SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

OVERVIEW OF THE SECURITIES FINANCING MARKETS

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The 1960s and 1970s: The development of securities lending and repo markets

As the US securities trading markets expanded, so did the securities lending markets from the 1960s, with the development of an active inter-dealer market in stock loans in the United States during this decade, which was associated with increased short-selling activity and a rising incidence of settlement fails. Separately, a financing market developed in US Treas- ury bonds to enable dealers to finance their inventory through repo transactions with cash lenders such as banks and corporations. The first cross border or international securities lending transactions took place in the 1970s. During that time, US custodian banks began to lend specific securities to broker- dealers on behalf of their clients such as insurance companies, endowment funds and cor- porate investment portfolios. Meanwhile, the US treasury bond repo market became a key part of the money market, as an alternative to interbank deposit and bill/CD markets. The modern repo developed in the United States in the 1980s, driven by securities firms which lacked access to retail or interbank deposits. Without repo, such firms had to borrow in the unsecured market by issuing commercial papers and taking loans, both financed by commercial banks. The cost of such unsecured funds to securities firms was high, reflect- ing the highly leveraged and risky nature of their business. The collateralised nature of repo allowed securities dealers to benefit from a reduction in the cost of funding and an increase in leverage. Direct access to end-investors also did away with the need of third-party inter- mediaries such as the commercial banks. The European repo market development has been heavily influenced by the major US in- vestment banks, who imported the repos into Europe during the 1980s to make up for the lack of securities lending markets in countries such as Italy and to support trading in bund futures from 1988. In 1981, the Employee Retirement Income Security Act (ERISA), a US law governing private US pension plan activity, was amended to permit plans to lend securities in accordance with specific guidelines. This amendment led growth in securities lending. In 1982, the collapse of Drysdale Securities, a US securities firm, had a profound impact on the securities lending and repo industry. It led to the standardisation of contracts, collateral margin requirements being specified, coupon accrual being established and more careful scrutiny of counterparties and their balance sheets. Securities lending volumes increased sharply in the 1980s and 1990s, supported by hedging and trading strategies, as well as by the removal of many regulatory, tax and structural bar- riers to securities lending throughout the world during the 1990s. The activity also became increasingly international and the large US custodian banks began to run their securities lending businesses on a global basis from hubs in Europe, Japan and North America. The 1980s and 1990s: The globalisation of securities lending and repo markets

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In 1991, legislation in the United Kingdom reinstated the ability of British investors to lend non- UK assets. Further regulatory changes permitted British unit trusts to lend their securities.

Meanwhile the European repo market also grew at a dramatic pace, interrupted occasion- ally by market crises. By the early 1990s, most of the major European banks had followed

Securities Lending & Repo markets | page 19