Differences Between Securities Lending and Repurchase Agreements (REPOs)
The best securities lending and borrowing practices that relate to repurchase agreements make up an integral part of the U.S.-dollar-denominated money markets. Basically, the markets for these operations play significant roles in trading both securities and equities. Given the roles of these in the efficiency and performance of the financial system, it is therefore important to have a better understanding of them.
What is securities lending?
Securities lending is a type of securities financing transaction (SFT) where one party gives the legal ownership of a security (or securities) to another for a short period of time. Usually, this is done in exchange for the legal title to a collateral. The party who transfers the legal ownership to another is called the lender whereas the other party that is taking it is called the borrower.
- Most of the time, the collateral in securities lending can be in the form of other securities or money. Basically, the borrower will have to pay for the use of the security. When the collateral is in the form of cash, the lender needs to reinvest it and refund a certain amount to the borrower.
- When this happens, the lender subtracts the borrowing fee from the refunded amount of interest, instead of paying it separately.
- Aside from securities and equities, securities lending transfers also involve the turning over of the legal titles of attached voting rights and corporate actions. Because of this, the market has become conventional for loaned securities like fixed income and equities.
- Loaned securities can now be recalled by the lender in order to recover those securities if he or she wishes to practice his rights for voting and react to corporate actions.
What is a repurchase agreement?
Repurchase agreement (or repo), just like securities lending, is a type of securities financing transaction (SFT) wherein securities are sold to investor for a short period of time (most of the time on an overnight basis) and are bought again after a short period of time (usually the following day).
- Basically, repurchase agreements are done to raise some capital. In the perspective of the borrower’s party, the security is sold with an assurance of repurchasing it in the future; it is the repo. On the other hand, for the lender, the security if bought and agreed to be sold in the future; this is known as the reverse repurchase agreement.
- During a repurchase agreement, a borrower is not allowed to recall the securities he lent during the course of a transaction unless there is a right of substitution that has been agreed by both parties prior to the point of trade.
One major difference between that two is that most repurchase agreements are for general collateral and are driven by the need to lend and borrow money. On the other hand, securities lending is usually motivated by the need to borrow securities. Aside from that, the repurchase agreement market immensely uses fixed-income instruments like bonds and collateral while the latter utilizes equities.