Financial Stability Oversight Council press release Friday 2/4: “potential risks to U.S. financial stability arising from open-end funds, PARTICULARY THEIR LIQUIDITY AND REDEMPTION FEATURES.” The XRT ETF is an open-end fund.

by Flokki_the_Monk

Press Release from Financial Stability Oversight Council through Treasury on Friday: home.treasury.gov/news/press-releases/jy0587

FSOC includes Janet Yellen, Jerome Powell, & Gary Gensler. This is coming from the top, which means all 3 have been forced to admit these issues exist.

This section runs through most of what we’ve already learned about Hedge Funds, but it is pretty important to see them openly admitted by FSOC. Interesting that the release specifically adds “also used by hedge funds” when talking about Archegos, as if to make the point that the disaster Archegos caused in March 2021 is exactly what is happening with Hedge Funds now.

The last bit is also very interesting: “uncleared bilateral repurchase agreement, an important source of leverage for hedge funds.” Repo has been a big topic throughout this journey, and Apes have previously celebrated changes to Repo rules that have applied haircuts to certain collateral, or even stopped accepting them as collateral entirely. So what are these “uncleared bilateral repurchase agreements” that are so important to the leverage of Hedge Funds?

First, in review, a repurchase agreement in this context is when a Hedge Fund provides collateral in exchange for cash. The Hedge Fund now has the money to meet margin requirements or continue shorting or other such business.

So what is a BILATERAL repurchase agreement?

www.federalregister.gov/documents/2018/07/10/2018-14706/ongoing-data-collection-of-centrally-cleared-transactions-in-the-us-repurchase-agreement-market#h-21

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In essence, there are two important definitions here:

Uncleared: Will never be submitted to a Clearing House and will remain OTC.

Bilateral: Agreement is handled directly between the lender and borrower, as opposed to Triparty where an independent third party is put in place to ensure that the numbers / margin / settlement are correct and enforced.

Taken as a whole, FSOC’s statement asserts that Hedge Funds are being heavily funded with cash through repurchase agreements that are completely opaque. The lending parties could be accepting complete garbage collateral, valuing that collateral at whatever they choose, and deciding not to margin call the Hedge Funds no matter what’s going on with them or their collateral.

Continuing on with the Press Release, this was the most surprising commentary:

Liquidity and redemption is something that has been covered repeatedly in DD on ETF abuses. While this section doesn’t specifically mention ETF’s, and goes on to talk about other areas of the market, I suspect this was their best attempt to bury the lede.

And indeed, the XRT ETF is legally registered as an Open-End Fund:

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