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Fed to Develop Margin Rules

The Wall Street Journal reports that the Federal Reserve is looking to adjust margin requirements on “securities-financing transactions” in an effort to address concerns over “shadow banking.” Fed Governor Daniel Tarullo last month said that the new rules would apply to “repo, reverse repo, securities lending and borrowing, and securities margin lending--transactions that are the lifeblood of many kinds of shadow banks.” However, the article notes that the rules will exempt transactions using Treasurys and U.S. agency securities as collateral, which account for more than two-thirds of securities-financing transactions.

In a speech last month, Federal Reserve Vice Chair Stanley Fischer suggested that “more stringent regulation of the banking sector may push short-term financing activities to less regulated entities” and thus new rules applicable to all market participants are needed to limit “regulatory arbitrage.” Similarly, Tarullo argued that the margin requirements “would serve as a mechanism for limiting the build-up of leverage in the financial system.”  Also reducing regulatory arbitrage is a global agreement reached late last year where regulators from 25 other economies agreed to adopt similar rules to prevent firms from moving the transactions offshore. Critics, however, are concerned that the margin requirements could further limit liquidity, particularly during periods of market stress.

The Fed’s power to act in this area stems from provisions in the Securities Exchange Act of 1934, though it has not exercised the power since the mid-1970’s, according to the Wall Street Journal. The article noted that “[b]y the 1980s, policy makers considered such powers obsolete, as increasingly sophisticated investors found ways around the requirements, and Washington had come to embrace a greater deference to Wall Street.” The Wall Street Journal reports that Federal Reserve believes that the new margin requirements “are one of the few tools available to curb some of the destabilizing excesses exposed during the 2008 financial collapse.”