Lending & REPOs
Securities Lending & Borrowing
Bank Guarantees, SBLCs and other Securities to preserve access to bank loans for businesses.
Demand from firms for bank loans has soared to record levels since March 2020 as firms have scrambled to bridge liquidity gaps originating from the coronavirus (COVID-19) shock. This increase in demand was driven by a decline in the capacity of firms to finance their ongoing costs via operating cash flows, owing to a sharp fall in their revenues during the lockdown period. This resulted in acute liquidity needs to finance working capital and necessary investments. Moreover, in a context of high uncertainty, firms sought loans with a view to building up precautionary liquidity buffers or adapting their business to the new environment.
To help our customers accommodate the surge in loan demand at favourable conditions we have implemented schemes to provide guarantees for bank loans. These schemes transfer some of the credit risk and potential credit losses from customers to us, thereby mitigating the costs for banks.
To ensure that trades settle when expected, our customers can call on automated securities lending. This reduces the cost of failures, makes positions easier to predict and helps customers manage cash requirements with more certainty.
In addition to its automated services, we provide an actively managed lending service that uses its market knowledge to increase trading opportunities for borrowers.
Lenders benefit from some of the best available returns, so customers are freed from the daily administration associated with loans.
Operational services include:
- Checking the eligibility and sufficiency of collateral
- Daily mark to market
- Monitoring margin excesses and deficits
- Monitoring and managing corporate actions
- Collecting income.
These services bridge liquidity gaps by preventing settlement failure while providing a flexible source of securities to maximise trading strategies.
REPOs Repurchase Agreements
A repurchase agreement (repo) is an agreement between two parties whereby one party (the cash borrower) sells the other party (the cash lender) a security at a specified price with a commitment to buy the security back at a fixed time and price. In return, the cash lender provides the borrower a cash loan collateralized by the securities the borrower sold to — and will repurchasefrom — thelender.Maturitiescanvaryfrom overnight to a year, with the longer-maturity repos commonly referred to as “term” repos. Repurchase agreements provide important benefits to each of the parties to a repo transaction. For the broker-dealers that constitute a large majority of the cash borrowers, repos provide low-cost funding they can use
to finance the marketable securities on their books. For the lenders— moneymarketfunds,insurancecompaniesandother institutionswithsignificantamountsofcashattheirdisposal — repos often provide better returns than many other short-term debt investments.
Repos are particularly attractive to the managers of money market funds because they offer three distinct benefits:
- Liquidity — Repos allow the managers to invest cash overnight, making them a critical component in their effort to manage liquidity. The size of the market and supply of repos also provide for strong liquidity.
- Yield advantage — Repos have historically provided additional yield as compared to traditional money market instruments, such as Treasury bills, time deposits or agency discount notes. The yield advantage depends on such factors as the repo’s maturity date and its credit quality.
- Flexibility — The daily principal amount of repos can be adjusted up or down as fund cash flows dictate and transactions can be conducted late in the day.
Two basic types of repurchase agreements are the bilateral repo and the tri-party repo (see below).
If a counterparty defaults, a loss may be realized on the sale of the underlying security to the extent that the proceeds from the sale and accrued interest of the security are less than the resale price, including interest, provided in the repurchase agreement. Moreover, should a counterparty declare bankruptcy or become insolvent, a fund may incur delays and costs in selling the underlying security.
Our Management seeks to mitigate counterparty risk by providing credit and portfolio oversight through controls and reviews that include:
Credit review process
Our Management’s assessment of credit quality includes counterparty evaluations in which all counterparties must be vetted and approved by the firm’s credit review committee. If the counterparty is not on the approved list, our Management will not execute a repurchase agreement with it (even if it posts strong collateral).
Our Management’s collateral requirements are designed to protect fund investors should a counterparty default:
- The value of the security must be equal to or greater than the value of the repo itself (typically 102% but can be up to 115% of the repo value depending on the collateral’s credit quality).
- Repo positions must have first claim and priority lien on the collateral.
Management conducts periodic reviews to verify that the requirements noted above are met and that the appropriate legal agreements are in place to protect a fund’s interests in the collateral.
We believe our credit review process, collateral requirements and operating controls are well designed to manage counterparty risk associated with repo transactions.
With a bilateral repo transaction, a pension fund, insurance company or other cash lender buys securities from a cash borrower on the condition that the borrower will repurchase the securities at an agreed-upon price and date. On the trade date, the borrower delivers the securities to the cash lender, who simultaneously pays the cash to the borrower. The process is reversed on the repurchase date, when the lender returns the securities to the borrower, and the borrower, in turn, transfers the borrowed funds back to the lender with interest.
The second type of repo is the tri-party repurchase agreement. A tri-party repo differs from a bilateral repo in that a third party, a tri-party custodian bank acts as an intermediary between the borrower and the lender. The tri-party custodian bank holds the collateral, the securities, sold by the borrower to the lender. A tri-party repo creates operational efficiencies such as transaction settlement, custody of securities and collateral valuation.
Differences between REPOs and Lending
Securities lending, like repo, is a type of securities financing transaction (SFT). The two types of instrument have many similarities and can often be used as functional substitutes for each other.
In a securities lending transaction in the international market, as in repo, one party gives legal title to a security or basket of securities to another party for a limited period of time, in exchange for legal ownership of collateral (although it is also possible for the collateral to be pledged and there are still uncollateralized securities loans). The first party is called the lender, even though he is transferring legal title to the other party. Similarly, the other party is called the borrower, even if he is taking legal title to the security.
The collateral in securities lending can be either other securities or cash (securities lending against cash collateral looks very much like repo). The borrower pays a fee to the lender for the use of the loaned security. However, if cash is given as collateral, the lender is obliged to reinvest the cash and ‘rebate’ an agreed proportion of the reinvestment return back to the borrower. In this case, the lender usually deducts the borrowing fee he owes from the rebate interest that he pays to the borrower, rather than paying it separately, so the fee is implicit in the rebate rate.
A key difference between repo and securities lending is that the repo market overwhelmingly uses bonds and other fixed-income instruments as collateral, whereas an important segment of the securities lending market is in equities.
Because the securities lending of equity transfers not only the legal ownership, but also the attached voting rights and corporate actions, it has become convention in the securities lending market for loaned securities (both fixed income and equities) to be subject to an express right of recall by the lender, so that he can recover securities if he wishes to exercise voting rights or respond to corporate actions. In contrast, unless a termination open is specifically agreed between the parties, repo does not allow a seller to recall his securities during the life of a transaction.
Another difference between repo and securities lending is that most repo is motivated by the need to borrow and lend cash, whereas securities lending is typically driven by the need to borrow securities. However, there is an overlap between securities lending and the specials segment of the repo market, which is also driven by the demand to borrow particular securities. And securities lending is sometimes used by securities investors to raise cash.