ISLA’s 3rd Securities Lending Market Report shows an industry adapting well to market and regulatory changes

ISLA has released their 3rd Securities Lending Market Report. It is extremely well written with data and thoughtful analysis. In this post we take a look at securities lending in the fixed income world.

When most people think of securities lending, they think equities. It is true that equities comprise most of the market, but looking at the fixed income side gives insights into how the market uses sec lending to manage regulatory requirements.

According to the report, government bonds have grown in importance in securities lending and now represent 39% of all securities on loan, up from 35% a year earlier. There is a strong propensity to use non-cash collateral for these trades. From the report:

“…The drift towards the use of non-cash collateral across the industry continued. The proportion of loans collateralised with non-cash collateral increased to 60% of all transactions, up from 55% six months earlier. Fixed income government bond lending continued to record much higher levels of non-cash collateral with, for example, 90% of all European government bond loans being collateralised with other securities…”

In response to regulations, and in particular LCR, there is a lot of term activity in government bond borrowing. 24% of all government bond trades are for three months or more. For activity specifically between banks and broker/dealers, this figure rises to 50%.

What about activity in North America, where non-cash trades have never been as common? That is starting to change.

“…Unlike Europe, where non-cash collateral has been part of the market structure for many years, in North America the cash collateral model has prevailed. However in previous reports we have seen a gradual shift to a broader cash and non-cash collateral mix in respect of North American government bonds as borrowers look to optimise their balance sheet and capital charges. In this latest report we have seen for the first time the proportion of non-cash collateral exceed cash collateral in this asset class…”

The market for North American bond lending grew overall, but behind the figures is a big jump in non-cash collateralized business.

“…Further analysis of the data also reveals that although the overall level of North American bond lending rose by circa 10% non-cash collateral balances actually increased by 35% as cash collateral balances fell by 11% during the period…”

If not cash, what kind of collateral is being used? Equities. There looks to be a huge collateral upgrade trade going on, with banks taking in HQLA and lending out their equities for term. You don’t have to look much further than the LCR rules for the reason.

“…We have seen steady growth in the demand to borrow High Quality Liquid Assets (HQLA) as banks seek to source high quality collateral as part of a broader agenda to comply with Liquidity Coverage Ratio (LCR) requirements and to reduce the impact of balance sheet and capital charges for equity securities. This tends to be supported by the increasing use of equity securities as collateral and the continued growth of term transactions, especially in respect of government bond or HQLA transactions. Also the past six months has seen a 13% overall increase in the lending of equity securities…”

What about central clearing? While, according to ISLA, not much sec lending is run through CCPs, the market does play a big role in sourcing paper for margin requirements.

“…ISLA Members noted that whilst CCPs are widely used in derivatives markets and a material proportion of the repo market is also centrally cleared, only very minor securities lending activities are subject to central clearing. However it is clear that securities lending plays an important role in facilitating the collateral requirements of parties who use CCPs in these other markets…”

We would like to see more detail on the interaction with CCPs in future reports. What about Eurex? Equilend announced today that they will connect their sec lending platform to Eurex.

The report does an excellent job of laying out the trends in the market. It paints a picture of a market that is healthier than many give it credit for. Its ability to adapt to market conditions as well as be a tool to solve regulatory issues in impressive.

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