REPO MARKET PENSION RISK
Repo market pension risk arises from the very large amount of money invested in repo trades by pension plan managers. In spite of the risk, very few plan participants have any idea their money used for repo trades, nor do they understand the repo market pension risk.
The “repo market” is a form of short-term borrowing–typically overnight–using securities as collateral. The largest collateral type for repo trades is the US Treasury securities market. The largest repo traders are banks, who often need overnight borrowing to smooth short-term cash requirements inherent in the business of banking. Bank repo borrowing has been active since at least 1958.
Currently, the repo market transacts $4 trillion in overnight loans, each and every day. Repo has been an essential component for market stability for decades. But when repo market risks rise, the risks of market implosion also rise.
The repo market currently has two categories: (1) centrally-cleared (tri-party) repo and (2) bilateral (two-party) repo. About half of the $4 trillion daily repo is allocated to each category: ~$2 trillion to centrally-cleared repo; ~$2 trillion to bilateral repo.
CENTRALLY-CLEARED (TRI-PARTY) REPO
Centrally-cleared (tri-party) repo loans are no longer loans between two parties; rather, a third party agent (clearing house) has entered the mix. This structural change has transferred risk management for repo borrowing to the third-party clearing house. Also, tri-party repo takes place in public markets, with trading information generally available and transparent.
Importantly, centrally-cleared repo is limited to high quality collateral, typically treasury securities. So parties who want to use low quality collateral (MBS securities, other derivative securities, etc.) are locked out of this market.
But the problem is that the clearing house (repo agent) makes money on the volume of trades and has no incentive to manage risk for the borrower and lender. So, margin limits are set lower to increase transactions; but lower margins allow higher leverage–increasing risk. So, tri-party repo risk management is an illusion that virtually guarantees a break in the system when leveraged transactions break down requiring margin calls and additional collateral.
BILATERAL (TWO-PARTY) REPO
In bilateral (two-party) repo, no central clearing agent is involved, so trading parties must manage their own risk. While, conceptually, this may be a better approach (at least someone is on the hook for risk), in recent years, non-bank repo traders have entered the game–particularly hedge funds. And the type of collateral pledges for these non-bank loans has expanded to include corporate securities–sometimes corporate securities of the high-risk variety.
And importantly, bilateral repo are OTC private trades, for which very little information is publicly available. So regulators have no visibility into the bilateral repo market–a condition that, of course, allows for abuse by unscrupulous market participants.
Thus, overnight repo lending, originally a low-risk activity designed to smooth the overnight liquidity demands of banks, has been expanded to include a highly-leveraged borrowing for hedge funds to finance their own projects–both short term and long.
As the saying goes, “what could go wrong?”
(SOURCE: US Office of Financial Research)
Until Sept. 16, 2019, the repo rate of interest hovered below 2%. In practice, this meant that hedge funds and other financial entities could borrow from repo financing sources for short term uses at a rate below 2%. But on Sept. 16, 2019, the repo rate skyrocketed to 10%–literally overnight. This created serious liquidity problems in the repo market, since fund providers suddenly were not comfortable lending money to hedge funds and other financial entities without a huge interest rate premium. This overnight jump in interest rates (from 2% to 10%) seized up the repo lending market, putting loaned funds in jeopardy.
What caused this overnight interest rate spike? Speculation centered around the then-imminent bankruptcy of the WeWork company, which threatened to collapse the global commercial real estate market, and related financial problems with WeWork’s principal investor, the Japanese hedge fund Softbank.
So, starting on Sept. 16, 2019, the Federal Reserve crossed the proverbial “Rubicon” by beginning to inject hundreds-of-billions of dollars into the short-term repo market, seemingly to rescue the disaster in the commercial real estate market caused by WeWork.
Eventually, after a $1.4 trillion injection into the repo market funding pool by mid-March 2020, the Fed brought the repo crisis under control–but at an enormous systemic cost: all in an effort to provide liquidity gone absent because of irresponsible repo activity by at least one hedge fund.
WHY IS THIS IMPORTANT TO PENSION PLANS?
Certainly, alternative investments such as hedge fund lending can be profitable in a stable market. But with market instability, alternative investments–such as repo lending to hedge funds–pose a high liquidity risk to pension funds during times of market volatility. In short, money needed for pension payouts may not be available when needed.
One of the largest banks active in the repo market is Bank of New York Mellon. In turn, pension funds invested in a collective investment trust with BNY Mellon for short term lending (that undoubtedly includes repo lending) are the following funds:
| AARP EMPLOYEES PENSION PLAN |
| ALLEGHENY TECHNOLOGIES INC MASTER PENSION TRUST |
| AMERICAN FEDERATION OF MUSICIANS AND EMPLOYERS PENSION PLAN |
| AMPHENOL CORPORATION MASTER TRUST |
| BALL CORP MASTER PENSION TRUST |
| BASF CORP PEN MASTER TR |
| CARPENTERS ANNUITY TRUST FUND |
| CARPENTERS PENSION TRUST FUND |
| CB& T PENSION FUND |
| CENTRAL MAINE HEALTHCARE CORP . RETIREMENT PLAN |
| CHILDREN’S MEDICAL CENTER OF DAYTON , OHIO EMPLOYEES PENSION PLAN |
| CIBC WORLD MARKETS RT PLN US EMPLOYEES |
| CITIGROUP PENSION PLAN |
| DAIMLER TRUCKS NA LLC PEN |
| DETROIT DIESEL UAW 163 HOURLY SAVINGS PLAN |
| DETROIT DIESEL UAW 412 SAVINGS PLAN |
| EFH CORP RET PL |
| EMPLOYEE RETIREMENT INCOME PLAN TRUST OF MINNESOTA MINING AND MANUFACT |
| ESOP/401K MANAGERS BANK OF NEW YORK MELLON |
| GROUP MEDICAL/ DENTAL EXPENSE PLAN |
| HIGHMARK RETIREE WELFARE BENEFITS PLAN |
| IBEW LOCAL 25 MASTER TRUST PLANS |
| INTEGRYS ENERGY GROUP TRUST |
| IRONWORKERS LOCAL 11 ANNUITY FUND |
| KOCH COMPANIES DEFINED BENEFIT MASTER TRUST |
| LIFE TECHNOLOGIES CORPORATION 401 (K) SAVINGS AND INVESTMENT PLAN |
| MAINE MEDICAL CENTER PENSION PLAN |
| MERCER TRUST FUND |
| MT FOR RETIREMENT PLANS |
| OE LOCAL 324 PENSION FUND |
| PACIFIC GAS AND ELECTRIC CO RET PL MASTER TRUST |
| PENSION PLAN FOR THE WASHINGTON POST AND COMPANIES |
| PG& E RETIREMENT PLAN |
| RAYTHEON CO MASTER TR |
| ROCKWELL AUTOMATION MASTER TRUST |
| SHELL PENSION PLAN |
| TD BANK US RETIREMENT MASTER T |
| THE AAA RETIREMENT PLAN |
| TIME WARNER CABLE PENSION PLS |
| UNDERWRITERS RET INCOME TRUST |
| UNUM GROUP PENSION PLAN |
This overview of the repo market, and pension funds that almost certainly provide cash to the repo market through BNY Mellon, JP Morgan and others, is one more effort at creating transparency in ERISA plans.
ERISA does not dictate the type of investment a plan fiduciary may undertake–ERISA only requires that any investment be prudent, and be exercised solely in the interest of plan participants.
ERISA also requires disclosure of underlying plan assets, so that participants and beneficiaries understand the nature of their pension investments.