U.S. regulators would rely on the 'principles' of sharks who have none

US Repo Sector Could Face Crackdown

By Gillian Tett
Financial Times, London
Tuesday, June 19, 2007

http://www.ft.com/cms/s/7e58c29e-1e8a-11dc-bc22-000b5df10621.html

American regulators may be forced to clamp down on activity in the so-called repurchase, or repo, market involving US government bonds if the industry does not clean up its behaviour, a senior official has warned.

However, finance officials strongly hope that a heavy-handed response can be avoided if banks and investment groups adopt a new set of "principles" to guide their behaviour, William Dudley of the New York Federal Reserve Bank recently told compliance officers in New York.

The comments will be closely watched by the market since it comes at a time of widespread investor interest in the US government bond sector, which has seen heavy trading volumes in recent days as a result of sharp price swings.

American finance officials attach a huge importance to maintaining the reputation of the $4,000 billion-plus Treasury market and the related repo market. In the repo market, traders do not buy or sell bonds but use them as collateral for short-term financing. However, last year there was criticism from the US Treasury and others that traders had been trading to make profits by hoarding specific securities or manipulating the timing of trades.

"In my view a public-private partnership is the way to go" to address these issues, Mr Dudley said. He added that, if it turned out that an approach based on "flexible, best practices" did not work, there would then be a "regulatory response."

The debate about the repo market has an added significance in regulatory circles at present, since it is highlighting a wider debate that is currently going on behind the scenes in America about the use of a "principles-based" approach towards regulation, rather than relying on a heavy-handed enforcement approach.

The New York Fed is currently seeking to improve standards by working with the market to create new guidelines. Last month a formal list was published for the first time, seeking to rein in trading practices such as "holding the box' -- jargon for a trader asking for the execution of a trade to be delayed.

This partnership approach has been used by the Fed before: a similar industry initiative was launched 18 months ago to improve processing and settlement in the credit derivatives world, for example.

However, its use in the repo market underlines the degree to which the New York Fed is quietly placing more emphasis on "principles-based" techniques.

Mr Dudley himself emphasised this point in his recent meeting with compliance officers, urging them to focus on the "underlying intention" of the new code of conduct rather than "trying to parse the precise language" to discover loopholes which could then be exploited by traders.

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