification of the COVID-19 outbreak; on-site work was conducted during February 18–March 5, 2020. The note was factually updated based on information available as of May 15, 2020. - FSOC composition and monitoring: - FSOC continues to play a key role in identifying threats and coordinating regulatory responses of member agencies. - FSOC composition: 10 voting members and 5 non-voting members. - The Systemic Risk Committee (SRC) meets monthly; all FSOC member agencies participate on the SRC. ### Key findings on systemic risk oversight - Communications and reporting - The FSOC annual report provides a comprehensive discussion of the financial risk landscape with particular attention to structural vulnerabilities. - The FRB Financial Stability Report and the OFR annual report are complementary. - FSOC communication and effectiveness could be improved through: - release of more detailed minutes; and - improved traceability of actions taken to address identified vulnerabilities. - FSOC approach and data gaps - FSOC’s final interpretive guidance prioritizes an activities-based approach to identifying/addressing financial stability risks in the nonbank sector; entity designation remains possible. - Significant data gaps remain, including those on collateralized loan obligations (CLOs) and repurchase transaction (repo) market activity. - Toolkit adequacy - Tools to address structural vulnerabilities in the banking system are generally sufficient. - Coverage of the Countercyclical Capital Buffer (CCyB) should be extended to improve effectiveness. ### Money markets, Fed balance sheet, and structural vulnerabilities - Fed balance sheet effects and market structure - A key structural driver of money markets has been the Federal Reserve System’s (Fed) balance sheet changes. - The Fed responded to interest rate spikes and volatility in September 2019 by restarting regular Open Market Operations (OMOs) and reversing some reduction in reserves since 2014. - The Fed decreased reserve balances by about US$1.25 trillion from the peak in 2014 to the September 2019 trough—a reduction of almost 50 percent. - Bank behavior and intermediation - Fewer reserves exposed vulnerabilities from post-crisis regulatory tightening and tighter bank liquidity risk management frameworks. - Banks have become more conservative and highly averse to borrowing from the Fed’s Window, producing a less flexible set of large intermediaries less able or willing to provide liquidity when conditions tighten. - Reserves are now concentrated at GSIBs. ### COVID-19 crisis response and market resilience - Fed actions (sequence of major measures as of end March 2020): - Policy announcements: - Feb 28: FOMC statement to use tools as appropriate. - Mar 3: FOMC cuts Fed Funds target range by 50 basis points to 1-1.25 percent. - Mar 15: FOMC cuts Fed Funds target range by 100 basis points to 0-0.25 percent. - Mar 23: FOMC announces open-ended commitment to purchase US Treasury and Agency MBS securities. - Open Market Operations (selected actions): - Mar 9: Overnight repos increased to $150 bn per day and 2 week repo operations to $45 bn twice weekly. - Mar 11: Overnight repos increased to $175 bn per day and new $50 bn one month repo operations announced. - Mar 12: Three month repo operations introduced of $500 bn and one month operations increased to $500 bn. - Mar 15: FOMC announces intention to increase US Treasury and Agency MBS holdings by $500 b and $200 bn respectively. - Mar 16: New $500 bn afternoon daily overnight repo operation introduced, morning overnight repo OMO increased to $500 bn. - Other policy announcements: - Mar 15: Primary Credit rate cut to 0.25 percent and Reserve Requirements eliminated. - Mar 15: Interest rate on FX swap lines cut to 0.25 percent and new weekly 84 day US $ operations begin by recipients. - Mar 19: Fed expands its swap line network to include nine additional countries. - New liquidity facilities under FRA 13-3: - Mar 17: Primary Dealer Credit and Commercial Paper Funding facilities established. - Mar 18: Money Market Mutual Fund Liquidity facility established. - Mar 20: MMLF expanded to include state and municipal securities. - Mar 23: Primary and Secondary market Corporate Credit & the Term Asset Backed Securities Loan facilities established. - Mar 31: Foreign & International Monetary Authorities Repo facility established. - Effectiveness - Market resilience was severely tested in March–April 2020 but market pressures were quickly contained, supported by a plethora of timely Fed actions. - Initial experience suggests market pressures were quickly contained; much of the March impact was an announcement effect given few facilities were immediately operational. ### Operational and structural recommendations (selected) - FSOC and systemic risk oversight - Improve traceability of actions taken to address identified vulnerabilities (¶12). Timing: ST. Agency: FSOC. - Ensure each FSOC member has an explicit financial stability objective in their mandate (¶13). Timing: MT. Agency: Congress. - Upgrade the State Insurance Commissioner member to a voting member (¶14). Timing: MT. Agency: Congress. - Intensify efforts to close data gaps, including reporting disclosures of holdings of CLOs and leveraged loans (¶15). Timing: ST. Agency: FSOC/OFR. - Complete OFR recruitment for key positions and skills (¶15). Timing: ST. Agency: OFR. - Encourage FSOC members to prioritize development of macroprudential tools to address risks in the nonbank sector (¶28). Timing: Ongoing. Agency: FSOC. - Provide an overview of how the new activities-based approach will be operationalized (¶29). Timing: I. Agency: FSOC. - Consider extending the CCyB to Category IV banks (¶31). Timing: MT. Agency: FRB. - Systemic liquidity and money markets - Promote fungibility of Treasury securities and Reserves by adjusting assumptions about firms’ access to the Discount Window in liquidity metrics (¶78). Timing: ST. Agency: Fed, OCC, FDIC. - Continue operating regular fine-tuning OMOs (¶80). Timing: I. Agency: Fed. - Include repo rates explicitly in the Fed’s operational target and focus on a single policy rate (¶82 & 83). Timing: ST. Agency: Fed. - Examine merits of an appropriately priced standing repo facility (¶84). Timing: ST. Agency: Fed. - Develop robust backup plans if BNYM cannot settle and clear repo transactions (¶90). Timing: MT. Agency: Fed. - Enact legislation to restore power to provide bilateral liquidity assistance to designated systemically important nonbanks (¶86). Timing: MT. Agency: Congress. - Advance preparedness for providing liquidity to systemic nonbanks and Central Counterparties (CCPs) during stress situations (¶87). Timing: ST. Agency: Fed, Treasury. - Develop a more comprehensive framework to guide market-wide liquidity support in securities markets (¶88). Timing: MT. Agency: Fed, Treasury. - Develop FX liquidity provision protocols (¶89). Timing: MT. Agency: Fed, Treasury. - Cross-cutting - Authorities to set hard targets with deadlines for firms to transition to SOFR and consider applying regulatory powers to encourage faster preparations; provide guidance on standards for new SOFR products (¶91). Timing: I. Agencies: Fed, OCC, FDIC, SEC, CFTC. ### Structural and market infrastructure considerations - BNYM concentration and tri-party repo - Bank of New York (BNYM) plays a unique role in clearing and settlement and in the conduct of the FRBNY’s repo OMOs. - 60 percent of repos were against US Treasury securities over 2019 (FRBNY data). - Share of repo trading by segment in 2019 (percent): - Tri-party: 30% - GCF: 10% - Sponsored: 2% - Bilateral (estimate based on 2014 share): 49% - Recommendations: - Establish robust backup plans to preserve market functioning if BNYM experiences problems. - Consider repo transactions settling across FRBNY systems and accounts as an option. - Cleared repo growth - Demand for cleared repo is increasing; IDTA members estimated daily turnover at US$150–200 billion per day from April 2018–February 2019 (around a fifth of the total repo turnover used to calculate the SOFR benchmark). - The uncleared bilateral repo market is widely understood to comprise around half of total activity. ### Activities-based approach to nonbank financial companies - Intent and scope - Shift from entity-focused to activities-based assessment (final interpretive guidance, late 2019). - Activities-based framing questions: - (i) What are the triggers that could give rise to a potential financial stability risk? - (ii) How is this potential risk transmitted to other parts of the financial system? - (iii) What is the magnitude and breadth of the spillover effects? - (iv) Could cumulative adverse effects impair the financial system and harm the U.S. economy? - Engagement and escalation - FSOC will engage primary regulators to mitigate risks; may issue non-binding recommendations (DFA s120) subject to a cost-benefit test. - If inadequate, FSOC may consider entity-specific designation (DFA s113) as a last resort; such designations are subject to cost-benefit analysis and an assessment of likelihood of material financial distress. - Challenges - Cost-benefit analysis requirements could constrain timely FSOC action due to difficulty estimating costs and probabilities of extreme events. - Risk that individually non-systemic activities, when combined across an entity, are missed. - Activities outside the regulatory perimeter (for example dominant payment service providers) may pose systemic threats with no primary regulator to act. ### Macroprudential priorities and sectoral recommendations - Mortgage finance and GSEs - Of the US$11 trillion in residential mortgages, US$3.6 trillion (33 percent) is held by banks, representing 20 percent of banking sector assets. - Over half of the mortgages are originated by nonbank mortgage companies. - Recommendation: take a holistic approach to GSE capital regime, mortgage underwriting and insurance standards, and lending restrictions; consider integrating macroprudential elements (for example debt service ratio standards or CCyB-like elements into GSE capital requirements). - Asset management / mutual funds - SEC should require mutual funds to perform liquidity stress tests as part of liquidity risk management. - Asset managers should align redemption frequencies with asset liquidity. - SEC could consider mandatory liquidity buffers for mutual funds exposed to liquidity risk. - CCyB and coverage - FRB framework for implementing the CCyB (issued 2016) applies to banks with more than US$250 billion in assets (categories I–III). - Current CCyB coverage is 70 percent of banking assets; extending to Category IV banks would increase coverage by another 10 percent of banking assets. ### Discount Window, liquidity backstops, and operational readiness - Discount Window characteristics and usage - Legal basis: Federal Reserve Act Section 10(B) and Regulation A. - Primary Credit priced at 50 basis points over the top of the