Three lessons for a trade repository in securities lending from the Interest Rate Derivatives market

A recent Federal Reserve report, An Analysis of OTC Interest Rate Derivatives Transactions: Implications for Public Reporting, has some lessons for the potential impact of trade reporting in securities lending. We think that global regulators, particularly those working on Shadow Banking issues, will soon make calls for these kinds of trade repositories. Market practitioners might want to get up to speed on what sorts of impacts they can expect.

Here’s the punchline from the Fed report: “While a select group of standard instruments trade with relative frequency and may provide timely and pertinent price information for market participants,
many other IRD instruments trade infrequently and with diverse contract terms, limiting the impact on price formation from the reporting of those transactions.”

1) GC vs. hard to borrow
The similarities with securities lending are obvious: a number of GC transactions occur regularly and with easily observable pricing movements. These loans would be easy to report and variations easy to spot.

However, hard to borrow or special transactions have less liquidity and hence less relevance for trade reporting facilities, although this is where regulators would likely want to focus most of their scrunity. The Fed paper acknowledges this fact for the Interest Rate Derivative market too: low trading volumes mean that reporting data aren’t that useful after all.

2) Pre-trade vs. post-trade
In the Interest Rate Derivatives market, “pre-trade quoted prices will likely continue to be the most meaningful source of information for prospective investors.” While data services like SunGard ASTEC and Data Explorers offer pretty good sources of post-trade data, it is also true in the securities lending market that a pre-trade quote is the final best source of information for each individual counterparty. This especially holds true where the credit quality of counterparties differ.

3) Product standardization
The Fed paper hints that greater product standardization will make analysis easier, and that perhaps more regulation will push the Interest Rate Derivative market towards standardization. We have heard similar comments from OTC derivative clearers as well. In securities lending, could there be similar standardization? A GC loan won’t look like a hard to borrow, but hard to borrows could potentially get grouped into buckets (the 500-10000 bps range, for example). This would also require more credit counterparty standardization – CCPs would solve this problem but with additional costs.

The idea of a trade repository in securities lending looks interesting for regulators on paper since they can keep track of the market. On the other hand, the data will be unhelpful without a means for analysis. A lack of liquidity for most hard to borrow securities as well as a lack of standardization among product types will also limit the usefulness of trade repositories. Hopefully, regulators will consider the lessons provided in the Fed paper when looking at a trade repository for securities lending.

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