The proposals on securities lending and financing in the Financial Stability Board’s paper on shadow banking have reassured market participants, but it is unclear whether they will override more draconian ideas.

What’s happening?

At the end of August 2013, the Financial Stability Board (FSB) published its latest report, Strengthening Oversight and Regulation of Shadow Banking. The report identifies five workstreams, of which the fourth is addressing shadow banking risks in securities lending and repos (repurchase transactions). The FSB requested responses to its proposed policy framework on this topic by November 28, 2013.

What are the main proposals?

The FSB is already undertaking a quantitative impact study on its November 2012 proposal to set minimum haircuts for repo collateral, to prevent excessive repo-financed leverage. The latest report reiterated the importance of minimum standards on collateral valuation and management for all repo and securities lending participants.

Most of the new recommendations focus on increasing the quality and transparency of data available on securities lending and repos, both in the banking sector and among regulated investment funds. The FSB proposes basic regulatory regimes for non-bank securities lenders and for the rehypothecation (lending out) of assets provided as repo collateral, all designed with the intention of minimising liquidity risk.

The FSB also proposes an expert group on the protection of client assets in rehypothecation and further study on the possibility of introducing central clearing counterparties (CCPs) for repo or widening the participation of key market players in existing repo CCPs.

What do market participants think?

The general consensus is that the FSB has engaged with the industry relatively well. This means it has correctly identified priorities rather than seeking to duplicate regulation on the banks or intervene in market practices that operate well already.

“Repo volumes are 30% to 40% lower than before the crisis, but the proportion of hedge fund participation is higher, and so is the proportion of non-traditional collateral such as equities and high-yield bonds. As a result, we should expect greater regulatory involvement in this part of the industry that is less regulated and less transparent at the moment,” says James Treseler, head of equity financing at Société Générale Corporate & Investment Banking.

David Hiscock, deputy head of market practice and regulatory policy at the International Capital Market Association (ICMA), says the market is rather less opaque than its popular characterisation would suggest. The European Repo Council conducts a survey of the market twice yearly, and earlier this year fixed-income market data provider Markit teamed up with Bank of New York Mellon to provide data on tri-party repo.

“There is some scope for improvement on the supply of information and the industry is keen to help, provided this does not generate unnecessary additional reporting burdens. Part of the challenge is that different bodies want different information for different purposes. Central banks want to know about monetary policy transmission, prudential regulators worry about systemic risk and the funding strategy risks of individual firms, while conduct authorities want to know the details of every transaction,” says Mr Hiscock.

Kevin McNulty, chief executive of the International Securities Lending Association, is reassured that the FSB has taken a cautious stance on regulatory demands to move repo activity onto central clearing, calling for further study rather than proposing an immediate shift. The proposals on rehypothecation are similarly modest.

“The FSB has recognised that aggressive regulation is not needed, provided some globally prescribed minimum standards are agreed. We believe that the standards for securities lending are generally in line with best market practice and while some detail remains to be worked out, we do not believe there will be much disruption to markets should the FSB proposals be implemented as written,” says Mr McNulty.

What’s next?

The international response to the FSB report is the big question mark, however. Mr Treseler emphasises the importance of global agreement if minimum haircuts are applied to collateral, to avoid geographical regulatory arbitrage.

Meanwhile, proposals from the Basel Committee on Banking Supervision for a tougher leverage ratio measure of bank capital adequacy have already sparked a response from ICMA and other market participants. Their concern centres on whether “appropriate counterparty netting would be prohibited” for repo transactions. If so, this would significantly increase the impact of repo activity on capital requirements.

“The leverage ratio is definitely a higher current concern for the repo industry than the FSB report. If it becomes a blunt instrument that simply discourages all forms of repo, then it could cut to the heart of the financing machine and contradict other initiatives such as the liquidity coverage ratio and the use of collateralised central clearing for derivative transactions,” says Mr Hiscock.

However, Mr Treseler cautions that reliable netting of repos is not always easy. “If you are talking about two repos involving the same legal entity of the same counterparty in the same bankruptcy jurisdiction using the same asset class as collateral with the same duration, then netting can be straightforward. If you change any of those variables, it becomes more complicated. The market will evolve to enable netting on non-traditional repos, but it will take time,” he says.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter