(Bloomberg) -- Facing a shrinking pool of dealers in a key part of the $2.6 trillion money-fund industry, Deborah Cunningham did something last month she's never done before in her 34 years at Federated Investors. She arranged one of these collateral trades directly with an new partner - an insurance company.

Cunningham, chief investment officer for global money markets at Pittsburgh-based Federated, is seeking alternatives to traditional counterparties for repurchase agreements, or repos, as new regulations drive banks from the business. With that market contracting, money funds are finding new ways to get the securities they need, opening a door for other institutions to step into roles once dominated by banks.

"We sort of went down the non-traditional path and used an insurer we deal with on a direct repo basis, which is the first time we went outside the bank or broker-dealer market," Cunningham said in New York at a panel on money markets organized by the Center for Business Innovation. "Traditional collateral is in short supply."

The new trading relationships are being forged by a confluence of post-crisis regulations that are both driving up demand for low-risk, short-term securities such as repo transactions while at the same time making the trades more costly for banks that act as middlemen.

Meanwhile, the supply of short-term Treasury bills that asset managers seek is at multi-decade lows.

J.P. Morgan expects an extra $900 billion of demand for government securities during the next 18 months, putting pressure on a sizable chunk of the $1.4 trillion bill market.

The mismatch between supply and demand has been so acute that four-week bill rates fell to minus 0.0304% on April 29, the lowest on a closing basis since December 2008. The Treasury said it would increase issuance to meet growing demand.


Many top U.S. asset managers, from Federated to Fidelity Investments to BlackRock, are diverting assets into government debt from money-market funds that invest in company IOUs known as commercial paper.

The change comes as Securities and Exchange Commission regulations set to take effect in 2016 will no longer allow funds that invest primarily in commercial paper to report a fixed $1 share value, requiring values to float instead.

The amount financed daily through the tri-party repo system, where banks lend the securities used as collateral and clearing banks serve as middlemen, is down 17% to $1.62 trillion as of May 11 from $1.96 trillion in December 2012, data compiled by the Fed show. J.P. Morgan and Bank of New York Mellon are the two institutions serving as the industry's clearing banks.

There may be more change to come. Joe Abate, money-market strategist at Barclays, predicts that part of this market may contract another 20% in the next year or two, even after U.S. financial institutions have already reduced their balance sheets to comply with capital requirements and the risk-curbing rules of the Dodd-Frank Act.


"The largest, capital-constrained banks are not providing enough repo to meet market demand from money funds," Abate wrote in a June 5 note. "Balance sheet reporting pressures are intensifying and have reduced liquidity in the market for Treasury collateral."

Given the dearth of places to put cash, many money funds have turned to the Federal Reserve.

In the Fed's reverse repo program, it temporarily borrows cash using Treasuries as collateral, reversing the process typically the next day. Since 2013 the Fed has been testing the program as a one of the tools it may use when it removes its unprecedented accommodative monetary policies.

Cunningham is trying not to let Federated become too reliant on the central bank since the program isn't permanent.

"We strive each and every day to have 17, or 18 or 20 or so different counterparties that we are always dealing with," Cunningham said during the panel.

"They each might not always have the best rate or all the collateral we need. Becoming dependent on an unnatural player in the marketplace, the New York Fed, is something that is not necessarily anything we want to become too comfortable with."


The Fed caps daily usage of its overnight reverse repos at an aggregate $300 billion for its more than 100 counterparties. The Fed's share of the tri-party repo market reached a peak of around 30% in May, according to Barclays.

The changing market has also been a boon to smaller financial firms. The average daily repo volume for Boca Raton, Florida-based broker/dealer AVM has risen 63% to $80 billion in the past two years, with an increasing percentage of direct repo, according to Jeff Kidwell of AVM, who also spoke at the panel.

That comes as dealers' matched-book repo, where banks rely on repurchase agreements and securities lending to fund clients while using the same collateral and terms to borrow themselves, falls. "A lot of people are coming to us because they can no longer leave their cash at the banks," Kidwell said.

"Regulations that are already being implemented and more that are ongoing will cause banks to trim their capital more and their repo matched-book activity."

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