How securities lending and repo are converging

Key Takeaways

• Volatility and macroeconomics prompt rethink of finance models
• The lines between securities lending and repo are blurring
• Automation, electronification, and new data tools will be key drivers

Securities lending and repo transactions may have distinctive characteristics, but they are increasingly being used in tandem due to the demand for flexibility and enabled by advances in technology. The trend will continue as there is a growing need for funding and financing on the back of shifting market conditions, regulatory changes, and investor behavior.

A briefing paper by S&P Global Intelligence reflects these undercurrents. It noted that over the last five years, a confluence of tighter margin requirements, short-selling legislation, and constrained balance sheets has meant better capital resource allocation and more efficient optimization strategies have come into sharper focus.

In addition, the paper found that from the start of 2023 the demand for liquidity has jumped, which in turn has led to a convergence of capital, directly influencing supply and demand dynamics across the securities lending landscape.

It is no surprise, then, that against this backdrop, market participants are rethinking the traditional dividing lines between repo and securities lending.

Origins and evolution

Historically, repo enables sellers to offload securities to a buyer and then agree to purchase them back at a higher price. Bonds remain the preferred type of collateral, and it is typically deployed as a financing tool for firms looking to raise cash and leverage.

By contrast, securities lending, which emerged in the 1980s, was kickstarted by prime brokers acting on behalf of hedge funds to short securities. Securities (bonds or equities) are imparted to a borrower for a set or unlimited period with cash being the collateral of choice.

Although cost and operational efficiency have always been concerns, for both business streams, they are more of a worry in today’s higher-for-longer interest rate environment. Even with the current spate of cuts, it is unlikely that the era of near-zero interest rates of the not-too-distant past will make a comeback anytime soon.

As a result, both activities are increasingly being used alternately to support regulatory capital and client trading needs. However, total integration between the two will not happen overnight because the related transactions have different business motivations, legal documents and reasons for entering into one type of trade versus another. This is not even mentioning the choice over the use of collateral.

In the meantime, various configurations are being explored. For example, some trading desks have combined product types with repo, swaps, securities lending, and financing to enhance revenues and manage costs effectively. Others have merged operations for collateralized trades but have kept different client-facing teams for each product.

There are also those that created financial resource, treasury, or central collateral desks that adopt an overview position of each individual trading desk to optimize exposures across the firm. On the other end, a handful of organizations are undoing the merger of siloes on the front end to re-create securities lending and repo desks while bolstering their collateral optimization and inventory management capabilities.

The role of technology

These different options could not have happened a few years ago. Consolidation of the technology stack across fixed income and equity business lines has been part of the solution design for Anvil, ION’s Secured Funding platform since it was originally conceived. While electronification and automation have been features for some time, the post-COVID era of heightened volatility and trading activity has accelerated the progress. Technology providers have been busy helping firms either remold or combine business lines to create an effective funding and financing ecosystem. It is a challenge not to be underestimated given the highly entangled nature of the, often legacy, infrastructure involved.

Fully supporting the two business lines throughout the trade lifecycle and in one application enables market participants to decide how to execute transactions based on the need and the relationship, and taking into account various factors. These range from completing the trade with the least friction possible to minimizing manual actions and the best use of collateral or P&L impact.

Driving cross-product efficiency between repo and securities lending and grappling with the exponential volumes of data require a real need for tools that deliver a faster and more standardized means of determining optimal assets for each product use. There are multiple benefits. These include developing enhanced lending strategies by assessing demand and pricing trends, as well as having flexibility for both trading parties on terms and collateral requirements.

Equally important, better quality and comparable data go a long way in supporting conversations with regulators and internal risk teams regarding market monitoring across collateral quality, counterparty risk, and volatility management.