Fed funds target range (as of March 9); Primary Credit available on a “no questions asked” basis to depository institutions in sound condition. - Secondary Credit at a further 50 basis point margin above Primary Credit. - Discount Window loans must be collateralized; a very broad set of collateral may be used. - Usage was low prior to March 2020; heavy stigma inhibits use even when economically sensible. - Liquidity support to CCPs and nonbanks - CCPs designated by FSOC have access to Fed liquidity in extremis under Title VIII of the DFA, but practical operational arrangements are not fully developed. - Bilateral liquidity support to other nonbanks is constrained by DFA and FRA; Section 13-3 authority interpreted to require broad-based facilities (available to five or more entities), preventing bilateral support like in the GFC. - Recommendations for legal and operational enhancements - Enact legislation to restore the power to provide bilateral liquidity assistance to designated systemically important nonbanks (¶86). Timing: MT. Agency: Congress. - Prepare operational requirements for providing designated CCPs with liquidity; establish procedures for FX liquidity support to banks and nonbanks. - Develop capacity to conduct repo OMOs in the absence of BNYM (¶90). Timing: MT. Agency: Fed. - Develop FX liquidity provision protocols (¶89). Timing: MT. Agency: Fed, Treasury. ### Regulatory drivers, demand for reserves, and operational framework adjustments - Regulatory impacts - Post-GFC prudential regulation and internal liquidity frameworks reduced incentives to intermediate liquidity and increased cash hoarding. - Relevant constraints include the supplementary leverage ratio (SLR), the GSIB surcharge, liquidity stress test requirements, and resolution funding requirements. - Regulatory drivers of reserves demand (Box 3) - OFR workforce reduced in 2018 by approximately 110 employees — a more than 50 percent reduction; OFR expected to employ up to 145 people once fully staffed. - Drivers affect both the level and slope of the reserves demand curve; net observed effect: shift right and steepening increasing both demand for reserves and volatility of money market rates. - Recommendations for Fed operational framework - Retain regular OMOs once conditions stabilize to provide liquidity certainty. - Promote fungibility of Treasury securities and Reserves by adjusting assumptions about firms’ access to the Discount Window (¶78). Timing: ST. Agency: Fed, OCC, FDIC. - Include repo rates explicitly in the Fed’s operational target; consider expressing a single policy rate as the level at which both the ONRRP and IOER rates are set (¶82). - Examine merits of a standing repo facility only if efforts to destigmatize Discount Window fail; design tradeoffs include pricing vs stigma and counterparty access. - Consider IOER quota or tiering systems as used by New Zealand and Norway to stabilize reserve demand (design complexity acknowledged). ### Repo market specifics and key statistics - Market size and turnover - The repo market is the largest globally and central to channeling liquidity and funding; repo market turnover is at least US$2.9 trillion a day. - Turnover in FX swaps involving the U.S. dollar is around US$2.9 trillion per day. - The Fed funds market typically trades between US$40–80 billion per a day. - Corporate paper outstanding was around US$1,149 billion as at the end of January 2020. - Market composition and maturities - Much repo activity is overnight, but perhaps a third to a half is for longer maturities up to six months. - Tri-party repo is around a third of the market and relies on BNYM; bilateral repo comprises about half of the market. - Cleared bilateral repo (sponsored repo) is relatively small but fast growing. ### FSAP 2015 recommendations follow-up (selected) - Systemic risk oversight - Recommendation to supplement member mandates with an explicit financial stability mandate: Current status: Not Implemented. - Recommendation for FSOC to publish more on monitoring framework and SRC: Current status: Not Implemented. - Recommendation to publish follow-up actions with responsibilities and timelines for material threats: Current status: Partially implemented. - Systemic liquidity and market infrastructure - Recommendation to reduce reliance on the two clearing banks and consider settlement in central bank funds: Current status: Not implemented (reforms 2010–2016 achieved matching before settlement and reduced intraday credit to less than 1 percent secured and committed). - Recommendation to review repo safe harbors: Current status: Not implemented. - Liquidity backstops - Recommendation for a Fed facility available from 3 p.m. to address unexpected shortfalls: Current status: Partially implemented (Primary and Secondary Credit available until Fedwire close; discussions of standing repo facility ongoing). - Recommendation to review broad-based eligibility for Fed liquidity support to allow individual designated nonbanks: Current status: Not implemented (13-3 final rule limits activity to programs with broad-based eligibility). *United States: Executive Summary — Technical Note (FSAP) — International Monetary Fund.* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Overview - The heterogeneity of the United States (U.S.) financial markets and complex regulatory and supervisory institutional setup underscore the importance of enhancing systemic risk oversight and building effective macroprudential tools. - An effective framework would encompass identification and prioritization of system-wide risks and vulnerabilities to spur timely policy action and would include structures that: - ensure interagency sharing of information; - identify possible emerging regulatory gaps; - obtain an overview of systemic risks; and - develop a cooperative framework to address identified threats to financial stability. - The Technical Note reviews these processes in the United States and examines systemic liquidity. - Analytical work was largely carried out before the global intensification of the COVID-19 outbreak; on-site work was conducted during February 18–March 5, 2020. The note was factually updated based on information available as of May 15, 2020. - The FSOC continues to play a key role in identifying threats to U.S. financial stability and coordinating regulatory responses of member agencies. - FSOC composition: 10 voting members and 5 non-voting members. - The Systemic Risk Committee (SRC) meets monthly to monitor and analyze financial markets, the financial system, and issues related to financial stability; all FSOC member agencies participate on the SRC. ### Key Findings on Systemic Risk Oversight - The FSOC annual report provides a comprehensive discussion of the financial risk landscape with particular attention to structural vulnerabilities. - The Financial Stability Report issued by the Board of Governors of the Federal Reserve System (FRB) and the OFR annual report are complementary communications and analyses. - FSOC communication and effectiveness could be improved through: - release of more detailed minutes; and - improved traceability of actions taken to address identified vulnerabilities. - The FSOC’s final interpretive guidance now prioritizes an activities-based approach to identifying and addressing financial stability risks in the nonbank sector; this approach still allows for designation of entities and aligns with international practices. - Significant data gaps remain, including those on collateralized loan obligations (CLOs) and repurchase transaction (repo) market activity. - Tools to address structural vulnerabilities in the banking system are generally sufficient, but coverage of the Countercyclical Capital Buffer (CCyB) should be extended to improve effectiveness. ### Money Markets, Fed Balance Sheet, and Structural Vulnerabilities - A key structural driver of money markets has been the Federal Reserve System’s (Fed) balance sheet changes. - The Fed responded to interest rate spikes and volatility in September 2019 by restarting regular Open Market Operations (OMOs) and reversing some reduction in reserves since 2014. - Fewer reserves revealed vulnerabilities from a nexus of post-crisis regulatory tightening and tighter bank liquidity risk management frameworks. - Banks have become more conservative and highly averse to borrowing from the Fed’s Window, producing a less flexible set of large intermediaries less able or willing to provide liquidity when conditions tighten. ### COVID-19 Crisis Response and Market Resilience - Market resilience was severely tested in the March–April COVID-19 crisis period but was backstopped by a plethora of timely Fed actions. - The Fed: - quickly scaled up OMOs and outright purchases of securities; - improved terms and accessibility of the Discount Window; - enhanced and widened its network of central bank FX swap lines; and - deployed a range of old and new liquidity support programs aimed at backstopping money and securities markets. - Initial experience suggests market pressures were quickly contained. - Market resilience could be bolstered further by: - retaining regular OMOs once conditions stabilize to provide liquidity certainty; - giving banks a better basis to plan to access the Discount Window to discourage reserves hoarding; - broadening the Fed’s operational target to include repo rates to reduce uncertainty. ### Operational and Structural Recommendations (selected) - FSOC and Systemic Risk Oversight - Improve traceability of actions taken to address identified vulnerabilities (¶12). Timing: ST. Agency: FSOC. - Ensure each FSOC member has an explicit financial stability objective in their mandate (¶13). Timing: MT. Agency: Congress. - Upgrade the State Insurance Commissioner member to a voting member (¶14). Timing: MT. Agency: Congress. - Intensify efforts to close data gaps, including reporting disclosures of holdings of CLOs and leveraged loans, to reinforce market discipline (¶15). Timing: ST. Agency: FSOC/OFR. - Complete OFR recruitment for key positions and skills as quickly as possible (¶15). Timing: ST. Agency: OFR. - Encourage FSOC members to prioritize development of macroprudential tools to address risks and vulnerabilities in the nonbank sector (¶28). Timing: Ongoing. Agency: FSOC. - Provide an overview of how the new activities-based approach will be operationalized (¶29). Timing: I. Agency: FSOC. - Consider extending the CCyB to Category IV banks (¶31). Timing: MT. Agency: FRB. - Systemic Liquidity and Money Markets - Promote the fungibility of Treasury securities and Reserves by adjusting assumptions about firms’ access to the Discount Window in liquidity metrics (¶78). Timing: ST. Agency: Fed, OCC, FDIC. - Continue operating regular fine-tuning OMOs (¶80). Timing: I. Agency: Fed. - Include repo rates explicitly in the Fed’s operational target and focus on a single policy rate (¶82 & 83). Timing: ST. Agency: Fed. - Examine the merits of