The SEC Financial Stability Oversight Council (FSOC) recently issued a guidance update on counterparty risk management practices for Tri-Party Repurchase Agreements. The update “provides the Staff’s views on the types of legal and operational considerations that a MMF and its investment advisor should consider if a counterparty fails and defaults on its obligations under a Tri-Party Repo.” The update stresses the importance of advance planning in case of default.
The update gives examples of risk management practices that will be useful when handling a default of a Tri-Party Repo. First, it recommends reviewing the master repurchase agreements and related documents to consider and specified repo default procedures. Second, the update recommends that a MMF should examine the operational aspects of managing a default to make sure that the parties are capable of accounting for the underlying collateral of the repurchase agreement.
Finally, the update recommends preparing for legal considerations that could arise at the time of any repo default. A MMF should look at the applicable regulatory framework under Rule 2a-7 of the Investment Company Act of 1940. Also, a MMF should “identify any required notifications to the SEC and/or the MMF’s board as a result of a default.” A MMF should also be aware that a “defaulted repo might trigger an automatic stay under the U.S. Bankruptcy Code or federal banking laws and regulations.”
The update’s recommendations and guidelines reflect the significant size of MMF holdings in Tri-Party Repos as compared to other types of mutual funds. At the end of 2012, the size of MMF portfolio holdings in Tri-Party Repos was approximately $591 billion. A counterparty default could be devastating for fund shareholders. The FSOC believes that “appropriate advance planning for portfolio defaults may help funds manage such adverse events more smoothly and lessen the chance that such a default has harmful effects that could have been ameliorated.”
Click here to read the entire guidance update.