Repo vs. Securities LendingHard

Two ways to swap a security for cash, and the difference is which one you actually wanted. One is borrowing money against a bond; the other is borrowing the bond itself — and the paperwork, the pricing and the motive all follow from that.

5 min read · 916 words

The same exchange, and opposite reasons for it

• In both, a security moves one way and cash moves the other, and both come back later. Photographed at any single moment they are indistinguishable, which is why they are constantly conflated.
• A repo is cash-driven. Somebody needs money for a few days, has a bond, and sells it with an agreement to buy it back. The bond is the collateral; the cash is the point. The repo page covers the instrument.
• Securities lending is security-driven. Somebody needs a specific security — usually to deliver against a short sale — and borrows it, handing over collateral that may be cash or other securities. The security is the point; the collateral is the protection.
• Which leg is the point decides everything else, including which rate is negotiated and which one is a residual.

Follow the rate and you can always tell them apart

• In a repo the price is the repo rate — what the cash costs. Collateral quality moves it a little; the money market moves it a lot. Two different bonds of similar quality borrow at almost the same rate, which is the giveaway that the bond is not what is being priced.
• In securities lending the price is the borrow fee — what that particular security costs to obtain. A widely held, easily borrowed name costs almost nothing; a name everybody wants to short costs a great deal, and the fee can move by multiples in a week.
• The special repo is where the two meet. When one bond is in exceptional demand, its repo rate falls below the general collateral rate — the cash lender accepts less interest because what they really wanted was that bond. A repo trading special is a securities-lending transaction wearing a repo's documents.
• So the honest test is not the form but the residual: which side of the trade is getting the negotiated price, and which side is taking whatever falls out.

What the two do to a balance sheet

• A repo is a financing. The seller keeps the economic exposure to the bond — the price risk, the coupons — and records a borrowing. The bond does not leave the balance sheet even though legal title moved, because the accounting follows the risk rather than the title.
• Securities lending is usually the same for the lender: the security stays on the balance sheet, and the lender continues to receive the economic value of any coupon or dividend as a manufactured payment from the borrower.
• What the lender does lose is the vote. Legal title moved, so the borrower holds the votes. A fund that lends stock across a contested meeting has lent its say in it, which is a governance question rather than a market one and is why many lenders recall around record dates.
• Both are secured, and the security is the point of the structure. How a position hits the books covers why the same asset can be carried in different places depending on what the arrangement actually transfers.

The collateral works differently

• In a repo the collateral is the security itself, valued daily and haircut. If the borrower fails, the cash lender keeps the bond and sells it; the haircut is the buffer against the price moving before they can.
• In securities lending the collateral is what the borrower posted — cash, government bonds, sometimes equities — held against the value of what was lent, and marked daily.
• Cash collateral creates a second business. A lender holding cash against a loaned security has to do something with it, and what it does is a reinvestment decision with its own credit and liquidity risk. That is the part of securities lending that has caused losses: not the lending, the reinvesting.
• The failure in both is the same shape and it is a two-sided one — the counterparty fails while the collateral is worth less than it was. Margin and collateral covers the haircut arithmetic.

The comparison

Why it is worth being able to tell them apart

• They answer different questions about a firm. Growing repo tells you about funding; growing securities lending tells you about short interest and about a fee business. Reading one as the other misreads what the firm is doing.
• Both are the plumbing under a great deal else. A short seller cannot short without a borrow, and a dealer cannot make markets in bonds without repo — short selling and the money markets shelf are the two halves.
• And both are where a squeeze starts. When a security becomes impossible to borrow, or a collateral type stops being accepted, the transaction that was routine yesterday is the constraint today.