Comments on the FSB interim report on repo and securities lending

The Financial Stability Board (FSB) Workstream on Securities Lending and Repos has released “Securities Lending and Repos: Market Overview and Financial Stability Issues” (April 27, 2012). We mentioned yesterday that it was more of an update than new information. Given all the “sturm und drang” we have been hearing from financial regulators who fold repo & securities lending into the shadow banking debate, the expectation was for the FSB report to be more critical, perhaps even foreshadow next steps. In fact, this report was remarkably tame but after a couple of reads, we have some details to report.

The report was more of a market primer. We liked the way the authors described the main market segments,

  • securities lending
  • leveraged  investment fund financing and securities
  • inter-dealer repo
  • repo financing

and how the areas interfaced with each other. Another segment that was well done was the review of regulation by country. We all live in our own jurisdictional bubbles and often fail to appreciate the subtle and not-so-subtle regulatory differences that impact how business is done in other countries. The report looked at differences in re-hypothecation, eligible counterparties and collateral, concentration limits, liquidity risk, minimum margin and haircuts, and cash collateral reinvestment.

One area that the paper did observe deficiencies was in market transparency. The report cited issues with macro-level market data, micro-level market data, corporate disclosure by market participants, and risk reporting by intermediaries to their clients. The authors also looked at the pro-cyclicality of collateral acceptance and haircuts.

The FSB described in reasonable detail the tri-party repo markets, but did not mention anything about the tri-party reforms in the U.S. Given the great interest that the Fed has in changing the unwind/rewind process and the way tri-party (and repo and general) can transmit systemic risk, it was surprising that it didn’t even rate a footnote.

To use this document to read the regulatory “tea leaves” is going to be hard. Certainly transparency will be on the FSB’s agenda. It is hard to imagine how the regulators will manage pro-cyclicality at the business level (and they are already doing that with capital anyway).  Perhaps some of their efforts will be to harmonize the rules to prevent regulatory arbitrage?

A link to the report is here.

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