Institutional Choice between Funding Markets: Repo vs. Securities Lending

Topic & Objectives

Following the global financial crisis, the increasingly prudent regulation and the unconventional monetary policy actions of central banks have given rise to a shortage of high quality, liquid, and collateral eligible assets. At the same time, institutions have gradually moved from the unsecured interbank lending market to the securities lending and repo markets to cover their funding needs. These two markets, repo and securities lending, seem to fulfill a similar role in providing funding liquidity and collateral, or supporting trading activities, by temporarily shifting ownership of assets in mostly overnight transactions.

In this project, our aim was to study the difference between these securities financing transactions by studying contractual specificities, market conventions, and the regulation. We wanted to understand if there are regulatory incentives (or obstacles) driving the choice between funding markets, and if so, how this affects the pricing dynamics and transaction volume in these markets.

Project Outcome

We wrote a research proposal to European Insurance and Occupational Pensions Authority (EIOPA) titled “Short-term Funding Markets and Systemic Risk: Evidence from the Insurance Industry”. The proposal was co-authored with Alessandro Fontana (EIOPA) and Stanislava Nikolova (University of Nebraska-Lincoln), and addressed one of the main questions of this project.

We are specifically interested in whether insurance firms’ participation in securities financing transactions could generate or mitigate systemic risk. We were planning to study this question based on the relation of insurers’ use of short-term funding markets, that is securities financing transactions, and the subsequently arising interconnectedness and systemic exposures in their collateral portfolios.

To that end, we approached EIOPA to provide us access to prudential regularity data on insurance portfolio holdings (based on Solvency II reporting templates), which would allow us to approach the research question both from a theoretical and empirical perspective. The application for the insurance regulatory reporting data has been rejected. Without the data access the proposed research project is considered as closed.