SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

OVERVIEW OF THE SECURITIES FINANCING MARKETS

the US pioneers into the nascent European repo market. The reform of the French market in 1994 and the creation by the Bank of France of a group of repo primary dealers known as “Spécialistes en pensions sur valeurs de Trésor (SPVTs)”, as well as the opening of a sterling repo market in the United Kingdom in 1996 and a change in regulation in Germany the same year to exempt repos from the minimum reserve requirement, played a key role in the take-off of the European repo market. Other key drivers included regulatory capital pressure on unsecured lending and the rapid growth of hedge funds and proprietary trading in fixed income. In 1997, the industry was marked by the Asian crisis, when liquidity really dried up. This was the first elevation of the business – so far considered as a back-office activity mainly used for settlement coverage and not properly recognised as a business in its own right - with se- curities lending and repo being used to protect liquidity; It was no longer just an operational business but a funding business. The rising hedge fund industry and the increasing use of prime brokerage arrangements were key factors in the more recent growth of securities lending and repos. The growth of securities lending itself also further fueled repo market volumes as the lend- ers often turned to the repo markets to reinvest the cash collateral received. With the start of European Monetary Union in January 1999, the Eurosystem adopted repos as a key instrument and in the 2000s, central banks began using repo more widely, not only as a liquidity management instrument, but also as an efficient way of funding investments and investing their growing pools of reserves. Meanwhile, the market became more seg- mented, with specialist regional players developing and outsourcing developing (e.g. third party securities lending agents). New securities lending markets such as Brazil, India, Korea or Taiwan emerged, as well as new transaction types (e.g. equity repo, contracts for diffe- rences, total return swaps). The rising hedge fund industry and the increasing use of prime brokerage arrangements were key factors in the more recent growth of securities lending and repos. The growth of securities lending itself also further fueled repo market volumes as the len- ders often turned to the repo markets to reinvest the cash collateral received. The financial market turmoil that began in August 2007 with the subprime crisis and led to the collapse of Lehman Brothers in mid-September 2008, affected the repo and securities lending markets in several ways. Below are a few – non exhaustive – illustrations of major impacts faced by the industry: > During the liquidity crisis, a global shift from unsecured to secured financing was expe- rienced. Unsecured money market models collapsed and the markets in general were looking for deeper protection. In this difficult context, securities lending and repo instru- ments provided a secured option to market participants. As the ability of banks and other institutions to borrow in the interbank market was severely constrained, repos offered an alternative form of financing to market participants. The 2000s before the financial crisis: Growth of emerging markets, deve- lopment of new transaction types and arrangements 2007-2010: The credit crunch and the Lehman collapse

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