an appropriately priced standing repo facility (¶84). Timing: ST. Agency: Fed. - Develop robust and effective backup plans in the event BNYM is not able to settle and clear repo transactions (¶90). Timing: MT. Agency: Fed. - Develop capacity to conduct repo OMOs in the absence of BNYM (¶90). Timing: MT. Agency: Fed. - Enact legislation to restore the power to provide bilateral liquidity assistance to designated systemically important nonbanks (¶86). Timing: MT. Agency: Congress. - Advance preparedness for providing liquidity to systemic nonbanks and Central Counterparties (CCPs) during stress situations (¶87). Timing: ST. Agency: Fed, Treasury. - Develop a more comprehensive framework to guide market-wide liquidity support in securities markets (¶88). Timing: MT. Agency: Fed, Treasury. - Develop FX liquidity provision protocols (¶89). Timing: MT. Agency: Fed, Treasury. - Other Cross-Cutting Issues - Authorities to set hard targets with deadlines for firms to transition to SOFR and consider applying regulatory powers to encourage faster preparations; authorities to provide more guidance on standards for use in new SOFR products (¶91). Timing: I. Agencies: Fed, OCC, FDIC, SEC, CFTC. ### Structural and Market Infrastructure Considerations - The authorities and market participants should address the sole provider vulnerability in government securities settlement and triparty repo markets. - Bank of New York (BNYM) plays a unique role in clearing and settlement and in the conduct of the FRBNY’s repo OMOs. - Focus should be on establishing robust and effective backup plans to preserve market functioning in the unlikely event of BNYM problems. - One option is considering repo transactions settling across the Federal Reserve Bank of New York’s (FRBNY) systems and accounts, as is common internationally. - The Alternative Reference Rates Committee (ARRC) and the authorities have made great strides on the LIBOR to SOFR transition, but more needs to be done: - Firms need to move from planning to transition to SOFR to actually moving business to the new benchmark. - Authorities should play a more proactive role with time-bound deadlines and firm targets to ensure firms move business before LIBOR cessation. ### Legal and Operational Enhancements for Liquidity Backstops - Liquidity backstops would be bolstered if the Fed could lend bilaterally to designated systemically important nonbanks; the ability to provide bilateral liquidity support to an individual designated systemically important nonbank should be reinstated in the law. - The Fed’s liquidity support tools could be enhanced if: - operational requirements for providing designated CCPs were fully prepared; and - procedures for providing FX liquidity support to both banks and nonbanks were better established. *United States: Executive Summary — Technical Note (FSAP) — International Monetary Fund.* ### 7. The FSOC annual report provides a rich and comprehensive discussion of the financial ### 1usaea2020006 - 7. The FSOC annual report provides a rich and comprehensive discussion of the financial ### Coverage of financial stability reports and focus areas - FSOC annual report (2019) discusses cybersecurity, CCP resilience, short-term wholesale funding markets, LIBOR transition, and nonbank mortgage origination and servicing. - FSOC report contains recommendations and a section on regulatory developments and FSOC activities, but these are not tied back to previously identified vulnerabilities. - FRB Financial Stability Report (semi-annual; first issued November 2018) covers cyclical issues across four categories: - (i) asset valuations (covering a wide range of asset classes from farmland to financial assets); - (ii) borrowing by businesses and households; - (iii) financial sector leverage (including bank and nonbank financial institutions); - (iv) funding risks (assessing the functioning of core funding markets, liquidity conditions of banks, and liquidity and maturity mismatches in nonbanks). - OFR annual report structures assessment around categories: macroeconomic, market, credit, solvency and leverage, funding and liquidity, and contagion. - OFR publishes quarterly updates of its Financial System Vulnerabilities Monitor with a heat map of 58 indicators. ### FSOC structure, duties, and authorities (Box 1 summary) - FSOC duties and objectives include: - Facilitate regulatory coordination and identify gaps in regulation (statutory duty to provide forum for discussion and resolution of jurisdictional disputes). - Facilitate information sharing and coordination (collect information and coordinate among member agencies and other Federal and State agencies). - Take an activities-based approach to identifying and assessing financial stability risk. - Designate nonbank financial companies for consolidated supervision and enhanced prudential standards (DFA Section 113). - Designate systemic Financial Market Infrastructures (FMIs) and systemic payment, clearing, or settlement activities (DFA s804); eight FMUs have been designated. - Recommend stricter standards (DFA s120) and make formal recommendations to primary regulatory agencies. - Take action regarding firms that pose a “grave threat” to financial stability (affirmative vote role; no actions taken under this provision to date). - Designated FMUs listed in the source: Clearing House Payments Company LLC; Continuous Linked Settlement Bank International (CLS); Chicago Mercantile Exchange (CME); Intercontinental Exchange Clear Credit LLC (ICE); Depository Trust Company (DTC); Fixed Income Clearing Corporation (FICC); National Securities Clearing Corporation (NSCC); Options Clearing Corporation. - FSOC Committees include: Deputies Committee; Data Committee; Financial Market Utilities and Payment, Clearing, and Settlement Activities Committee; Nonbank Financial Companies Designations Committee; Regulation and Resolution Committee; Systemic Risk Committee. ### Data sharing, OFR resourcing, and gaps - FSOC has improved data sharing through interagency MoUs; OFR maintains the FSOC Interagency Data Inventory to catalog data collections and analyze gaps and overlaps. - Procedures exist to expedite ad-hoc data sharing where no pre-existing MoU exists. - OFR began publishing data from its new survey on cleared repo transactions. - Other FSOC members have gathered data on leveraged loans, CLOs, and nonbank mortgage lending to support systemic risk analysis. - Data gaps remain related to these activities; recommendations emphasize intensifying efforts to close gaps. - OFR staffing and funding (text and Figure 1): - OFR workforce reduced in 2018 by approximately 110 employees — a more than 50 percent reduction. - OFR is in the process of hiring and, once fully staffed, is expected to employ up to 145 people. - Note: Figure 1 indicates OFR staffing and funding time series for 2014–2019 (data presented visually in the source). ### Key recommendations (Section B) - Improve FSOC communication and effectiveness: - Release more detailed minutes and improve traceability of actions taken to address identified vulnerabilities. - Annual report should be structured to allow matching identified stability risks with actions being considered or already taken by members. - Where possible, identify specific actions being considered by member agencies to mitigate identified potential systemic risks and link subsequent actions back to identified vulnerabilities. - Consider releasing more detailed minutes of Principals’ meetings that are not open to the public (three non-public meetings in 2019 and seven in 2018), weighing transparency benefits against risks of disclosing supervisory and market-sensitive data. - Strengthen member mandates: - Recommend each member agency be provided with an explicit objective to promote financial stability as it relates to that member’s work on the FSOC, to reinforce focus and incentivize actions to address stability risks. - Insurance sector representation: - Recommendation to upgrade the State Insurance Commissioner member to a voting member, noting current representation: an independent voting member with insurance expertise, the Director of the Federal Insurance Office (non-voting), and a State Insurance Commissioner (non-voting). Of these, only the State Insurance Commissioner has supervisory authority over insurers. - Intensify efforts to close data gaps: - Collect additional repo data covering the bilateral non-cleared market to complement existing data. - Collect data on leveraged loans, CLOs, and residential mortgages originated and serviced by nonbanks. - OFR should complete recruitment for key positions and skills as quickly as possible following its restructuring. ### Toolkit for addressing systemic risks — adequacy and gaps - Tools are distributed across FSOC members; FSOC-level tools include: - Authority to issue recommendations for new or heightened regulatory standards (DFA s120). - Designate nonbank financial companies for consolidated supervision (DFA s113). - Designate systemically important financial market utilities or payment, clearing and settlement activities (DFA s804). - Noted gap: United States lacks borrower-based tools in the housing sector (stands out among peers). - Banking system tools: - Structural resilience tools include the GSIB capital surcharge and enhanced capital and liquidity standards for large banks (category I and II banks). - Cyclical tools include the Countercyclical Capital Buffer (CCyB), applicable to large internationally active banks; CCyB was introduced in 2013 and has not been activated since introduction. - FRB framework for implementing the CCyB issued in 2016; applies to banks with more than US$250 billion in assets (categories I–III). - FRB considers a wide range of indicators for CCyB, including asset valuation pressures, risk appetite, leverage, and maturity and liquidity transformation. - Concerns that CCyB activation could lead to migration of credit activity to banks not subject to CCyB or to nonbanks. - One view: because of high through-the-cycle capital requirements, it is appropriate to set the CCyB at zero in a normal risk environment, which could be most of the time. - Stress Capital Buffer (SCB): - SCB includes supervisory stress test losses, four quarters of planned common stock dividends, and the GSIB buffer. - Two components potentially acting countercyclically: (i) stress scenarios (gap between current economic conditions and stress scenario); (ii) planned dividends (higher planned dividends when conditions are good). - Macroeconomic stress scenarios appear less effective as a countercyclical tool than the requirement to pre-fund dividends and share buybacks. - Reducing the pre-fund requirement to four quarters, instead of nine, might have reduced the countercyclical nature of the stress tests. ### FSOC’s new activities-based approach to nonbank financial companies - Final interpretive guidance (late 2019) shifts FSOC approach from entity-focused to