Germany
15 june 2010
Conservative in regulatory terms and investor behaviour, Germany鈥檚 securities lending market has to fight to get its voice heard
Image: Shutterstock
The German securities lending and repo markets are a significant part of the wider European market.
German government bonds are considered high quality and highly liquid collateral and are very desirable. There is a lot of activity surrounding them and increasingly so in a market dominated by a desire for high quality assets.
German investment culture tends to be very conservative as is the German regulatory authority, the Bundesanstallt fuer Finanzdienstleistungsaufsicht (BaFIN). Its hedge fund community is, consequently, very small.
鈥淗edge funds are not a big topic in Germany,鈥� says Arne Theia, head of Repo and Collateral Trading at UniCredit. 鈥淭here is no significant hedge fund community in Germany because there are so many, many requirements involved in setting up a hedge fund. Therefore hedge funds prefer less restricted locations outside Germany. Also, German investors and customers are very conservative and are cautious about hedge funds. They tend to go to conventional asset managers or even the Exchange Traded Fund (ETF) business.鈥�
The lending market is also fairly restricted. The German Investment Act, article 56, doesn鈥檛 allow asset managers, Kapital Anlage Gesselschafte (KAG) to lend more than 10 per cent of their holdings to any one counterpart. KAGs have to find 10 separate counterparts to lend out a full portfolio.
An exception to this rule, however, is that if you lend through a BaFin qualified 鈥渙rganised system鈥� you can lend beyond the 10 per cent limit. Clearstream Banking Frankfurt is the only company to have been awarded this official stamp. An 鈥渙rganised system鈥� essentially means that BaFin is convinced that at any given time the organisation will make sure that a loan is collateralised and will not cause any harm for the asset manager or underlying investor, in case of default, simply because there would be enough collateral in place.
It is interesting, however, that this historically restrictive and conservative environment could have produced a market environment that is to some extent demonstrative of the future of securities lending and repo, where third party agents who can manage collateral almost in the manner of a market utility could give the market security and therefore life.
Since the beginning of the financial crisis, Theia observes markets have evolved significantly. 鈥淒uring the liquidity crisis there was a shift from unsecured to secured financing,鈥� he says. 鈥淯nsecured money market models collapsed and the markets in general were looking for deeper protection. 网爆吃瓜 lending and repo markets provided a secured option. They are, therefore, without doubt, winners of the financial crisis.鈥�
In terms of market size, Europe repo is much bigger than the European securities lending market. A recent survey from the International Capital Markets Association (ICMA) shows that the European repo market has a current volume of around EUR 5.6 trillion, whereas the US has a volume of USD 4.5 trillion. It also shows that within Europe repo is 85 per cent of the market and securities lending 15 per cent.
Theia says: 鈥淚n terms of size the repo market is much bigger than the securities lending market in Europe because repo has become the main refinancing product. As the unsecured money markets get more limited and expensive the secured repo product became the way that banks managed liquidity and collateral and it is now the predominant method.鈥�
G枚sta Feige, global securities financing sales manager at Clearstream, agrees. Clearstream Banking is a collateral agent so by its nature, would only see collateralised transactions. However within this context it has seen a clear increase in [collateralised] transactions.
鈥淲e see a clear increase in triparty transactions as the trend goes towards collateralising almost everything,鈥� he says. 鈥淲e see the unsecured money market disappearing and being replaced by the triparty repo market. It is the same for securities lending, whatever transaction we see is collateralised,鈥� he continues. 鈥淭he lenders of securities dismiss any unsecured lending whatsoever, and in all secured lending they have a close look at the collateral they are getting. They also have a lot of questions about the procedures we apply surrounding haircuts, price age, concentration limits, also our background and who we are. They want to know if we are neutral or if we have a market interest.鈥�
Maria Carina, director of securities lending and borrowing services at Euroclear adds: 鈥淩epo is a very interesting instrument because it is a secured way of financing. Ever since the financial crisis began, there has been a bigger push towards secured financing transactions and repo is an instrument that can help clients to secure these types of transactions. One of the market developments that we have seen since the crisis is that more corporates and insurance companies, as well as money market funds, are using triparty agents to manage collateral movements relating to repos because of their secured characteristics.鈥�
The ICMA survey also shows that while the market decreased during the financial crisis it has recovered by about 20 per cent this year. According to Theia, the trend in this market is towards high quality collateral that is liquid in the secondary market, so that in case of counterparty default you are able to execute your collateral in the markets.
