SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

OVERVIEW OF THE SECURITIES FINANCING MARKETS

• GC versus Specials The general motivation for repos is financing, i.e. the need to borrow or lend cash. Such repos are called “General Collateral (GC) repos” and constitute the bulk of the repo market. With GC repos, the buyer does not insist on the seller providing a particular securities issue as collateral but will accept any of a range of similar quality issues However, repos can also be used to borrow securities in order to cover short positions. In that case, buyers will seek a specific security as collateral in the repo market. Such repos are called “specials” and are comparable to securities lending. The interest given up by the buyer of a special in the repo market is equivalent to the fee paid by the borrower of the same securities in the securities lending market. The repo rate for a security in demand is generally below the GC repo rate. • Reverse repo A reverse repo is the mirror image of a repo (buyer’s viewpoint). It involves the short-term purchase of securities versus a transfer of cash, with a simultaneous agreement to resell the securities at a future date at an agreed-upon price. Reverse repos may be used to borrow specific securities in order to cover short positions, to finance a new purchase or meet short-term cash needs. • Credit repo The bulk of collateral in most repo markets is comprised of domestic government bonds, gen- erally considered as free of default risk and liquid. An alternative collateral repo market – called “credit repo” and including instruments such as covered bonds, other Mortgage-Backed Securities (MBSs), other Asset-Backed Securities (ABSs), Collateral Debt Obligations (CDOs) or unsecured corporate bonds – also exists but is much smaller and was set back by the recent crisis. • Equity repo In addition to traditional government bonds repos that have been around for many years, it should be noted that there is a growing but still fairly new equity repo market. In the past, equity repowas not popular because fixed income assets were considered themost safe, but with the collapse in the structured products market and as modern markets have expanded, banks and broker-dealers have sought to increase their financing capabilities by using alter- native forms of repo collateral, such as equities. Equity repo has become a strong component of the overall repo market because of the benefits provided by transparent pricing, which is a more dependant book of liquidity, and reduced execution risk. Adding equity repo to a portfo- lio disaggregates risk and makes it more transparent. Simply put, equity repo is a repurchase agreement, which uses various types of equities as collateral 2 . The repo market is currently a key tool for market participants in search of liquidity or specific securities. As a fund-raising tool, repos are an alternative to unsecured loans and the issuance of short-term securities. Originally confined to the back-office, repo has gradually grown in importance and is now considered as an integral liquidity man- agement tool for all financial institutions across the industry. Repo is also an essential tool used by central banks to manage their open-market operations in the implementa- tion of monetary policies. With unsecured financing no longer an option beyond the very short term, the repo market has become increasingly attractive.

2 Source: Investor Services Journal, “Securities Lending Market Guide 2009”, 2009

page 12 | Securities Lending & Repo markets