There is no doubt that the securities lending market in Germany has undergone significant change over the last couple of years. It has transformed from being a largely parochial market engaged primarily in unsecured security loans between German counterparts to a developed international market place in terms of products, liquidity and market participants. A number of factors have contributed to this change such as liberalisation of the regulatory system, the successful introduction of the euro and the demand and availability of a wider range of securities lending and repo products. Although actual numbers are not readily available on the size of the market, it is estimated that the overall size of the German repo/securities lending market amounts to between e170-200bn. This is equivalent to some 55% of the overall outstanding German government market, which is the highest in Europe.
The most significant event was the Bundesbank’s abolition of the minimum reserve requirement on all repurchase transactions back in January 1997. This change aligned the German market with that of other markets in Europe and repelled the previous distinction between the dominating international offshore market in London and the local market. Following this change, Deutsche Bank decided to relocate its repo activities in German securities from London to Frankfurt. However, to a large extent, the main sources of borrower demand, primarily from international broker-dealers, remains in London.
The introduction of the euro was the other major event that boosted the German market. As the bond markets converged across Europe, investors focused their government bond activities in euro to the German, French and Italian markets. The increased trading activity in the German market naturally increased demand from participants for financing long and short positions via the repo and securities lending market. The increased liquidity also led to a narrowing of spreads and the number of securities trading at special levels.
This way the German repo and securities lending market expanded from being initially focused on mainly bonds to include shorter-term securities such as treasury bills and Bundesschatzanweisungen. In addition, the scope of securities broadened as more foreign investors started to become active in the predominantly domestic Jumbo-Pfandbrief market. After a few teething problems in this market segment a number of initiatives such as dedicated market makers and the introduction of a Pfandbrief futures contract further facilitated the investment and the
repo activity.
These market developments have had a number of beneficial effects. The increased liquidity coupled with a number of regulatory changes that have started to attract a wider number of institutional investors has led to a strong market growth estimated to be between 25-30 % per annum. The introduction of the CAD rules in Germany, in 1998, promoted the shift to mainly collateralised securities lending transactions and the use of repurchase agreements also between German counterparts. Whereas the bulk of transactions are still between banks and broker-dealers, other participants such as insurance companies and the domestic funds (Kapitalanlagegesellschaften – KAG) have also increased their presence. Given their large size and the increasing diversification of their portfolios they constitute significant potential sources of supply. Nevertheless, some remaining domestic regulations continue, to some degree, to hamper the ability to unlock the full potential.
A number of changes have been introduced for KAGs over recent years such as the ability to use repurchase transactions up to 10% of the value of each fund. The bulk of transactions however are still carried out in the forms of security loans against a fee. Prior to the euro, only so called Lombardable securities constituted eligible bond collateral but this has now been aligned with the criteria defined by the European Central Bank.
An outstanding issue for domestic funds that requires further clarification is the transfer of security collateral, which still relies mainly on a pledge arrangement instead of the widely accepted concept of full transfer of title implicit in the PSA/ISMA and OSLA documents. Another constraint against widening participation in the repo market, in particular by corporate institutions, is the tax treatment of the accrued interest on securities in a repo bond, ie, Zinsabschlagssteuer, which remains unclear.
As some of these issues become resolved, the potential for continued strong growth of the market remains good. A number of factors are set to propel this process: the planned reform of the pension system in Germany will add an important investor segment; the broadening of investment criteria with German investors clearly adds to the diverse supply of international assets; and the continued growth of the corporate capital market both in terms of size and investor base will provide a wider choice of available collateral as well as funding levels.
Today, Deutsche Bank is one of the largest participants in the international repo and securities lending markets for both fixed income and equities and is at the forefront to continue to develop the market infrastructure both in Germany and beyond. In this role the bank offers a wide range of services for direct repo trading in all major markets as well as an international agency securities lending programme. The programme, for example, provides an efficient and secure means to maximise the incremental return on portfolios for clients who are looking to complement their own activities or who do not want to commit the resources for directly participating in the market
Fredrik Carstens is product manager, securities lending Western Europe at Deutsche Bank in