activities-based assessment of nonbank financial companies. - Activities-based approach aims to: - More effectively identify and address underlying sources of risk to financial stability on a system-wide basis. - Reduce possible competitive market distortions resulting from entity-specific designations. - First step: ongoing activities-based assessment of nonbank financial entities with framing questions: - (i) What are the triggers that could give rise to a potential financial stability risk (e.g., sharp reductions in asset prices or large credit losses)? - (ii) What is the manner or mechanism in which this potential risk is transmitted to other parts of the financial system? - (iii) What is the magnitude and breadth of the spillover effects from this risk to other companies and markets? - (iv) Could the cumulative adverse effects of the potential risk impair the financial system and harm the U.S. economy? - Engagement and escalation: - When an activity poses a potential risk, FSOC will engage with relevant state and federal financial regulators to leverage existing regulatory authority to mitigate risks. - If actions taken by relevant regulators are inadequate, FSOC may publicly issue non-binding recommendations to relevant regulators (DFA s120), now subject to a cost-benefit test under the final interpretive guidance. - FSOC will conduct a cost-benefit analysis prior to making a final recommendation in cases where the primary regulator would not be expected to perform such an analysis. - If activities-based measures do not adequately address risks, FSOC may consider entity-specific designation (DFA s113) as a last resort; such designations are now subject to both a cost-benefit analysis and an assessment of the likelihood of the nonbank financial company’s material financial distress. - Under Section 113(f) of the DFA, FSOC may waive or modify procedural requirements related to nonbank designations if necessary or appropriate to prevent or mitigate threats to U.S. financial stability. *Source: Excerpt from the IMF United States FSAP chapter provided in the supplied PDF content.* ### 24. The activities-based approach to identifying risks to financial stability is in line with ### 24. The activities-based approach to identifying risks to financial stability is in line with ### Activities-based approach — intent and scope - Intended to identify and address risks to financial stability on a system-wide basis, regardless of the type of entity, regulatory body, or charter. - Aims to reduce potential for regulatory arbitrage and competitive disadvantages across entities and sectors. - Allows existing regulatory entities (for example, the state insurance regulators) to address potential threats to financial stability rather than have an additional regulator (i.e., the FRB) involved. - Under the “final interpretive guidance,” risks to financial stability that can be assessed include: - elevated asset valuation risk, - rising credit risk, - excessive leverage, - elevated liquidity risk, - interconnectedness across the financial sector, - growth of unregulated financial activities, - operational risks including those arising from the digital transformation of the financial sector. ### Challenges and constraints - Restriction on the use of DFA s120 and s113: - The new restriction is a potential barrier to the FSOC’s ability to issue recommendations to primary regulators or undertake entity-specific designation. - Cost-benefit analysis under the final interpretive guidance requires calculating: - the expected costs if a financial stability risk is triggered (challenging; requires strong assumptions about impacts on other financial institutions, markets, and the economy), - an estimate of the probability of the trigger occurring (exceptionally difficult given the large number of extreme but plausible events). - Concern: the process must not constrain the FSOC from responding to identified risks within a timeframe that allows mitigation. - Identifying collective systemic importance from multiple activities: - The activities-based approach could miss situations where multiple non-risky individual activities, collectively, are systemically important. - Example: a nonbank financial institution with high leverage and reliance on short-term wholesale funding performing multiple intermediary activities may not show systemic risk when each activity is assessed individually, yet combined failure could cause cascading market failures (example cited: Lehman Brothers). - Activities outside the regulatory perimeter: - Payment service providers not subject to state or federal prudential regulation could, if dominant in payments intermediation, pose significant systemic risk if disrupted. - In such cases there may be no primary financial regulator to gather information or take action, yet FSOC must report gaps in regulation (DFA s112(a)(2)(G)). ### Recommendations — macroprudential priorities and specific actions - FSOC should encourage members to prioritize development of macroprudential tools for the nonbank sector, with high priority on tools to address systemic risks from high corporate leverage. - Mortgage finance system changes — opportunity to embed macroprudential elements: - Of the US$11 trillion in residential mortgages, US$3.6 trillion (33 percent) is held by banks, representing 20 percent of banking sector assets. - Over half of the mortgages are originated by nonbank mortgage companies. - Authorities (including the CFPB, Treasury, and FHFA) are considering changes (CFPB: qualified mortgage definition; Treasury/FHFA: options for ending conservatorship of Fannie Mae and Freddie Mac). - Recommendation: take a holistic approach to GSE capital regime, mortgage underwriting and insurance standards, and lending restrictions; consider integrating macroprudential elements (e.g., debt service ratio standards or integration of CCyB-like element into GSE capital requirements). - Asset management / mutual fund liquidity risk (consistent with stress testing work during the FSAP): - SEC should explicitly require mutual funds to perform liquidity stress tests as part of their liquidity risk management program. - Asset managers should be required to align redemption frequencies more closely with asset liquidity. - SEC could consider mandatory liquidity buffers for mutual funds exposed to liquidity risk. - FSOC procedural and transparency recommendations: - FSOC should, as soon as possible, provide more detail on how the new activities-based approach will be operationalized; the Deputies Committee has approved a process and a summarized but sufficiently detailed description should be communicated to the public. - FSOC should be transparent about its use of the activities-based approach in its annual report: identify potential risks being considered, describe ongoing engagement with relevant regulators, and outline actions taken or planned by primary regulators and the FSOC. - FRB capital buffer extension: - FRB should consider extending the CCyB to Category IV banks. - Current limitation of CCyB to Category I–III banks results in 70 percent of banking asset coverage; extending to Category IV banks would increase coverage by another 10 percent of banking assets. - Extension would reduce risk of migration of credit activity to other large banks and increase efficacy of the instrument. - This approach aligns with recommendation to consider extending the LCR and the Net Stable Funding Ratio to all large banks. ### Money market vulnerabilities and backstops — key findings - Systemic liquidity risk definition and amplification: - Systemic liquidity risk: the risk that multiple institutions simultaneously face liquidity difficulties; if not contained, can lead to solvency concerns and propagate via financial interconnectedness. - Drivers of systemic liquidity vulnerabilities: - Maturity mismatches and foreign exchange mismatches increase vulnerabilities (funding liquidity risk and market liquidity risk); FX mismatches compound vulnerabilities since central banks can more easily backstop domestic currency shortfalls. - Structure and importance of U.S. money markets: - U.S. credit intermediation occurs primarily in markets; banks hold about one-fifth of financial system assets, while nonbanks are heavy users of markets for funding and liquidity management. - Key liquidity market statistics and facts: - The Fed funds market typically trades between US$40–80 billion per a day. - Turnover in FX swaps involving the U.S. dollar dominates global FX swap market turnover at around US$2.9 trillion per day. - Corporate paper outstanding was around US$1,149 billion as at the end of January 2020. - The repo market is the largest globally and central to channeling liquidity and funding; repo market turnover is at least US$2.9 trillion a day. - The uncleared bilateral repo market is widely understood to comprise around half of total activity. - Much repo activity is overnight, but perhaps a third to a half is for longer maturities up to six months. - Repo market participants and structure: - Cash lenders: fund and asset managers and other liquid nonbank financial institutions (for example foreign central banks). - Cash borrowers: primary dealers, hedge funds, and other smaller broker-dealers who use repo to finance securities holdings or matched repo books. - Money market funds play an especially prominent role as key cash investors via overnight repos. - Smaller broker-dealers notably participate in the cleared FICC DVP repo market; a group of larger such entities (IDTA) estimated their members’ daily turnover at US$150–200 billion per day from April 2018–February 2019 (around a fifth of the total repo turnover used to calculate the SOFR benchmark). - Repo market segments: - Tri-party repo is around a third of the market and relies on BNYM for clearing and settlement infrastructure; includes non-centrally cleared tri-party repo and General Collateral Finance (GCF) repo novated to the FICC. - The bilateral repo segment comprises half of the market. - There is a robust DVP centrally-cleared market and a relatively small but fast growing cleared bilateral repo segment in the DVP market called sponsored repo (transactions negotiated bilaterally but settled at the FICC through settlement agents/guarantors). *Source: 1usaea2020006 - 24. The activities-based approach to identifying risks to financial stability is in line with* ### 43. While a wide range of securities are used as collateral, Treasury, and agency securities ### 43. While a wide range of securities are used as collateral, Treasury, and agency securities predominate ### Collateral composition and market structure - Treasury and agency securities are the largest collateral segments; a very wide range of other collateral is available in repo—especially outside of the tri-party repo market. - Federal Reserve Bank of New York data indicate that 60 percent of repos were against US Treasury securities over 2019. - Share