SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

OVERVIEW OF THE SECURITIES FINANCING MARKETS

1.1.2

Securities loans

1.1

Securities loan refers to a transaction in which one party (the lender) transfers to another party (the borrower) securities (equities, bonds), often against the transfer of collateral in order to protect the lender against the possible default of the borrower, with the simulta- neous agreement by the borrower to transfer to the lender equivalent securities on a fixed date or on demand (open), against the transfer to the borrower by the lender of assets equivalent to such collateral. Open term loans, which can be recalled at any time with a minimal notice period, are more commonly used than fixed term. Indeed, they provide flexibility as they enable the lender to exit the securities lending transaction on demand and sell at any time the concerned securi- ties. Thus, in a deteriorating credit environment a lender can reduce his exposure to, or even cease trading with, a counterpart in very short order. Throughout the life of the loan, the market value of the lent securities and of the collateral (if securities collateral) will fluctuate. To maintain sufficient levels of collateralisation, a daily (or even intraday) mark to market is typically done and margin calls are exchanged accordingly between the parties. The borrower pays the lender a fee for the use of the borrowed securities, paid monthly or at the termination of the transaction (in fine). This fee takes into account factors such as demand and supply (the more sought-after on the market securities are, the higher the fee a lender can obtain) or collateral flexibility. In case of cash collateral, the securities lender pays the borrower an interest rate calculated on the cash collateral received (rebate rate). A rebate rate of interest implies a fee for the loan of securities and is therefore regarded as a discounted rate of interest.

Figure 4 illustrates the characteristics and the main flows of a standard securities lending transaction, while figure 5 shows a valuated example of securities loan transaction.

Figure 4: Illustration of a standard securities lending transaction

Securitieslendingtransaction characteristics Trade date

Settlement date Lender identity Borrower identity

Securities lending Collateral delivery (Cash/Securities)

Maturity (open/fixed) Security name and ID Dividend entitlement Quantity lent Loan market value Lending fee Nature of collateral

Party A «LENDER»

Party B «BORROWER»

Margin calls

Lending fee Possible interest on cash collateral (rebate)

(cash/securities) Margin required Amount of collateral required Settlement instructions

Copyright CACEIS, 2010

Party B

Securities Lending & Repo markets | page 13