Demystifying U.S. Repo and Securities Lending Markets

The Office of Financial Research released a working paper today intended to serve as a reference guide for the U.S. repurchase agreement, or repo, and securities lending markets. The first such comprehensive reference to these securities financing transactions, it is critically needed.

The OFR working paper, “Reference Guide to U.S. Repo and Securities Lending Markets,” authored jointly with staff from the Federal Reserve Bank of New York, gives an overview of the repo and securities lending markets, including the institutional structure, role and motivation of market participants, vulnerabilities and potential systemic risks, and recent efforts to limit those risks.

The paper also provides an overview of existing data sources, highlighting specific shortcomings related to data standards and data quality, and steps regulators are taking to improve data coverage.

The repo and securities lending markets are important sources of short-term funding for financial companies that need to finance securities, such as broker-dealers and hedge funds. During the financial crisis, both experienced and transmitted distress. Despite significant improvements since the crisis in oversight and data, both markets remain opaque to regulators and market participants. And the participants in both markets are changing as traditional business models evolve and some activities migrate to new corners of the financial system.

The OFR, in collaboration with other agencies, is expanding our research and data collections to demystify these markets and promote a better understanding of how they might behave when stressed again.

Repos allow firms to sell securities to each other while promising to buy those securities back at a later date at a specified price. Securities lending involves a short-term loan of stocks or bonds in exchange for cash or noncash collateral.

Both markets came under pressure during the financial crisis. Mortgage lenders and investment banks lost billions of dollars in repo funding in a short time span, leaving them with few options to finance extensive holdings of mortgages and mortgage-linked securities; American International Group, known as AIG, suffered devastating losses on $75 billion of securities lending cash collateral that it had reinvested in mortgage-linked securities.

Estimates for the size of the repo market at its pre-crisis peak range widely, from $5 to $10 trillion. OFR researchers estimate the market is now about $3.4 trillion in repos (in which dealers sell securities and receive cash) and $2.4 trillion in reverse repos (in which dealers deliver cash and receive securities)

The authors of the paper do not attempt to size securities lending because no comprehensive regulatory data collection covering this activity is currently available. Instead, market participants and policymakers rely on market surveys and data collections conducted by data vendors.

Data available to regulators and market participants have improved since the crisis but remain insufficient to evaluate the risks or even the level of activity in these markets. For example, counterparty information is not provided in any existing sources covering securities lending, making it challenging to track market interconnectedness. Many of the data elements available to regulators may not be available to the public.

Some of the data quality issues could be remedied by requiring market participants to uniquely identify counterparties by using legal entity identifiers (LEIs) in regulatory reporting. LEIs are not currently required, although many filing forms recommend LEIs or list them as an option.

Working in partnership with the Federal Reserve, the OFR is now filling these critical data gaps through voluntary data collections. We have already begun to collect data on the bilateral repo market in a pilot project and expect to publish aggregated data later this year. We will soon begin collecting data on securities lending activities in a second pilot project as well. These U.S. initiatives are consistent with and complementary to the efforts of the Financial Stability Board to improve visibility into these increasingly global markets.

Richard Berner is Director of the Office of Financial Research.