of repo trading by segment in 2019 (percent): - Tri-party: 30% - GCF: 10% - Sponsored: 2% - Bilateral (estimate based on 2014 share): 49% ### Role of BNYM and tri-party infrastructure - Cleared and tri-party repo markets are tightly linked because all use BNYM’s tri-party repo settlement infrastructure. - BNYM provides a critical monopoly role in the settlement of U.S. Treasury securities; primary issuance of U.S. treasuries occurs over the accounts of BNYM. - Cleared repo market segments ultimately settle at BNYM; even the FRBNY’s repo transactions settle at BNYM. - Concentration of collateral management operations at BNYM has produced settlement efficiencies that encourage ancillary repo market segments to also settle there. ### Tri-party market reforms and risk reduction - Reforms have reduced risks associated with tri-party repo. - Historically, tri-party repo-providing banks supplied intraday credit (daylight overdrafts) to dealers rolling overnight repo; such overdrafts are now very costly and not significantly utilized following post-GFC regulatory reforms. - Tri-party repo remains important for minimizing cash requirements and optimizing collateral use. ### Growth of cleared repo and market access - Demand for cleared repo is increasing because participants seek netting benefits and better repo market access. - Growth in FICC sponsored repo has broadened access to centrally cleared, netted repo for cash investors (money market funds in particular) and borrowers (leveraged investors and hedge funds). - Cleared repo is advantageous for risk management and balance sheet efficiency under tighter leverage, capital, and liquidity rules. ### Money market liquidity and volatility before March 2020 - Money market volatility increased as the Fed reduced its balance sheet; volatility patterns shifted from early 2017 as commercial bank reserves at the Fed fell. - Several volatility spikes occurred, culminating in mid-September 2019 when the Fed funds rate moved outside the target range and repo rates sharply spiked to 10 percent. - Despite increased volatility, the repo market generally continued to function and cleared even on volatile days; the Fed’s significant and regular repo operations and resumed Treasury securities purchases were instrumental in restraining liquidity fears during the September 2019 event. - The Fed decreased reserve balances by about US$1.25 trillion from the peak in 2014 to the September 2019 trough—a reduction of almost 50 percent. ### Fed balance sheet normalization and non-reserve liabilities - Growth in the Fed’s non-reserve liabilities contributed to the balance sheet normalization process in the absence of regular OMOs. - The Treasury General Account (TGA) has expanded and become more variable, in part due to exceptional run-downs when the debt ceiling has been binding. - The Foreign Repo Pool (FRP) grew significantly as the Fed loosened rules on foreign central bank deposits; its size later dipped after the Fed set FRP remuneration in line with the ONRRP. - Title VIII of the DFA allowed the Fed to open accounts for designated FMIs that CCPs use to hold cash collateral, contributing to non-reserve liabilities growth. - In periods of ample reserves, the Fed did not regularly conduct OMOs, so growth in non-reserve liabilities organically reduced reserve balances. ### Collateral supply and dealer financing - U.S. Treasury collateral supply has expanded significantly as the U.S. budget deficit has increased; primary dealers and other leveraged investors absorbed this supply and required more repo financing. - Most players used overnight repos to finance the growth in collateral supply because overnight repo was cheap and readily available in the era of ample reserves. ### Regulatory impacts on market functioning and behavior - Post-GFC prudential regulation and upgraded internal liquidity risk management frameworks changed bank and broker-dealer behavior, contributing indirectly to cash hoarding, diminished incentives to intermediate liquidity, and reduced willingness to step in during sudden volatility. - Reserves are now concentrated at GSIBs. - Relevant regulatory constraints that bind to different extents across firms include: the supplementary leverage ratio (SLR); the GSIB surcharge; liquidity stress test requirements; and resolution funding requirements. - Tighter risk management has resulted in fewer buffers available to customers and less balance sheet flexibility in major intermediaries, driven by: - Increased market discipline and management intolerance of liquidity shortfalls. - More restrictive and sophisticated regulatory frameworks requiring larger buffers and planning for tail-event risks. - Pressure on returns prompting optimization of bank balance sheets, leaving fewer idle capital and liquidity buffers and reducing responsiveness to unexpected liquidity needs. ### The Fed’s liquidity provision approach in normal times - Prior to the COVID-19 crisis, the Fed operated an ample reserves system with few regular open market operations (OMOs) in business-as-usual circumstances; the Fed supplied significantly greater reserves than required by banks. - The FOMC’s balance sheet normalization principles state the Fed will operate the ample reserves framework with the smallest balance sheet possible while ensuring the Fed funds rate remains well within the 25-point-wide target range established by the FOMC. - The Fed uses standing facility rates to influence market rates: the ONRRP and Interest on Excess Reserves (IOER). - The Fed has varied IOER and ONRRP levels in recent years to keep the Fed funds rate well within the target range. - The Fed’s operating target guiding liquidity management is the Fed funds rate, though the Fed considers a wider set of benchmark money market rates (including repo rates) when determining its operational stance. *Source: IMF staff chapter text as provided.* ### 2. Total versus required reserve balances ### 2. Total versus required reserve balances ### SOMA composition and duration - The SOMA is composed of both U.S. Treasury and Agency securities reflecting past QE operations. - The FOMC’s normalization principles state that in the long term the Fed will aim to predominantly hold U.S. Treasury securities in the SOMA. - Currently, the composition of the SOMA is in transition where a portion of maturing Agency securities are rolled over, and the balance reinvested in new treasuries. - The average duration of the domestic securities in the SOMA portfolio was around 5.5 years in 2018. ### Fed counterparties and facility access - Main counterparts: depository institutions and primary dealers. - The Fed deals with money market funds, depository institutions, GSEs and primary dealers. - Money market funds only have access to the ONRRP facility. - Depository institutions can access the ONRRP, IOER, term deposit auctions, and the Fed’s standing credit facilities (in principle). - GSEs only have access to the ONRRP facility as they are not permitted to receive interest on reserves. - The Fed currently has 24 primary dealers. ### Discount Window (Bilateral liquidity backstop) - Legal basis: Federal Reserve Act Section 10(B) and Regulation A. - Primary Credit: - Available to depository institutions in sound financial condition on a “no questions asked” basis. - Priced at 50 basis points over the top of the Fed funds target range (as of March 9). - Typically advanced for one day but may be extended up to a few weeks for smaller institutions. - Secondary Credit: - Provides credit to weaker financial institutions at a further 50 basis point margin above the Primary Credit rate. - Typically extended on an overnight basis, but may be advanced for a longer period as a backup source of funding or to facilitate orderly resolution. - Collateral: Discount Window loans must be collateralized to the satisfaction of the advancing reserve bank; a very broad set of collateral may be used. - Maturity and rollover: Typically short maturities; during recent crisis periods (including since March 15, 2020) loans have been permitted to be rolled over upon request, subject to discretion and legal limitations. - Usage patterns: - The Discount Window is rarely used in significant volumes; prior to March 2020, usage was low and dominated by idiosyncratic liquidity needs of smaller depository institutions. - Larger depository institutions did not use the Discount Window and did not incorporate access to it in their liquidity planning. - Fed surveys show a strong aversion to using the Discount Window; firms planned instead to raise funding from customers (for example, FHLBs), reduce lending, or run down liquid assets. - The Discount Window was not used by depository institutions during recent periods of money market volatility even when profitable to do so to fund repo market investments. - Stigma: - The Discount Window is heavily stigmatized. - Contributors to stigma include the penalty rate, publication of use, lack of use, and perceptions that the facility is used when something has gone wrong. - The Discount Window mixes market backstopping and Emergency Liquidity Assistance (ELA) objectives; Primary Credit looks more like a standard standing credit facility while Secondary Credit resembles an ELA instrument. ### Liquidity support to CCPs and nonbanks - CCPs designated by the FSOC as systemically important have access to Fed liquidity in extremis under Title VIII of the DFA. - The DFA sets a high bar for advancing credit to a CCP; the Fed expects CCPs to plan prudently to avoid recourse to the Fed. - Practical arrangements to facilitate liquidity provision to a CCP are not fully developed (for example, legal lending contracts and arrangements to receive collateral are not in place). - Bilateral liquidity support to other nonbanks is constrained: - DFA and FRA restrict such support. - Section 13-3 authority can extend credit to nonbanks only in the context of a broad-based facility (interpreted as available to five or more entities). - Bilateral support of the type provided to Bear Stearns and AIG in the GFC is no longer possible. ### Market-wide liquidity provision: OMOs and FX swap lines - Authority and tools: - The Fed has broad authority to use OMOs to support market-wide liquidity (Section 14 of the FRA) using U.S. government and agency securities for market liquidity support. - OMOs using repos are flexible and scalable. - Limits on outright purchases: - The FRA does not allow asset purchases outside of Treasuries- and Government-guaranteed agencies except within the context of an FRA 13-3 program approved by the Treasury Secretary. - The Fed can provide collateralized credit to depository institutions or special purpose vehicles that may then purchase securities. - FX swap lines: - The Fed’s network of bilateral FX swap lines is an important source of market-wide liquidity support given the global role of the U.S. dollar. - The network was scaled back since the GFC to a set of