Repo Market – Implications from foreign markets Seminar material No. 2

Japan – ASEAN Financial Technical Assistance FundTechnical Assistance for Developing Bond Markets in Thailand Repo Market – Implications from foreign markets Seminar material No. 2 21st February, 2007

1. Size of repo market 2. Players in repo market 3. Repo rates and terms 4. Fail practice

Relative size of repo market • Size of Thai money market is small compared to Japan (as proportion against banking sector asset). • Especially, size of interbank borrowing and lending is small, while repo with central bank being relatively large. Note: Average during 2006. Thai data includes commercial banks, and Japanese data includes domestic banks.

Composition of interbank transactions in Japan • In Japan, repos play important roles in the interbank market. • Japan has two forms of “repo”: “securities lending” repo and “repurchase agreement” repo, with both having almost the same functions. Repo vs. call money 100 million yen Repo

Change of outstanding value History of repo market in Japan • Japan’s repo market has grown along with the financial crisis and financial system reform.

Market size of tri-party repo • In Japan, tri-party repo is not commonly used, possibly attributable to low return of repo during zero interest rate environment. • In the US, tri-party repo service is provided by BONY and JPMorgan Chase, which accounts for 17% of repo. • In the euro area, tri-party repo accounts for 11% of repo. Counterparty for Repo (Euro Area) Outstanding volume by product (US) (Source) TBMA (January 2005) Repo & Securities Lending Survey of U.S. Markets Volume and Loss Experience (Source) Survey by International Securities Market Association (March 2004)

Market size of bond lending • In Japan, composition of GC and SC repos are 4:6. • Based on questionnaire by BOJ in June 2006. • In the US, 30% of repo transactions are securities borrowing / lending. Outstanding volume by product (US) (Source) TBMA (January 2005) Repo & Securities Lending Survey of U.S. Markets Volume and Loss Experience

Repo players in major markets • Active repo players in major markets usually involves banks, securities firms, and in some markets, institutional investors, insurance and non-financial companies. Participants in repo market in G10 countries (Source) BIS (March 1999), “Implications of repo markets for central banks.”

Repo players in Japan: At a glance • In Japan, the most active players in the repo market are securities firms and foreign banks, followed by mega and regional banks, trust banks, insurance and funds.

Repo players in Japan: By types of players • Collateralized repo has only been active after the financial crisis in the late 1990s. • “Collateral management” has been provided by trust banks and custodian banks in Japan, but so far remained unpopular. This is because of zero interest rate environment, whereby any small cost (collateral management cost) becomes high in comparison with interest rate.

Repo players in Japan: By types of transactions • For GC (general collateral) repo, borrowers of funds are dealers, while lender of funds are banks. • For SC (special collateral) repo, borrower of bonds are dealers, while lender of bonds are trust banks and banks. • Trust banks do repo on behalf of customers, including insurance, funds or other investors.

Repo players in Japan: Outstanding repo by player type • Mostly due to the zero interest rate environment, banks and investors are not so proactive in using repo, while bond dealers are very active for the purposes of trading and hedging (note: statistics only show gensaki repo). （￥100 million）（Source) JSDA. Average of outstanding at each month-end for the past three years.

Repo players in the US • In the US, most active players in the repo market are bond dealers. • Aside from bond dealers, funds, corporates and other various players are also active(shown in the left hand side graph). • For securities lending, mutual and pension funds, investment companies and insurance companies all share important roles. Note: “40 Act Invest” means investment companies under “Investment Company Act of 1940.” (Source) TBMA (January 2005) Repo & Securities Lending Survey of U.S. Markets Volume and Loss Experience

Repo tenure: Lengthened maturity (Japan) • Repo will enable longer borrowing tenure. • In Japan, more than 30% of GC (general collateral) repo is of term tenure. • Reference; Nearly 90% of SC (special collateral) repo is of term tenure. Composition of GC repo by maturities

Repo tenure: Lengthened maturity (Europe) • In the statistics of European Central Bank, tenure of “unsecured” borrowing is concentrated on O/N, while tenure of “secured” borrowing (mostly repo) is concentrated from T/N to 1M, while there are longer tenures as well. (Source) European Central Bank, “Euro Money Market Survey 2005.”

Repo rate vs. clean money rate • According to BIS survey (1997 to 98), repo rates are 3 to 10 bp higher than clean money rate for O/N, while there are some exceptions. • This may be explained by: • Higher operational cost of repo • Fewer participants in comparison with interbank market • For tenure longer than 1 week, repo rates are lower in most cases, with spread reaching up to 58 bp. • Costs may be justified by longer tenure and higher yield of term repos.

Repo rate vs. clean money rate: Japan • In Japan, clean loans usually have lower rates. • This is partly because these loans were intentionally kept low due to monetary policy. • However, for longer tenure (e.g. 1M), repo rates are lower. • Also, rate move is more stable in comparison with clean loans. Repo rate vs. clean money rate % %

Bond lending fee • Bond lending fee depends on time (period), series and short-term interest rate level. • In Japanese market, bond lending fee has ranged from 5 bp up to 45 bp p/a. • Below graph shows bond lending fee for tenure of 1M. • In the U.S., the fee is usually 30 to 40 bp p/a. bp Removal of quantitative easing policy

 Purchase the squeezed bonds at manipulatively high prices when delivery date comes.  Borrowers do not have to purchase the bond when it is speculated.  Manipulators will lose the incentive for manipulation. Importance of fail practice • In developed countries, “fail practice” have helped decrease the risk of squeeze, as it can be used as a tool to correct manipulative prices. • As “practice” needs wide acceptance, SROs can gather views of market participants and develop guideline on the treatment of fail and methods for closing out transactions. Without fail practice,bond borrowers have to … With fail practice, …

Implementation of “fail” practice in Japan • JSDA, BOJ and repo study group have jointly made efforts to implement “fail” practice in Japan. • Repo study group is a group consisting of market participants to consider the practices of repo transactions. JSDA functions as the secretariat to this group. JSDA • “Guideline on RTGS of JGBs” • “Rules Concerning the Reduction of Fails in Securities Delivery” BOJ • Conducting and disclosing surveys on fails in the market • Rules on fails in conducting monetary operations using JGBs • “Bond lending and borrowing best practice guide” • “MOU on fails” Repo study group

Some countries have bond lending facilities to cover fails • Some countries have bond lending facilities to cover fails. • Mostly for equities, but sometimes also for bonds. The Securities Settlement System of the National Bank of Belgium • Automatic lending service. • It is mandatory for PDs to participate as the potential lender of securities in this system. Case Study: Clearstream • Clearstream, global custodian, provides “Automated Securities Lending” (ASL) and “Strategic Securities Lending” (SSL) services. Securities include various debt securities. • ASL is catered for settlement fails (and to avoid chain of fails), whereby borrowing starts automatically when fail is identified, and the loan is reimbursed as soon as the securities are available. • Procedure is conducted with no prior consultation. • Lent bonds are recallable at any time from the borrower. • SSL is an agency lending program catered to support trading of the counterparty, whereby Clearstream negotiates on the terms of loan on behalf of the lender. • Lending agreement is based on the OSLA (Overseas Securities Lending Agreement). • Clearstream conducts daily collateral management, such as mark-to-market and margin maintenance.

Repo Market – Implications from foreign markets Seminar material No. 2