SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

MAIN PLAYERS AND ARRANGEMENTS

Borrowers

2.1.2

The most active borrowers of specific securities are typically major securities dealers, bro- ker-dealers, hedge funds, prime brokers and investment banks. Since 2008, the borrower global landscape has dramatically changed, with the disappearance of major players such as Lehman Brothers and Bear Stearns. Securities borrowers seek to borrow securities in circumstances where they do not cur- rently have possession of those securities, for example: > When they need to cover a failed transaction in the course of their trading activity; > When they have put on a short position; > When they need to deliver securities they have not yet purchased against the exercise of a derivatives contract; > When they want to raise specific collateral, perhaps for another securities lending transaction.

Their motivation can also stem from trading strategies requiring short positions, as those displayed in the following table.

2.1

Figure 22: Illustration of trading strategies relying on securities borrowing

Trading strategy

Definition and objectives

Directional short-selling strategy

Borrowing of securities that one does not own, with the aim of realising a profit from an expected fall in the security price. Someone sells a security and simultaneously borrows the same quantity of the security to deliver to the purchaser, in the hope he will be able to buy back the security once the price has fallen. The security bought back is then used to unwind the securities borrowing trade. P rofiting from the relative price movements of specific securities irrespective of broader market movements (e.g. pairs trading) Borrowing securities as a defensive measure against market movements (e.g. using short positions to gain protection against long exposures) Exploiting a price difference between two instruments that should have identical values (e.g. buying a security at low price in one market and simultaneously shorting the same security in another market at a higher price) Common forms of arbitrage transactions involving securities borrowing are convertible bond arbitrage, index arbitrage or yield enhancement

Market neutral short-selling strategy

Hedging strategy

Arbitrage strategy

Copyright CACEIS, 2010

Other borrowing motivation includes financing, i.e. borrowing as part of a financing trans- action motivated by the desire to lend cash. In the case of bonds, the typical financing transaction will be a repo whereas in the case of equities, both securities lending and repo may be used.

Securities Lending & Repo markets | page 33