five countries but these lines are now permanent standing lines. - The FOMC has broad authority to deploy and extend the FX swap line network in a future stress event. - Focus is on market-wide liquidity support, not country-specific or individual institution issues. - Constraints for market-wide support to nonbanks: - Section 13-3 broad-based requirement complicates Fed options to support the nonbank sector and securities markets. - 13-3 programs need pre-approval by the Treasury Secretary and certain lending must be reported to Congress within a week, limiting confidential provision of liquidity. ### Foreign exchange liquidity provision - The framework for liquidity provision in currencies other than U.S. dollar appears less well developed. - The FRB has not taken a public position on the FRA’s authority to advance liquidity in currencies other than U.S. dollar and has not developed a detailed policy or operational framework. - Sources of FX to meet an FX liquidity need include the Fed’s FX swap lines, but sources beyond those are unclear. - FX liquidity provision could be important in the event of liquidity stress in a CCP that clears instruments in currencies aside from the U.S. dollar. ### Fed response to COVID-19 market pressures (late February – end March 2020) - Market dislocations: - Markets were severely disrupted from late February 2020; repo rates rose significantly, the Fed Funds rate moved to the top of the target range, commercial paper and asset-backed rates rose, and volumes dropped. - Cross currency basis swap margins to risk free rates rose significantly reflecting a global shortage of U.S. dollar liquidity. - Securities markets, including core U.S. Treasury and U.S. Agency MBS markets, exhibited extreme stress and became illiquid as evidenced by wider credit spreads and on-the-run off-the-run Treasury spreads. - Sequence of major measures (as of end March 2020): - Policy announcements: - Feb 28: FOMC issues statement noting the Fed will use its tools as appropriate to support the economy. - Mar 3: FOMC cuts Fed Funds target range by 50 basis points to 1-1.25 percent. - Mar 15: FOMC cuts Fed Funds target range by 100 basis points to 0-0.25 percent. - Mar 23: FOMC announces an open-ended commitment to purchase US Treasury and Agency MBS securities. - Open Market Operations (selected actions): - Mar 9: Overnight repos increased to $150 bn per day and 2 week repo operations to $45 bn twice weekly. - Mar 11: Overnight repos increased to $175 bn per day and new $50 bn one month repo operations announced. - Mar 12: Three month repo operations introduced of $500 bn and one month operations increased to $500 bn. - Mar 15: FOMC announces intention to increase US Treasury and Agency MBS holdings by $500 b and $200 bn respectively. - Mar 16: New $500 bn afternoon daily overnight repo operation introduced, morning overnight repo OMO increased to $500 bn. - Mar 16: New $500 bn afternoon daily overnight repo operation introduced, morning overnight repo OMO increased to $500 bn. - Other policy announcements: - Mar 15: Primary Credit rate cut to 0.25 percent and Fed noted willingness to extend term loans. - Mar 15: Reserve Requirements eliminated. - Mar 15: Interest rate on FX swap lines cut to 0.25 percent and new weekly 84 day US $ operations begin by recipients. - Mar 19: Fed expands its swap line network to include nine additional countries. - Mar 20: G5 central banks increase frequency of 7 day US $ operations to daily from weekly. - New liquidity facilities under FRA 13-3: - Mar 17: Fed establishes the Primary Dealer Credit and Commercial Paper Funding facilities. - Mar 18: Fed establishes the Money Market Mutual Fund Liquidity facility. - Mar 20: Fed expands the MMLF to include state and municipal securities. - Mar 23: Fed establishes the Primary and Secondary market Corporate Credit & the Term Asset Backed Securities Loan facilities. - Mar 31: Fed establishes the Foreign & International Monetary Authorities Repo facility. - Coordinated central bank action: - Enhanced and expanded FX swap lines provided U.S. dollar liquidity globally and helped reduce pressures on the domestic money market. - The Foreign and International Monetary Authorities Repo facility provided most foreign official institutions a mechanism to quickly raise funds from the Fed without resorting to outright securities sales in the stressed treasuries market. *Source: IMF staff summary of chapter "2. Total versus required reserve balances" (extracted content).* ### 73. Many GFC-era liquidity facilities ### 73. Many GFC-era liquidity facilities ### Re-activation of GFC-era facilities - Many GFC-era liquidity facilities were re-activated under Section 13-3 of the FRA with the support of the Treasury. - Primary Dealer Credit Facility was re-activated to provide liquidity support to Primary Dealers due to money market stress. - Commercial Paper Funding and Money Market Mutual Fund liquidity support were re-activated to support securities markets. ### New facilities and Treasury support - New or re-activated facilities included the Term Asset-Backed Securities Loan facility (TALF) and other securities market support facilities. - New corporate securities support facilities were developed in the form of the Primary and Secondary market credit facilities. - Elevated risks associated with these facilities were backed through an injection of US$105 billion of capital funding from the Treasury’s Exchange Stabilization Fund and through the CARES Act. - These securities market support facilities were operationalized through a set of single Special Purpose Vehicles. ### Effectiveness and market response - The Fed’s actions were effective in bringing markets under control. - Much of the impact in March has been an announcement effect as few of the newly announced facilities were immediately operational, implying high credibility of the Fed’s timely measures. - Money market volatility came down relatively quickly and repo and Fed funds rates moved back inside the Fed funds target range. - Commercial paper and other securities markets took longer to respond, reflecting significant uncertainty about corporate credit quality and the underlying business environment. - Figures referenced: Figure 6 (Commercial Paper and Asset Backed Securities Spreads vs the prices of the new Fed CP and ABS facilities) and Figure 7 (Money Market Conditions and Fed Lending Programs in March 2020). ### Regulatory drivers of reserves demand (Box 3) - Regulatory factors indirectly drive the demand for reserves through their impact on the precautionary demand for reserves of depository institutions. - Two possible impacts: - On the level of demand for reserves (position of the reserves demand curve). - On the slope of the demand curve (degree of substitutability of reserves for other HQLA). - Factors affecting the level of demand (examples): - Banks’ internal intraday liquidity stress testing requirements: require liquidity to meet very short horizon payments obligations; non-reserves HQLA often unsuitable if managers assume no access to the Federal Reserve Discount Window. - Resolution funding requirements: require firms to hold liquidity to meet payments obligations where payments inflows may be uncertain and/or access to repo funding may be uncertain; larger, more complex firms require more resolution funding as liquidity must be prepositioned within each material entity. - Factors affecting the slope of the demand curve (examples): - The Supplementary Leverage Ratio: adds an extra capital cost for a leveraged broker-dealer to engage in marginal financing activity, reducing incentives to intermediate reserves. - The GSIB surcharge: adds a very high capital cost on the entire firm if marginal financing activity moves the firm from one GSIB category to another; impacts are most evident around December 31 and in months leading up to year end. - Net observed effect: post-crisis regulatory environment has shifted the demand curve to the right and steepened the curve, increasing both the demand for reserves and the volatility of money market rates for any given level of excess reserves. ### Implications of large bank risk management and balance sheet optimization - Complexity of large bank risk management frameworks and balance sheet optimization has reduced large banks’ flexibility to provide liquidity quickly during stress. - Business areas have some capacity for expected customer demand but less flexibility to respond to unexpected spikes in liquidity demand from other market participants. - Changes to accommodate new lending or alter HQLA composition take time because they must fit within aggregate balance sheet optimization frameworks. - Result: elevated potential for market volatility as large firms may not scale up liquidity provision or alter HQLA quickly unless demand changes are persistent. ### Recommendations: destigmatize and promote use of the Discount Window - U.S. authorities should promote the Discount Window as a tool to make reserves and Treasuries more fungible once conditions normalize. - Reluctance to assume Discount Window access encourages larger precautionary demand for reserves and reduces flexibility in responding to unexpected demand changes. - Increased fungibility of reserves and Treasuries would help reduce the slope of the reserves demand curve, reduce interest rate volatility, and bolster market resilience; a fall in demand for reserves could enable the Fed to operate with a smaller balance sheet. - Suggested measures: - Regulatory authorities clarifying that it is acceptable and desirable for regulated firms to assume access to the Discount Window (using U.S. Treasury securities as collateral) in stress situations when planning for resolution and intraday stress test requirements. - Clarifications could be made to the Fed’s Regulation A and through revised interagency guidance to banks (for example in the areas of resolution funding and liquidity stress test requirements). - Outreach to regulated firms to encourage incorporation of this guidance into liquidity planning. - Examples and precedents: - Bank of Canada and the Bank of England provide recent examples of useful approaches. - Measures taken by the Fed in the COVID-19 crisis to reduce the cost of accessing Primary Credit, lengthen its maturity, and provide guidance that use of Primary Credit is desirable are cited as good examples that might aid de-stigmatization. - Note: Any revisions to resolution liquidity requirements should not undermine their purpose to ensure material entities have adequate access to liquidity in a resolution scenario. ### Recommendations: reconsider FHLB treatment in the LCR - Banks have an incentive to access funding from FHLBs, which increases interconnectedness. - Funding from FHLBs remains relatively generously treated in the LCR; FHLBs procure funding for advances by issuing short-term notes purchased by Money Market Funds and other investors. - FHLBs play an