With over three decades in securities lending and repo tell us a little about your career and how the industry has changed?
I celebrated 35 years in the repo and securities lending industry in December. I was hired during the Drysdale crisis in May 1982 and have witnessed a lot of history, including the savings and loan crisis, Orange County, and long-term capital. I saw the rapid expansion of the industry in the 1980s and 1990s, followed by the failures and consolidation of 2007 to 2009, and the hyper-regulated environment that we work in now. I began in IT, moved on to overnight repo trading, then to term repo trading, risk management, and sales/trading management, for broker-dealers and their repo-matched book operations in the US, Canada, and Europe. Currently, I deal on a global basis, but as an introducing broker for institutional clients and broker-dealers. I’ve seen it when there were 47 primary dealers, some running repo matched books with over $1 trillion in balance sheets and then seen those primary dealers dwindle down to 21 and their balance sheets shrink by 60 percent or more. That led to smaller boutique broker-dealer startups and the movement of business to international banks.
When I started, repo and securities lending was traded through a broker-dealer, typically a primary dealer. Clients on both sides of the market dealt with a repo-matched book at a broker-dealer or had third parties, such as securities lending agents deal with those repo-matched books on behalf of them. The broker-dealer repo-matched books were managing the interest rate risks, documentation risks, settlement risks, default risks, and counterparty credit risks themselves. Therefore, clients on either side of those huge repo-matched books had no idea who the clients were on the other side, how they might impact each broker-dealer or that client. Things have changed enormously since I started and now, I am introducing those clients to each other, and they are assuming those risks themselves rather than putting blind faith in someone doing it for them, especially since the financial crisis.
You were brought in to create a repo desk for broker-dealer AVM, how did this come about?
A repo desk already existed at AVM and handled financing for some of their clients, as an introducing broker. I left Wall Street at the end of 2007 and was visiting clients around the country to keep in touch, and I happened to visit my client AVM in Boca Raton. They recognised the value I could bring from my long history on Wall Street and thousands of client relationships to bolster their repo desk. I was intrigued because it would be a new side of the business for me, it would allow me to help many of my clients, who were suffering from lack of liquidity during the financial crisis.
How has your role developed since then?
It turned out that the financial crisis crippled the repo and securities lending industry, causing firms to fail, forcing mergers, spurring layoffs, and drastically reducing liquidity for certain classes of securities and overall drastically reducing balance sheets. The US repo market shrunk from about $7.2 trillion in 2007 to about $3.2 trillion. The repo markets in Europe, Asia, and Canada shrunk similarly. In my conversations with clients, it wasn’t that the cash providers still didn’t have the cash to invest, or the collateral providers still didn’t have the collateral to finance, or the securities lending beneficial owners didn’t have the securities they would like to lend and then reinvest the cash, they just couldn’t get it all to function through the traditional broker-dealer pipeline anymore. And that became a more permanent challenge, when regulations were proposed and enacted while dealing with the systemic risks that the financial crisis had laid bare. The market needed other pathways to liquidity, besides the traditional broker-dealer pipeline, and I had access to those clients on both sides. So, it seemed logical to me, within weeks of starting at AVM that I should introduce those clients to each other so they could establish their own ‘direct’ pipelines, I coined the term direct repo for that connection. Of course, to change client behaviour that had developed over decades in the repo industry, I had to re-educate the market, brand our trademarked Direct Repo, extensively market the product, tweak the product for different clients’ needs, attempt to streamline the processing of credit and documentation, and eventually publish rates and push for trade executions. The education and branding process took a long time, and many of the folks in the industry saw me speaking at many conferences and writing many articles for a few years.
Direct Repo was set to challenge the standard process in the market, how has this worked out?
Direct Repo is a ‘challenge’ to the standard process, a disruption if you will, but it has not been met with a negative reaction from the broker-dealers. If anything, several broker-dealers welcomed it because it took the burden off of them to get their clients who had bought securities from them financed away from them. In fact, we’ve worked closely with several broker-dealers who no longer had the distribution to finance positions or source collateral. The challenge with the customer is that it is ‘different’ than what they are used to doing, but it isn’t. It’s still repo or securities lending, still governed by the same documents (sometimes with even better terms than the ones they had with broker-dealers), still done with another principal, maybe more fitting for their tenor needs (rather than all long-term to fulfill broker-dealer liquidity coverage ratio requirements), at a mid-market rate, which is a significant benefit to the client, possibly at better margin percentage—another benefit to the client—and probably stickier supply.
The real difference is that their credit department may have been used to looking at an elephant (broker-dealer) at the watering hole (market) and now would also be looking at a giraffe (non-broker-dealer) or a lion (another non-broker-dealer). So, they are still mammals, but different species. And that’s not to say an elephant is better than a giraffe, or vice versa. However, at least in this scenario, the client gets to choose what species it can trade repo with, and the counterparties don’t all have to be elephants. I am biased, but I think it’s worked well. As I see the Federal Reserve doing its reverse repo programme, central counterparties (CCPs) are popping up and doing all-to-all trading, electronic trading platforms popping up and doing peer-to-peer or all-to-all financing, and the Treasury’s Office of Financial Research (OFR) is publishing data about Money Funds doing repo with non-broker-dealers in peer-to-peer financing, I think how much the concept has been ‘accepted as self-evident.’
Where is Direct Repo at right now and where is it going?
Direct Repo is growing, and large clients have recently joined, which will likely lead to greater volume. Segments of the market that have been slower to change, like municipalities, money market funds, and central banks/sovereign wealth funds then, are suddenly changing their investment policies to open up their restrictions on repo counterparties and take advantage of extra liquidity, extra diversification, and extra savings. Some segments, like pension funds, have now realised that they know a lot more about hedge funds than they thought, and are now in dialogues about lending to the hedge funds directly. Now money funds have gone through waves of regulatory reforms; they finally have the time to focus on adding alternative repo clients and grabbing back yield and liquidity in government securities, which have suffered in liquidity during the broker-dealer balance sheet shrinkage.
What do you predict this year will hold for the securities lending market?
Each of the pathways that are being developed, and probably some we haven’t seen yet, will continue to be implemented and grow. Some may not survive, some may have to consolidate, but I believe, in the end, that the market will accept several pathways and that there isn’t one pathway that will solve all clients’ needs.