People are looking for government paper, covered paper and even equities,鈥� Theia says. 鈥淓quities that are traded on a stock exchange are welcomed as an asset class because you get a market overview of their value 鈥� what they are worth. Market infrastructure is also booming 鈥� people are far more interested in doing business through central counterparts at a clearinghouses or through a Triparty Agent because it reduces operational risk and bilateral risk.鈥�
Carina agrees: 鈥淐ollateral helps you to cover risks and exposures, but the collateral itself is also a source of risk, meaning that you have to value and manage the movements of collateral to reflect changes in the market. The role of a third party agent to deal with these aspects of collateral management is very important and will become even more important.鈥�
So, while secured products like repo and securities lending have remained popular options with original market participants, they have also become increasingly popular options outside of the market.
Denis Peters, director, corporate communications at Euroclear, says: 鈥渨e have seen a greater variety of entities exploring how Euroclear Bank, as a triparty agent, could help them manage their collateral requirements than ever before. The growth we are experiencing is not only a matter of more and more activity coming from the same entities, but a diversification of the type of entity that is interested in outsourcing to an agent like Euroclear Bank.鈥�
Although secured products are the seeming winners of the liquidity crisis the regulatory environment has changed. Regulators and central banks have put increased pressure on banks because they want to avoid another capital crisis. One major influence comes from the United Kingdom鈥檚 Financial Services Authority (FSA), which has proposed that banks should raise capital to create 鈥渓iquidity buffers,鈥� which means banks should have enough liquid assets available to survive a 30 day stress scenario. The liquidity buffer must therefore contain high quality and highly liquid paper.
Theia explains that many people consider this a problem. The only asset class that could match these kinds of requirements are well-rated European government bonds. He thinks that the regulation would create a new 鈥渞egulator approved鈥� asset class and that this would have a huge impact on the securities lending and repo markets.
鈥淭he problem here is that if the regulators define what is high quality it could lead to a fragmentation in the market between 鈥済ood鈥� and 鈥渂ad鈥� quality,鈥� he says. 鈥淭his has an impact on the owners of the paper and the secondary market. If there is a run for prime assets then everyone has to buy them in the secondary market, which means that there will be an even lower supply. This doesn鈥檛 exactly relax the situation in the bond markets. What will happen to issuers not matching the requirements of the regulators? Financing will clearly get more difficult and expensive for them.
鈥淢anaging collateral and liquidity is now considered to be key in surviving the financial markets which in general means a big push for securities lending and repo, however departments are now working in a much tougher financial and regulatory environment. Banks will have to adjust their business model and it will be much harder to make a profit, as they will have to pay for regulatory requirements and the increased capital costs.
鈥淭he entire banking industry has had to face the liquidity crisis, but the next stage will be institutional customers. Asset managers, insurers, and even a lot of corporates will need collateralised protection in order to provide liquidity. This will provide a big push for the securities lending and repo markets.鈥�
Another significant impact on the market is the European Central Bank鈥檚 (ECB) monetary policy. In July 2009 the ECB offered a one-year refinancing operation in which they pumped EUR 440 billion into the financial market system, lending at one per cent. Since then the market has been facing a huge liquidity surplus and people and banks are now happy just to find a home for the money. 鈥淭his has had quite a huge impact on the sec lending and repo markets,鈥� Theia explains, 鈥渂ecause spreads within ECB eligible assets have more or less disappeared on a daily basis. People want to invest the money but are only willing to do so in a secured way, so they do it in the repo market. This has also been a push for this market.鈥澛�
Feige says: 鈥淭he effect of the ECB actions means that many houses who have been participating in these auctions, now have an issue of how to reinvest the cash. They don鈥檛 want to reinvest it unsecured which is why they put in place collateralised reinvestment schemes like triparty repo.鈥�
The one-year basket will close in July and it will be interesting to see the reaction of the market.
Feige says: 鈥淗ouses are preparing by looking at collateralised solutions rather than just relying on the central bank. There are assets for example that one can鈥檛 re-finance with a central bank, but that could potentially be re-financed in the inter bank market. So they are setting up triparty solutions in order to be sure they have sufficient options to re-finance themselves.鈥�
Liquidity is in any case still clearly a priority for the ECB. It recently announced two other options: a three month tender with full allotment at a fixed rate and a six month tender with full allotment at a minimum bid historic average rate of the weekly repo. Also, the ECB will continue accepting GR collateral.
