The Office of Financial Research published a brief entitled, "Repo and Securities Lending: Improving Transparency with Better Data" yesterday, which discusses "data gaps in U.S. repurchase agreements and securities lending markets." Written by OFR's Viktoria Baklanova, it says, "A paucity of data and a limited understanding of the institutional structure of these markets prevented regulators from fully identifying and responding to vulnerabilities during the 2007-09 financial crisis. The OFR and Federal Reserve are conducting a pilot data collection to close these data gaps." We excerpt from the OFR paper below, and we also excerpt from J.P. Morgan Securities most recent analysis of the securities lending cash reinvestment space. (Note: Federated Investors will also host its latest quarterly earnings call this morning at 9am; watch for coverage Monday.)
The OFR brief says, "Before the crisis, regulators had only limited information on the nature of funding obtained in the repo market, the quality of collateral, and the adequacy of risk management practices in securities lending. During the crisis, three types of vulnerabilities emerged to threaten financial stability: (1) risk related to the leverage and liquidity incurred by market intermediaries, (2) weaknesses in the market infrastructure, and (3) the risk of asset fire sales."
It continues, "Regulators have taken important steps to address some of these vulnerabilities. New standards for leverage and liquidity have led banks and affiliated dealers to reduce their repo dealings. Clearing banks addressed the intraday credit to repo dealers and market participants took steps to improve their liquidity and credit risk management, following the recommendations of a private sector task force sponsored by the Federal Reserve Bank of New York."
The OFR piece explains, "This brief reviews available data sources about repo and securities lending. It also assesses the data gaps and discusses the role of regulators in the United States and internationally in bridging those gaps. In the near future, the OFR will release a reference guide on U.S. repo and securities lending markets. The guide will examine more closely how dealers and their clients use these markets, building on the ongoing research on the sources and uses of short-term funding."
Finally, it adds, "High-quality data covering repo and securities lending are needed for regulators to conduct in-depth analysis of the pros and cons of policy options and to monitor current market developments. Comprehensive data coverage is still lacking. For example, the potential migration of repo activities from primary dealers to other firms is difficult to track. In 2014, the OFR and the Federal Reserve launched a joint pilot project to collect data to improve our understanding of bilateral repo and securities lending.... The pilot task force identified data elements essential for analyzing risks related to repo and securities lending. Data are needed to capture the dependence on short-term funding of individual repo market participants, counterparty exposures, and interconnections among participants."
J.P. Morgan Securities also sheds some light on the securities lending sector in its latest "Short-Term Fixed Income weekly. A section entitled, "Revisiting Securities Lenders," says, "For better or worse, money market funds have been the subject of many people's attention recently. With $1.4tn of assets under management, prime money market funds have the ability to influence many parts of the short-term markets. Other investors, like securities lenders (sec lenders), who also play a large role in the money markets, tend to get lost in the shuffle. While sec lending reinvestment portfolio balances have declined significantly since mid-2007, data from the Risk Management Association (RMA) reveal that they still have approximately $700bn of assets under management."
It continues, "In fact, over the past two years USD balances of sec lender portfolios have grown, to the tune of $114bn or 19% according to RMA.... This scale of growth is consistent with other data sources. When we looked at the amount of global collateral held by four large sec lenders in support of sec lending indemnification agreements, over the past two years balances have increased by $155bn (or 19%) to $974bn as of 4Q2014.... Similarly, Fed data on primary dealer financing activity shows that sec lending activity has also grown. In particular, total securities borrowed by primary dealers increased by $60bn over the past two years, driven primarily by an increase in equities borrowed.... An increase in securities borrowed activity by dealers typically results in higher sec lender portfolio balances as securities lent are usually collateralized by cash."
JPM's Alex Roever, Teresa Ho and John Iborg write, "That cash is then reinvested in the short-term markets. To that end, sec lenders' asset profile is very similar to prime MMFs. They invest in CP, CDs, repo and time deposits. But unlike MMFs, they are not regulated by the SEC and hence can invest in highly-rated securities outside of 2a-7 (e.g., 1-3y corporate bonds). Indeed, according to RMA, WAMs to final maturity on sec lending portfolios are 88 days long. Even so, yields on sec lenders' cash reinvestment portfolios are modest, returning only 0.22% as of 4Q2014. This is likely attributed to the fact that 56% of their portfolio are invested in repos, time deposits and MMFs.... Similar to other short-term investors, sec lenders have increased their liquidity positions over the past two years, impacting returns."
Finally, JPM, which lists the four largest sec lenders in a table -- State Street, Bank of NY Mellon, J.P. Morgan and Northern Trust -- tells us, "Overall, sec lending balances have stabilized after falling by a significant amount in 2008. The deleveraging among market participants that took place immediately after the crisis is largely behind us, as evident by the recent boost in assets under management. That said, it's unclear whether this trend could be sustained going forward. One challenge could be regulatory related as balance sheet constraints related to capital, liquidity and leverage could limit the amount of sec lending activity taken by dealers (though so far, the regulations do not appear to have had a significant impact on activity)."
