FSB publishes report: 'Securities Lending and Repos: Market Overview and Financial Stability Issues'

27 April 2012

The report describes the segments, operations and practices of these securities financing markets, which may constitute an important element of the shadow banking system.

The FSB is examining the regulation of securities financing markets from a financial stability perspective as part of its wider work on shadow banking, on which the FSB will issue recommendations by the end of 2012.

The report is an Interim Report of the FSB Workstream on Securities Lending and Repos, and is preliminary to its work to develop policy recommendations in this area. The Workstream has reviewed current market practices through discussions with market participants, and classified the markets into four main, inter-linked segments:

(i) a securities lending segment which comprises lending of securities by institutional investors to banks and broker-dealers against the collateral of cash or securities;

(ii) a leveraged investment fund financing and securities borrowing segment which comprises financing of leveraged investment funds’ long positions by banks and broker-dealers using both reverse repo and margin lending secured against assets held with the prime broker, as well as securities lending to hedge funds by prime brokers to cover short positions;

(iii) an inter-dealer repo segment which comprises primarily government bond repo transactions amongst banks and broker-dealers that are typically cleared by central counterparties (CCPs); and

(iv) a repo financing segment which comprises repo transactions primarily by banks and broker-dealers to borrow cash from “cash-rich” entities, including central banks, retail banks, money market funds, securities lenders and increasingly non-financial corporations.

The Workstream identified five key drivers that have contributed to the growth of these markets: (i) demand by risk-averse institutions for “money-like” instruments to support their primary investment objectives of preserving principal and liquidity; (ii) the financing needs of financial intermediaries such as banks and broker-dealers; (iii) growth of investment strategies that use leverage and involve short selling; (iv) increased need for banks and broker-dealers to gain access to securities for the purpose of optimising the collateralisation of repos, securities loans and derivatives (the so-called “collateral mining”); and (v) securities lenders and their agents seeking to enhance investment returns.

The Workstream views the following aspects of securities financing markets as constituting potentially important elements of the shadow banking system, as defined by the FSB:

• repo financing by non-bank entities to create short-term, money-like liabilities, typically collateralised by longer-term securities;
• leveraged investment fund financing that may lead to further leverage and maturity transformation;
• securities lending cash collateral reinvestment by which the cash proceeds from short sales are used to collateralise securities borrowing and then reinvested by securities lenders into longer-term assets, thus constituting a long credit intermediation chain with maturity transformation; and
• collateral swaps (also known as collateral downgrade/upgrade transactions) that can further lengthen transaction chains or allow banks to meet liquidity requirements.

Full report

© Financial Stability Board