important intermediation and funding role but face significant liquidity mismatches as the maturity of their advances is typically much longer than short-term funding received. - Recommendation: Reconsider treatment of funding from FHLBs in the LCR to ensure a level playing field with other unsecured lenders in the Fed funds market to reduce concentration risks on FHLBs and enhance market resiliency. ### Designing the Fed’s operational framework to support money market resilience - The Fed’s ample reserves system could be more effective in supporting market resilience if supplemented with regular fine-tuning operations in normal times. - Current Fed preference to operate without regular liquidity-providing operations reduces the liquidity insurance that an ample reserves regime could provide; availability of reserves in aggregate does not assure access to reserves for individual institutions and especially nonbanks. - Suggested adjustments to the Fed’s operating framework: - Restructure the SOMA to include a higher proportion of short-term instruments (treasury bills, repo operations) that can be regularly rolled over. - Regularly operate repo OMOs where the Fed varies the volume of OMOs offered in response to revealed market demand. - Benefits: - Allow primary dealers regular access to Fed repo OMOs and enable easy scaling up if bidding behavior suggests increased demand. - Conducting repo (and reverse repo) operations via the FICC’s cleared repo services could widen the reach of Fed OMOs, reduce pressures on dealer balance sheets (as repo operations could be netted), and reduce reliance on the BNYM. - Operational rationale: - Regular fine-tuning operations would provide de-stigmatized liquidity insurance, give the Fed regular information on market liquidity and resiliency, and enable quicker and more effective responses to market pressures (as occurred with rapid scaling up and lengthening of repo operations in the COVID-19 period). *International Monetary Fund — UNITED STATES chapter excerpt* ### 82. The Fed could explicitly include repo rates in its operational target to better guide ### The Fed could explicitly include repo rates in its operational target to better guide liquidity provision ### Operational target and repo markets - The Fed's focus on the Fed funds rate as the operational target diverts attention from repo markets, which are "key to price discovery and liquidity risk management for banks and nonbanks." - Shocks to liquidity demand are often initially felt in repo markets (for example if nonbanks need repo funding) and then transmitted to the Fed funds market as banks, FHLBs and GSEs operate in both markets. - Recommendation: The FOMC could reconsider its operating target to include repo rates: - Explicitly reference SOFR as the operating target; or - Specify the operating target as the general level of overnight wholesale market rates (thus incorporating the Fed funds rate and other unsecured wholesale market segments included in the Overnight Bank Funding Rate). - Rationale: The Fed's aggressive response to repo market pressures during the March COVID-19 crisis period was appropriate; making repo rates more explicit in the operational target would make such actions clearer and more easily anticipated by market participants. ### Ample reserves (floor) system design - Central banks operating ample reserves systems typically align market rates with a single central bank policy rate; having a target range for short-term rates is unusual. - Using a single policy rate means overnight money market rates should "settle close to the policy rate on average over time" — short-term volatility is acceptable and valuable for price discovery. - Practical implementation: Express the single policy rate as the level at which both the ONRRP and IOER rates are set; regular OMOs would then provide liquidity to keep overnight money market rates close to the policy rate on average over time. ### Standing repo facility — design tradeoffs - Stigma is a key challenge in ample reserves regimes; standing facilities are costly and rarely used. - Market participants are likely to use a standing repo facility only if it is priced close to normal market rates, implying a narrow interest rate corridor and reduced market-based price discovery. - Counterparty access: A standing repo facility may need broader access than the current list of large primary dealers if primary dealers cannot intermediate to the wider nonbank repo market during stress. - Recommendation: Introduce a new standing facility only if efforts to destigmatize the Discount Window fail. First, try to get banks to incorporate the Discount Window in their liquidity planning (see referenced paragraph 78). If that fails, consider a standing facility acknowledging trade-offs in counterparty access, pricing versus stigma, and moral hazard risks. - Design suggestion: A facility using U.S. government securities as the only eligible collateral might be priced somewhat closer to the top of the FOMC target range to induce regular use. The facility could be made available to large banks with a regular interbank market presence and broker-dealers (perhaps wider than the existing Primary Dealers if those dealers can meet the Fed’s counterparty credit standards). - Note: Such a facility could be done under FRA section 14’s OMO authority. ### IOER quota or tiering system to stimulate interbank activity - The central banks of New Zealand and Norway use quota or tiering systems in ample reserves systems to stabilize reserve demand and disincentivize liquidity hoarding. - These systems are effective and could be considered in the U.S., though diversity of depository institutions may make developing a quota system challenging. - Design note: It is possible a simple system could be developed where the bulk of banks (for example with assets less than US$50 billion) were developed a de-minimis quota, leaving allocation of specific quotas to larger firms based on their balance sheet and payments system characteristics. ### Liquidity provision to nonbanks and CCPs - Bilateral liquidity support to systemically important nonbanks: - The DFA restricts the Fed’s ability to provide liquidity support to nonbanks, constraining options to maintain financial stability when a large, interconnected nonbank faces liquidity difficulties. - Recommendation: Explore legislative changes to return power for authorities to provide bilateral liquidity support to FSOC-designated systemic nonbanks. - Preparedness to operationalize liquidity provision to designated CCPs: - Authorities have power to provide liquidity support to FSOC-designated systemically important CCPs, but DFA sets a high bar (desirable for moral hazard reasons). - CCP supervisors provide timely, granular liquidity information and have taken steps to ensure CCP liquidity resources are adequate, but extreme circumstances could still challenge stressed liquidity plans. - Recommendation: The Fed should enhance arrangements to provide emergency liquidity support to designated CCPs quickly if authorized. ### Market-wide securities liquidity support framework - Banks and nonbanks rely on liquidity in key securities markets to manage liquidity and intermediate credit. - The Fed deployed programs to support key securities markets in the GFC and COVID-19 crisis periods. - Recommendation: Develop a more comprehensive framework to guide market-wide liquidity support in securities markets, including: - Formal criteria for which markets would be candidates for support; and - Associated operational modalities to facilitate quick support. ### FX liquidity provision protocols - The standing central bank FX swap lines provide a useful source of FX to finance FX liquidity provision, though it is less clear whether the Treasury's FX reserves might be available. - Recommendation: The FRB should develop its FX liquidity support protocols to both banks and CCPs. ### Repo market clearing and settlement resilience - The concentration of risks at BNYM is a significant concern warranting structural change. - Recommendations: - Work with market participants to develop capacity for repo clearing and settlement to continue in the absence of BNYM, possibly involving direct settlement arrangements at the Fed. - Enhance resilience of the cleared FICC repo market so cleared transactions could settle away from BNYM, at least as a backup. - Develop an effective option for the Fed to conduct repo operations in the event of a protracted BNYM outage. - The FRB should undertake a simulation exercise to test a response to a tail risk of a protracted BNYM operational outage or reduction in BNYM capacity. ### Managing LIBOR to SOFR transition risks - Progress and remaining gaps: - The ARRC and authorities have made great strides promoting transition away from Libor by end 2021. - Most Libor-related exposures are in derivatives markets where significant progress has occurred; slower progress is evident in corporate securities and loan markets. - Recommendations to reduce Libor transition risks: - Authorities remain focused on ensuring regulated firms manage and disclose Libor-related risks effectively. - The authorities (Fed, SEC, and CFTC) move to set hard targets with deadlines for firms to transition to SOFR-based products; these could be supported by supervisory tools and adjustments to collateral haircuts and eligibility to encourage faster transition. - Authorities provide more guidance on best practices and common standards when structuring new SOFR-based products to help markets develop and transition faster. *Source: 1usaea2020006 - 82. The Fed could explicitly include repo rates in its operational target to better guide* ### Appendix I. FSAP 2015 Recommendations and Follow-Up ### Appendix I. FSAP 2015 Recommendations and Follow-Up ### Systemic Risk Oversight - Remit, Responsibilities, and Organization of FSOC - Recommendation: Clarify organization and governance arrangements for each Committee in Charters; appoint Chairs for each supporting staff Committee. - Current status: Partially implemented — Charters include suggestions that participants have the necessary experience. - Recommendation: Supplement mandates and mission statements of each FSOC member agency with an explicit financial stability mandate; publish voluntary statements of support. - Current status: Not Implemented. - Strengthening Systemic Risk Identification - Recommendation: FSOC should set a clear short-term deadline to address obstacles to data sharing and agree a flexible data sharing protocol across member agencies. - Current status: Partially implemented — MoUs are in place across the FSOC membership. - Recommendation: OFR should prioritize work to address data gaps in short-term wholesale funding markets, in nonbank financial intermediation (such as asset management) and in interconnectedness indicators. - Current status: Partially implemented — Surveyed data on cleared repo is published but other