Repo in review

Repo in review

Repo market veteran Jeffrey Kidwell, who has over 36 years’ experience in securities finance, takes a journey back through 2018 and looks at the issues on the industry’s plate in 2019.

We can’t even say the year 2018 without mentioning that it was a record year for securities lending revenues globally. That $10.7 billion of global revenue was the highest recorded since 2008! It was earned through a volatile and exciting year, with EM lending leading the charge, with over $1 billion in revenues, the global credit markets uncertainty leading to many short issues, ETF Lending hitting a record of nearly $400 million in revenues, Treasury lending doing its best since the crisis but slowing, and US equities diverging halfway through the year to crush short-sellers and plummet revenues down 27%. The volatility erupted from sudden Central Bank tightening (including our Federal Reserve), trade wars between the US and others, the US political drama, the Brexit saga, and oil price and currencies volatility. However, despite a record year of revenue, we saw even more puzzling large-scale layoffs and consolidation among banks, particularly at the middle- and upper-management layers.

If we turn away from revenues and jobs, there were many developments in our industry in 2018. We had a bizarre year-end funding in 2018 that made old folks like me reminisce about year-ends decades ago. There was a dislocation of funding that caused a divergence for buyside cash providers and buyside collateral providers that was exacerbated by some broker/dealers only providing balance sheet to their “platinum” accounts (who pay for other services at those banks or trade in many other products) and turning away other collateral providers, and some broker/dealers keeping balance sheets very low for new regulatory purposes (what we used to call “window dressing” on quarter-ends), which turned out not to be the same across different jurisdictions or size of organizations. This all forced some collateral providers to hit bids over 6% and some cash providers to jump back into the Fed’s RRP program and put up with sub-market interest rates, creating this huge gap in rates on the offer side and the bid side. This calls into question all of those articles about how market liquidity has ‘improved’ dramatically.

It all depends who you are and what you define as ‘liquidity’. The two positives that came from that are that more peer-to-peer or sponsored repo was traded, recognizing the benefit of closing that bid/offer gap somewhat, and a couple of opportunistic large broker/dealers swooped in, reallocating their enormous balance sheets out of less profitable bid/offer spreads and into repo, helping out some of the buyside customers and reaping the rewards for themselves. I should also note that these disruptions that occurred at year-end did not seem to be as prevalent at the first quarter-end of 2019, so that still leaves some puzzles to solve.

Inclusivity rises up the agenda

So, I was at most of our industry conferences in 2018 and some in 2019, even chairing one for a change. One huge change in 2018 that has carried over to 2019, and it is well overdue, is a focus on women and inclusivity (non-discrimination) in our securities financing industry. I was very honored to participate in those efforts to outline issues and to create action plans. I see on other conference agendas that it is now becoming a main staple discussion and I am very pleased with that. I know that other industries, like entertainment and sports, are just now broaching these subjects but an industry like ours, which is all about best service, best execution and revenues, should never have had these issues. Our industry was founded on performance-based pay and who can solve problems the best in teams.

Industry buzzwords maintain their hold

2018 was a year of innovative thinking for our industry. We saw beneficial owners start focusing on collateral flexibility, use of alternative collateral, trading term rather than overnight, and even delving deeply into non-cash collateral for their reinvestments. There was a new development of using ETFs for not only reinvestment cash but also as collateral to be lent. The buzzwords for 2018 (and carrying through to 2019) were collateral optimization, collateral transformation, varying pledge structures, indemnification, benchmarking, oversight, data usage, fintech, peer-to-peer, P4P, agented repo, blockchain, DLT, machine mearning, data mining, CCPs, and electronic trading platforms.

What lies ahead?

Let’s look at 2019. We’ve already had some significant events and issues. Since, the number one topic of 2018 was “revenues are back to 2008 levels”, we have to start by saying: “those revenues disappeared again in Q1 2019”. That has led, unfortunately, to even more layoffs. Ironically, some consolidation, like Commerzbank and Deutsche Bank, was actually waved off recently and didn’t happen. On the regulatory side, although we have the whole Banking Union, Capital Markets Union, and Digital Single Market to slog through, as well as the Libor/Euribor/Eonia replacement rates, the major focus will likely be on the impacts of SFTR and this Brexit delay (re-vote?). Also, we have some dark horses coming up on the outside, in China perhaps opening up its markets, CFTC proposing new rule changes on futures and swaps for money funds and insurance companies, and the surprisingly absent regulations on fintech. And, are we all done now with Mifid II and its impact on our market? Believe me, from my informal polls of my myriad clients, when I asked what the major disruptor of 2019 would be, from these topics: technology, regulations, macro-economic forces, geopolitics, China, and another financial crisis (?), they all said “regulations”. 

On the technology front for 2019, as much as I, personally, would like to say electronic trading platforms, CCPs, and blockchain, the likely big topics will be data mining and collateral optimization.

On the trading side, we still have to watch out for US government shutdowns, issuance of government securities, regulatory discrepancies across jurisdictions, and this elusive “liquidity” due to regulatory balance sheet restrictions, LCR, and other capital and liquidity ratios. I am also a little concerned by patterns breaking down, including the recent high funding and dislocations.

We are not only “not in Kansas anymore”, but we are “very far from Kansas”. New issues, new regulations, new transparencies, new technology, and more communication will create new opportunities. At least, for those who can adapt.

This article features in the Americas Securities Finance Guide 2019. Read the full guide here.

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