Major Milestones Ahead: An Update on U.S. Tri-Party Repo Reforms

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By year-end 2013, J.P. Morgan expects to complete the work needed to achieve the Phase Two Target End State as agreed with the Federal Reserve Bank of New York. To meet this aggressive target, the firm expects to hit three key milestones during Q4 2012, designed to eliminate a portion of the financing requirements that dealers and cash investors currently cope with on a daily basis.
1	Eliminate non-maturing tri-party repos (TPRs) from the daily unwind. This step alone will remove 40 percent of the volume	"During 2012, we expect to eliminate a significant portion of U.S. tri-party repo daily financing requirements." Mark Trivedi
from the process each day and significantly reduce the amount of credit extended for 90 to 120 minutes each day. To achieve this first step toward the systemic reduction of intraday credit exposure, J.P. Morgan is making a series of technological and processing changes internally.
2	Enable dealers to re-optimize purchased securities without unwinding the transaction. This capability leverages J.P. Morgan's award-winning Auto Substitution capability, which
allows securities-for-securities substitutions to keep the terms of the deal whole at all times. Systemic substitution enables appropriate collateralization throughout the day, but the composition and allocation may shift, creating flexibility that meets the requirements of both parties.
3	Introduce intraday substitution for intrabank General Collateral Finance (GCF) in tri-party repos, shifting the unwind for those securities to 3:30 p.m. in order to coincide with the broader
process. This will significantly reduce the duration of the credit extension for GCF repo. Intraday delivery of GCF rehypothecated securities will be supported by Auto Substitution.
According to Michael Albanese, global head of securities clearance at J.P. Morgan, these changes represent a significant step toward fully eliminating credit risk, the prime objective of the Phase Two Target End State. "Following our guiding principle of minimizing the impact of reforms on clients as much as possible, we expect the majority of this work to take place behind the scenes," he comments. "By the time these changes are introduced in the fourth quarter, we will have already provided our clients with the resources and tools they'll need."		"Our goal is to minimize the impact of reforms on clients as much as possible." Michael Albanese
Even so, the effect should not be underestimated. There are significant benefits to clients stemming from the removal of non-maturing TPRs from the daily unwind: for example, dealers will see their credit reliance on the clearing bank reduced, and the continuous allocation model will position the U.S. markets more in line with the international tri-party repo model.
A measured pace
Another guiding principle for J.P. Morgan's approach to reforms is to avoid creating unexpected risk or consequences. Thus, the firm is taking a measured pace and working collaboratively with clients to ensure that they are prepared in advance for any changes. Although the timeframes are aggressive, new processes are introduced gradually and sequentially so that market participants have a chance to understand them and gauge the impact of each event on their businesses.		"These are important discussions and we want to allow enough time for everyone to prepare." Jason Paltrowitz
Overall, J.P. Morgan doesn't want the introduction of reform-related changes to limit counterparties' financing activities. Specifically, the firm is steering clear of any wholesale exclusions of asset classes. "It's not for the clearing bank to determine asset eligibility," notes Albanese. "Those decisions will continue to be made bilaterally between the counterparties based on their risk tolerances and profiles." As the firm plans ahead for 2013, Jason Paltrowitz, Americas markets executive for banks and broker dealers at J.P. Morgan, expects that the draft term sheet for J.P. Morgan's new secured committed credit advance facility will be shared with clients near yearend. Although this will not go into effect until 2013, Paltrowitz says, "We want to share this early with our clients as it represents a significant shift from how credit is managed today. We want everyone to have sufficient time to absorb the implications of the changes that will come in 2013 and allow ample opportunity for productive conversations."
Seven Milestones on J.P. Morgan's Road to Reform According to Michael Albanese, global head of securities clearance, the following steps are needed to achieve the Phase Two Target End State:
1	Eliminate non-maturing trades from the daily unwind. Currently, these account for about 40 percent of each day's activity.

2	Change the operating model to accommodate a newly created settlement batch process that expedites the return of cash for maturing trades.

3	Allow algorithmic settlement with a clear and unambiguous process based on collateral type that is transparent to all market participants.

4	Streamline the optimization and allocation algorithm to expedite the settlement process.

5	Allow for simultaneous exchange of cash and collateral in an "operational moment in time" that keeps transactions fully collateralized.

6	Adjust the unwind for GCF collateral, postponing it to 3:30 p.m. to sync up with unwinding transactions.

7	Introduce J.P. Morgan's secure committed clearance advance facility as the final step of the target state to facilitate repo maturation on fully transparent terms.
Reaching the goal During 2013, J.P. Morgan expects to complete the final set of activities to meet the Phase Two Target End State. Market participants can expect significant change to the market model, including simultaneous exchange, a fully revised and integrated settlement process and the introduction of J.P. Morgan's secured committed clearance advance facility.
This ambitious set of activities requires a careful assessment of change, coordinated implementation, and taking the time to do it right to avoid unintended consequences. Paltrowitz says that J.P. Morgan will takethe same approach to future changes as it has to those in the past 24 months. "We've worked closely with our dealer and cash investor clients throughout this process and will continue that dialogue," he says. Given the range of topics to be discussed—new tools and technology, systems and operational changes, possible revisions to agreements or procedures, testing and implementation—there will be no shortage of things to talk about.		"During 2013, we'll introduce new innovations that streamline the process for counterparties to exchange cash and securities, helping them more easily manage their financing." Mark Trivedi
Paltrowitz notes, "The combination of our aggressive timeframes and careful approach has been the key to our success so far, and it's laid the foundation for reaching the target end state. It's a strategy we'll maintain until we reach our goal." By year-end 2013, J.P. Morgan will have achieved that goal—credit risk to the firm as the clearing bank will be limited and, overall, risk will be more appropriately aligned between the counterparties—all without any major market disruption.
Mark Trivedi Co-Chair of the U.S. Tri-Party Repo Task Force Operational Arrangements Working Group
Thought, Fall 2012
For the most up-to-date information on J.P. Morgan's approach to U.S. tri-party repo market reform, visit jpmorgan.com/visit/us_tpr_reforms

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