SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

MAIN PLAYERS AND ARRANGEMENTS

Beneficial owners have various possible routes to enter the securities lending business, direct or intermediated: > In the direct lending model, the lender will run its own securities lending program and will be responsible for revenue generation, risk management and operations. As this model requires having the necessary infrastructure in-house in place and sophisticated risk management to work with a broad range of counterparts, it generally concerns funds of a certain size which have an interest in getting control over the activity and can afford the cost. > In the intermediated model, beneficial owners can: • use their custodian bank or third party lenders to enter the securities lending market; • grant exclusive access to a part or the totality of their portfolios to a single borrower, either directly or through an auction (in that case, borrowers will bid for the lender’s portfolios by offering guaranteed returns in exchange for gaining exclusive access); • lend directly their portfolios but outsource to third parties collateral management and/or all the necessary administrative support (settlement instructions, corporate actions manage- ment, fee calculation and payment, etc.). Selecting one principal borrower will allow beneficial owners to avoid dealing and contracting with a vast number of counterparts. Then the principal borrower will be responsible for revenue generation, risk management and operations. He or she will also carry the counterpart risk when the securities of the beneficial owner are re-lent to the market. This model, illustrated in figure 21, is offered by many custodian banks to their clients under custody. It notably enables asset managers and other institutional investors to exchange potentially lucrative but unknown opportunities in the future for the certainty of an up-front fee.

Figure 21: Illustration of a typical “Principal borrower” model offered by a custodian bank

LENDERS (Beneficial owners)

PRINCIPAL BORROWER

- Bridge Securities lending

e.g. Custodian bank of the beneficial owner of securities

e.g. Asset manager or Institutional investor having their assets under custody with the Principal borrower

LENDER

BORROWERS

Securities lending

> Beneficial owners have only one counterpart: their custodian bank

e.g. Custodian bank of the beneficial owner of securities

Securities lending market

> The custodian bank carries all the market & regulatory risks in the securities lending transaction > The custodian bank operating as a principal borrower is remunerated by a split of the revenues generated by the loan of the beneficial owner’s securities (e.g. 70% for the beneficial owner and 30% for the custodian bank

Collateral delivery

Collateral re-investment in secure instruments

CASH & COLLATERAL MANAGEMENT

Copyright CACEIS, 2010

It should be noted that lenders can use a combination of different models across their port- folios and the various markets. However, only the largest institutional lenders with the most valuable and diversified portfolios would make use of all of the options described above.

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