German government bonds are considered high quality and highly liquid collateral and are very desirable. There is a lot of activity surrounding them and increasingly so in a market dominated by a desire for high quality assets.
German investment culture tends to be very conservative as is the German regulatory authority, the Bundesanstallt fuer Finanzdienstleistungsaufsicht (BaFIN). Its hedge fund community is, consequently, very small.
鈥淗edge funds are not a big topic in Germany,鈥� says Arne Theia, head of Repo and Collateral Trading at UniCredit. 鈥淭here is no significant hedge fund community in Germany because there are so many, many requirements involved in setting up a hedge fund. Therefore hedge funds prefer less restricted locations outside Germany. Also, German investors and customers are very conservative and are cautious about hedge funds. They tend to go to conventional asset managers or even the Exchange Traded Fund (ETF) business.鈥�
The lending market is also fairly restricted. The German Investment Act, article 56, doesn鈥檛 allow asset managers, Kapital Anlage Gesselschafte (KAG) to lend more than 10 per cent of their holdings to any one counterpart. KAGs have to find 10 separate counterparts to lend out a full portfolio.
An exception to this rule, however, is that if you lend through a BaFin qualified 鈥渙rganised system鈥� you can lend beyond the 10 per cent limit. Clearstream Banking Frankfurt is the only company to have been awarded this official stamp. An 鈥渙rganised system鈥� essentially means that BaFin is convinced that at any given time the organisation will make sure that a loan is collateralised and will not cause any harm for the asset manager or underlying investor, in case of default, simply because there would be enough collateral in place.
It is interesting, however, that this historically restrictive and conservative environment could have produced a market environment that is to some extent demonstrative of the future of securities lending and repo, where third party agents who can manage collateral almost in the manner of a market utility could give the market security and therefore life.
Since the beginning of the financial crisis, Theia observes markets have evolved significantly. 鈥淒uring the liquidity crisis there was a shift from unsecured to secured financing,鈥� he says. 鈥淯nsecured money market models collapsed and the markets in general were looking for deeper protection. 网爆吃瓜 lending and repo markets provided a secured option. They are, therefore, without doubt, winners of the financial crisis.鈥�
In terms of market size, Europe repo is much bigger than the European securities lending market. A recent survey from the International Capital Markets Association (ICMA) shows that the European repo market has a current volume of around EUR 5.6 trillion, whereas the US has a volume of USD 4.5 trillion. It also shows that within Europe repo is 85 per cent of the market and securities lending 15 per cent.
Theia says: 鈥淚n terms of size the repo market is much bigger than the securities lending market in Europe because repo has become the main refinancing product. As the unsecured money markets get more limited and expensive the secured repo product became the way that banks managed liquidity and collateral and it is now the predominant method.鈥�
G枚sta Feige, global securities financing sales manager at Clearstream, agrees. Clearstream Banking is a collateral agent so by its nature, would only see collateralised transactions. However within this context it has seen a clear increase in [collateralised] transactions.
鈥淲e see a clear increase in triparty transactions as the trend goes towards collateralising almost everything,鈥� he says. 鈥淲e see the unsecured money market disappearing and being replaced by the triparty repo market. It is the same for securities lending, whatever transaction we see is collateralised,鈥� he continues. 鈥淭he lenders of securities dismiss any unsecured lending whatsoever, and in all secured lending they have a close look at the collateral they are getting. They also have a lot of questions about the procedures we apply surrounding haircuts, price age, concentration limits, also our background and who we are. They want to know if we are neutral or if we have a market interest.鈥�
Maria Carina, director of securities lending and borrowing services at Euroclear adds: 鈥淩epo is a very interesting instrument because it is a secured way of financing. Ever since the financial crisis began, there has been a bigger push towards secured financing transactions and repo is an instrument that can help clients to secure these types of transactions. One of the market developments that we have seen since the crisis is that more corporates and insurance companies, as well as money market funds, are using triparty agents to manage collateral movements relating to repos because of their secured characteristics.鈥�
The ICMA survey also shows that while the market decreased during the financial crisis it has recovered by about 20 per cent this year. According to Theia, the trend in this market is towards high quality collateral that is liquid in the secondary market, so that in case of counterparty default you are able to execute your collateral in the markets.