areas have not been addressed. - Recommendation: FSOC should publish additional information on the monitoring framework underpinning systemic risk identification and on the work of the SRC. - Current status: Not Implemented. - Recommendation: FSOC should publish in each Annual Report the materiality attached to each identified threat, including a judgment on likelihood and impact. - Current status: Not Implemented. - Addressing Identified Threats to Financial Stability - Recommendation: For each material threat in the Annual Report, FSOC should publish specific follow-up actions with responsibility and timelines. - Current status: Partially implemented — Annual Reports discuss each material threat and updates on regulations and research agenda, but specific timelines and responsible agencies are not identified. - Recommendation: Members should consult FSOC as standard practice on development and implementation of major new regulatory rules affecting financial stability. - Current status: Partially implemented. - Macroprudential Toolkit - Recommendation: Prioritize development of U.S. macroprudential toolkit, focusing on time-varying measures to address cyclical and sectoral risks and strengthen resilience to run risks and fire sales; ensure instruments are ready and legal authorities in place. - Current status: Not Implemented. - Recommendation: FSOC to publish a summary of the U.S. toolkit identifying available tools, responsible agency/agencies, triggers, and implementation framework; update periodically. - Current status: Not Implemented. ### Systemic Liquidity - Tri-Party Repo Infrastructure - Recommendation: Reduce reliance on the two clearing banks and consider settlement in central bank funds. - Current status: Not implemented — Federal Reserve and industry Task Force reformed tri-party repo infrastructure 2010–2016 achieving: - All trades are matched prior to settlement. - Reducing the provision of intraday credit from 100 percent uncommitted and unsecured to less than 1 percent secured and committed (including FICC GCF settlements). - Improved risk management practices across the industry. - Developments: CCP introduced new products and enhancements increasing central clearing activity. JP Morgan exited Broker Dealer clearance and settlement in 2016; transition to BNYM concluded at end of 2018. Federal Reserve has not taken additional steps post-2016 to settle in central bank funds. - Repo Safe Harbors - Recommendation: Consider reviewing financial stability impact of allowing mortgage-backed securities and other illiquid loans and securities safe harbor from bankruptcy proceedings. - Current status: Not implemented — Federal Reserve has not taken actions; changes would require legislative action. - Broker-dealers - Recommendation: Complete review of regulation at broker-dealer level; SEC to finalize and implement rule changes to contain risk taking. - Current status: Partially implemented — June 2019 SEC rules adopted establishing capital and margin requirements for security-based swap dealers without prudential regulator (nonbank SBSDs). Key rule features include: - ANC broker-dealers: minimum tentative net capital requirements of US$5 billion. - Minimum net capital requirement equal to the greater of US$1 billion and 2 percent of the firm’s exposures to its SBS customers, plus existing Rule 15c3-1 ratio-based minimums (15-to-1 aggregate indebtedness ratio or 2 percent of customer debit items ratio). - Early warning notification if tentative net capital falls below US$6 billion. - Portfolio concentration charge modification: capital charge equal to aggregate uncollateralized current exposures from derivatives that exceed 10 percent of tentative net capital (reduction from 50 percent). - Other supervisory guidance: FINRA Regulatory Notice 15-33 on liquidity risk management practices; SEC amended FINRA margin rule for forward-settling agency MBS transactions (2016 approval). - Money Market Mutual Funds (MMFs) - Recommendation: Reduce forced-sale risk by restricting repo collateral to securities MMFs can hold outright; apply variable NAVs to all MMFs. - Current status: Not implemented — authorities note less than 7 percent of MMF collateral consists of non-Treasury or non-agency securities. SEC rules require floating NAVs for institutional non-government MMFs; retail and government MMFs may use amortized cost and penny rounding methods to maintain stable NAV; liquidity tools (liquidity fees and redemption gates) available if historical redemption patterns change. - Disclosure and monitoring: MMFs required to file Form N-MFP monthly including portfolio holdings, market-based NAV, and levels of daily and weekly liquid assets; stress testing required; Form N-CR required upon certain specified events. ### Fed Exit and Financial Stability - During normalization (recommendations) - Continue with Fed funds rate as operating target. - Announce floor system with IOER equating with Fed funds target. - Use ONRRP with counterparty allotment caps as primary tool to manage Fed funds rate at or slightly above IOER; assess need to expand counterpart list; manage dis-intermediation and shadow banking risks by announcing unlikely post-normalization use and use of allotment caps. - Re-instate single rate policy target with first move from 0–0.25 percent to 0.25 percent. - Explore term sterilization instruments—deposits and reverse repos—to lessen operational risks; small term premiums could be justified. - Current status: - Partially implemented — January 2019 FOMC statement and October statement indicated use of abundant reserves and administered rates for control of short-term rates; statement on ONRRP use and per-counterparty limits posted on FRBNY website. - Some recommendations (use of ONRRP as primary tool with caps; expanding counterpart list; managing dis-intermediation by announcing unlikely post-normalization use) marked Not implemented. - Implemented: FOMC view that changes in target range for Federal funds rate remain primary means; statement about maintaining an ample level of reserves issued in October. - Post-normalization (recommendations) - Consider alternate operating targets; de-emphasize single rate in favor of general level of money market rates; continue with floor system; withdraw ONRRP once IOER provides effective floor; use short-term repos and reverse repos to manage operating target close to floor; abolish reserve requirement. - Current status: - Implemented: Continue with floor system; FOMC reaffirmed ample reserves regime in October 2019. - Not implemented: Withdraw the ONRRP; use short-term repos/reverse repos to manage target close to floor. - Implemented: On March 15, 2020, Board of Governors announced reserve requirement ratios reduced to zero percent effective March 26. ### Data Gaps - Recommendation: Publish more granular data on tri-party repos (cash providers, repo maturities, collateral type and maturity). - Current status: Implemented — Data on tri-party and GCF repo markets are published regularly. February 2019 OFR rules require daily reporting by covered CCPs of centrally cleared repo transactions (approx. one-quarter of U.S. repo market transactions). October 2016 SEC reporting requirements for registered investment companies include securities lending information (annual information required beginning June 1, 2018 for larger companies; compliance date for smaller entities was June 1, 2019). - FRBNY collects trade-by-trade daily tri-party repo data from Bank of New York Mellon. OFR final rule requires FICC to report data on FICC-cleared repo transactions beginning October 2019; FRB will act as OFR’s collection agent. ### Liquidity Backstops - Standing or day-end facilities - Recommendation: Fed could create a facility open to well-capitalized depository institutions that are direct Fedwire members, available from 3 p.m. onwards to address unexpected shortfalls with collateral limited to Treasury and agency securities. - Current status: Partially implemented — Primary Credit and Secondary Credit Discount Window lending facilities are available to depository institutions all day until Fedwire close; a wide variety of assets may serve as collateral. Policymakers have discussed a standing repo facility with Treasury and/or Agency securities as collateral. - LCR and FHLB calibration - Recommendation: Consider systemic implications of LCR preferential treatment of FHLB funding; assess adequacy of FHFA liquidity and capital requirements. - Current status: Partially implemented — August 2018 FHFA guidance (Advisory Bulletin AB 2018–07) recommends FHLBs maintain positive liquidity days ranging from 10 to 30 days; guidance reduces liquidity arbitrage and generally precludes including inflows from maturing advances (100 percent haircut) versus 75 percent in LCR. FHFA does not believe adjustment to FHLB capital requirements is needed given secured advances composition and retained earnings coverage of RBC. - Broad-based eligibility for Fed liquidity support (DFA Title I) - Recommendation: Review broad-based eligibility criteria to allow Fed, at its discretion, to extend liquidity support to any solvent individual institution designated by FSOC, with solvency assessment and heightened prudential standards for designated nonbanks. - Current status: Not implemented — November 2015 Federal Reserve final rule specifies procedures for emergency lending under Section 13(3) limiting activity to programs/facilities with "broad-based eligibility" defined as programs where at least five entities would be eligible; solvent nonbanks designated by FSOC could participate to extent they satisfy facility eligibility requirements. ### Investment Funds and Systemic Risk - Settlement and redemption practices - Recommendation: Settlement to exiting investors should reflect sales prices where asset sales are made to redeem claims (sales-date NAV instead of redemption-date NAV); increase redemption fees where leverage used. - Current status: Implemented — Investment Company Act rule 22c-2 permits redemption fees; SEC 2016 rule (effective 2018) permits open-end funds to use swing pricing to mitigate shareholder dilution. - Securities lending data and disclosure - Recommendation: Use pilot survey insights to extend data disclosure requirements on securities lending activities. - Current status: Implemented — Early 2016 OFR/FRB/SEC joint securities lending pilot collected voluntary information from seven agents. April 2016 FSOC encouraged enhanced regular data collection and interagency sharing and adoption of permanent data collection. October 2016 SEC reporting requirements for registered investment companies include securities lending information; larger companies required to provide annual information beginning December 1, 2018; compliance date for smaller entities was June 1, 2019. *Source: Appendix I. FSAP 2015 Recommendations and Follow-Up.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1usaea2020006.pdf_