SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

MAIN PLAYERS AND ARRANGEMENTS

• Third-party agents Advances in technology and operational efficiency have made it possible to separate the administration of securities lending from the provision of basic custody services, and a number of specialist third-party agency lenders have established themselves as an alterna- tive to the custodian banks. Their market share is growing from a relatively small base. Their focus on securities lending and their ability to deploy new technology without reference to legacy systems can give them flexibility. Another category of intermediaries are dealers trading as principals. We can distinguish five broad types of principal intermediaries: Custodian banks, investment banks, broker- dealers, prime brokers and specialist intermediaries. In contrast to the agent intermediar- ies, they can assume principal risk, offer credit intermediation and take a position in the securities they borrow. Indeed, they intermediate between lenders and borrowers but they also use the market to finance their own wider securities trading activities and may seek higher returns by additional risks (collateral risk, counterpart risk, credit risk, liquidity risk). Through their prime brokerage operations, they also meet the needs of hedge funds and the borrowing of securities to finance their positions has grown rapidly. Principal intermediaries match the supply of beneficial owners who have large stable port- folios with those that have a high borrowing requirement. They also distribute securities to a wider range of borrowers than underlying lenders, who may not have the resources to deal with a large number of counterparts. • Broker-dealers Broker-dealers are the most important intermediaries in the securities lending markets and provide a wide range of services as well as trading in their own right. First, they act as prin- cipal intermediaries between the ultimate borrowers and suppliers of funds or securities. Running repo books, dealers use their capital and market-making capabilities to interpose themselves between two counterparties, earning a spread on the trade. This can offer the lender a measure of protection against an unknown counterparty and anonymity to a se- curities borrower who does not wish to reveal his identity. Secondly, broker-dealers offer exclusive securities lending programs or agency lending services to institutional investors, similar to those traditionally provided by custodian banks 12 . B - Principal intermediaries

2.1

Many broker-dealers combine their securities lending activities with their prime brokerage operation to achieve significant efficiency and cost benefits.

• Prime brokers Prime brokers serve the needs of hedge funds and other alternative investment manag- ers. Securities lending is one of the central components of a successful prime brokerage operation, with its scale depending on the strategies of the hedge funds for which the prime broker acts. Both long/short equity and convertible bond arbitrage strategies heavily rely on securities borrowing.

12 Source: Global Custodian, “Collateral: Securities Lending, Repo, OTC Derivatives and the Future of Finance”, 2007

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