People are looking for government paper, covered paper and even equities,鈥� Theia says. 鈥淓quities that are traded on a stock exchange are welcomed as an asset class because you get a market overview of their value 鈥� what they are worth. Market infrastructure is also booming 鈥� people are far more interested in doing business through central counterparts at a clearinghouses or through a Triparty Agent because it reduces operational risk and bilateral risk.鈥�
Carina agrees: 鈥淐ollateral helps you to cover risks and exposures, but the collateral itself is also a source of risk, meaning that you have to value and manage the movements of collateral to reflect changes in the market. The role of a third party agent to deal with these aspects of collateral management is very important and will become even more important.鈥�
So, while secured products like repo and securities lending have remained popular options with original market participants, they have also become increasingly popular options outside of the market.
Denis Peters, director, corporate communications at Euroclear, says: 鈥渨e have seen a greater variety of entities exploring how Euroclear Bank, as a triparty agent, could help them manage their collateral requirements than ever before. The growth we are experiencing is not only a matter of more and more activity coming from the same entities, but a diversification of the type of entity that is interested in outsourcing to an agent like Euroclear Bank.鈥�
Although secured products are the seeming winners of the liquidity crisis the regulatory environment has changed. Regulators and central banks have put increased pressure on banks because they want to avoid another capital crisis. One major influence comes from the United Kingdom鈥檚 Financial Services Authority (FSA), which has proposed that banks should raise capital to create 鈥渓iquidity buffers,鈥� which means banks should have enough liquid assets available to survive a 30 day stress scenario. The liquidity buffer must therefore contain high quality and highly liquid paper.
Theia explains that many people consider this a problem. The only asset class that could match these kinds of requirements are well-rated European government bonds. He thinks that the regulation would create a new 鈥渞egulator approved鈥� asset class and that this would have a huge impact on the securities lending and repo markets.
鈥淭he problem here is that if the regulators define what is high quality it could lead to a fragmentation in the market between 鈥済ood鈥� and 鈥渂ad鈥� quality,鈥� he says. 鈥淭his has an impact on the owners of the paper and the secondary market. If there is a run for prime assets then everyone has to buy them in the secondary market, which means that there will be an even lower supply. This doesn鈥檛 exactly relax the situation in the bond markets. What will happen to issuers not matching the requirements of the regulators? Financing will clearly get more difficult and expensive for them.
鈥淢anaging collateral and liquidity is now considered to be key in surviving the financial markets which in general means a big push for securities lending and repo, however departments are now working in a much tougher financial and regulatory environment. Banks will have to adjust their business model and it will be much harder to make a profit, as they will have to pay for regulatory requirements and the increased capital costs.
鈥淭he entire banking industry has had to face the liquidity crisis, but the next stage will be institutional customers. Asset managers, insurers, and even a lot of corporates will need collateralised protection in order to provide liquidity. This will provide a big push for the securities lending and repo markets.鈥�
Another significant impact on the market is the European Central Bank鈥檚 (ECB) monetary policy. In July 2009 the ECB offered a one-year refinancing operation in which they pumped EUR 440 billion into the financial market system, lending at one per cent. Since then the market has been facing a huge liquidity surplus and people and banks are now happy just to find a home for the money. 鈥淭his has had quite a huge impact on the sec lending and repo markets,鈥� Theia explains, 鈥渂ecause spreads within ECB eligible assets have more or less disappeared on a daily basis. People want to invest the money but are only willing to do so in a secured way, so they do it in the repo market. This has also been a push for this market.鈥澛�
Feige says: 鈥淭he effect of the ECB actions means that many houses who have been participating in these auctions, now have an issue of how to reinvest the cash. They don鈥檛 want to reinvest it unsecured which is why they put in place collateralised reinvestment schemes like triparty repo.鈥�
The one-year basket will close in July and it will be interesting to see the reaction of the market.
Feige says: 鈥淗ouses are preparing by looking at collateralised solutions rather than just relying on the central bank. There are assets for example that one can鈥檛 re-finance with a central bank, but that could potentially be re-financed in the inter bank market. So they are setting up triparty solutions in order to be sure they have sufficient options to re-finance themselves.鈥�
Liquidity is in any case still clearly a priority for the ECB. It recently announced two other options: a three month tender with full allotment at a fixed rate and a six month tender with full allotment at a minimum bid historic average rate of the weekly repo. Also, the ECB will continue accepting GR collateral.
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