Reference Guide To U.S. Repo And Securities Lending Markets by OFR
Office of Financial Research
Federal Reserve Bank of New York
Office of Financial Research
Abstract
This paper is intended to serve as a reference guide on U.S. repo and securities lending markets. It begins by presenting the institutional structure, describing the market landscape, the role of the participants, and other characteristics, including how repo and securities lending activity has changed since the 2007-09 financial crisis. The paper then discusses vulnerabilities in the repo and short-term wholesale funding markets and efforts to limit potential systemic risks. It next provides an overview of existing data sources on securities financing markets, and highlights specific shortcomings related to data standards and data quality. Lastly, the authors discuss a near-term agenda to help fill some of the data gaps in repo and securities lending markets.
Reference Guide To U.S. Repo And Securities Lending Markets – Introduction
This reference guide focuses on the market microstructure, vulnerabilities, and data gaps in the U.S. securities financing markets, where firms transact using repurchase agreements (repo) or securities lending contracts. Repos allow one firm to sell a security to another firm with a simultaneous promise to buy the security back at a later date at a specified price. The economic effect of this transaction is similar to that of a collateralized loan. Securities lending involves a short-term loan of stocks or bonds in exchange for cash or noncash collateral. The economic effect of this transaction can be similar to that of a repo especially in cases when a securities lending transaction is collateralized by cash. Under current U.S. market practice, repos are mainly used to borrow cash using securities as collateral. Securities lending contracts are mainly used to access collateral securities using cash as collateral. Such transactions enable firms to establish short positions, hedge, and facilitate market-making activity.
The importance of repo and securities lending in the U.S. financial markets is evidenced by their prevalent use. Although daily volumes in the repo market have declined since the crisis, they still dwarf the amount transacted in unsecured cash markets. Due to a lack of data, there is a wide range of estimates of total repo and securities lending activity. For example, total repo activity at its peak level before the 2007-09 financial crisis ranged from $5 to $10 trillion.2 In the current post-crisis era, our estimate of total repo activity is around $5 trillion and our estimate of the outstanding value of securities on loan is just under $2 trillion. Both repo and securities lending markets came under pressure during the 2007-09 financial crisis. Gorton and Metrick (2012) and Copeland, Martin, and Walker (2014) describe different mechanisms through which runs occur in repo markets, and Krishnamurthy, Nigel, and Orlov (2014) emphasize the role of collateral in propagating a run. In addition, Keane (2013) discusses the risks associated with securities lending and advocates for greater regulatory and market scrutiny of this activity. Coming out of the financial crisis, regulators have focused on reforming practices in both repo and securities lending markets.
Policymakers need comprehensive and timely data about the institutional structure of the U.S. securities financing markets and their vulnerabilities to inform financial stability monitoring and policy analysis. In Section 2, we review the basic mechanics of repo and securities lending activity, and describe the main users of these contracts and their motivations. This section also highlights the central role that securities dealers play in both markets, where, alongside their own trading activity, they also act as intermediaries (see also Pozsar, 2014). In Section 3, we describe the main vulnerabilities of repo and securities lending. We discuss ongoing efforts to improve the robustness of the settlement process for repo contracts and highlight outstanding risks. Further, we discuss risks specific to securities lending, such as the common practice of indemnification, where the agent facilitating a securities lending transaction may offer certain guarantees to the securities owner. In Section 4, we describe data sources on repo and securities lending activity available to regulators and the public. We highlight specific gaps related to data coverage and data quality. While fairly comprehensive and granular data are available for the triparty repo market and the General Collateral Financing Repo (GCF Repo®) Service, data available on bilateral repo and securities lending transactions are spotty and incomplete.4 Finally, in Section 5, we conclude by proposing a near-term agenda to assist with filling some of the data gaps in repo and securities lending activities.
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