Netting Rules for Repo, Securities Lending and Prime Brokerage

Finadium
September 2014

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The topic of netting for repo, securities lending and prime brokerage has been alternately praised and attacked in financial markets. Proponents argue that it strengthens risk management by encouraging safe, balancing transactions by banks and broker-dealers. Critics say that netting hides risk and can be manipulated to suit the needs of the institution. Which arguments have merit and which are based on heresay and rumor?

This Finadium research report investigates current netting practices and directions for their future evolution. Netting has been and will remain an important mechanism for freeing up balance sheet in securities finance transactions. However, its value is changing as Basel III and domestic rules shorten the time period of bank observations. Previously, banks would work to net their securities finance balance sheets once a quarter, a process that took weeks to arrange. Going forward, it is possible that netting will need to be done daily to meet daily average observation periods of stress tests. This would mean a different conception altogether of the importance and role of netting in financial markets.

Even in the post-Basel III world, netting still matters: our research finds that repo dealers believe that netting can compress High Quality Liquid Asset (HQLA) bilateral trading books by 60% to 80%. Non-HQLA books including corporate bonds, equities, or other less liquid assets do not compress as easily. Even so, the ability and intelligent application of netting rules means a major difference in securities finance capacity and profitability.

This report is valued reading for practitioners in securities finance, risk managers, Treasury managers and their advisors.

This report is 35 pages with 3 exhibits.

TABLE OF CONTENTS

■ Executive Summary

■ The Function of Netting

■ How Much Does Netting Save in Balance Sheet?
– Risk Weighted Assets

■ Accounting Netting vs. Economic Netting
– Methods Used to Net a Repo Book
– CCP Clearing

■ Netting and Client Positions, or Does Netting Matter Anymore?
– Reporting and Transparency

■ Netting in Prime Brokerage and Securities Lending

■ IFRS, GAAP, IAS 32 vs. Fin 39 & 41

■ The Net Impact

■ Annex 1: MF Global and Repo 105

■ About the Author

■ About Finadium