The 1997 Guide to Germany: Securities lending

The German securities lending and repo market

The development of the securities lending market in Germany was boosted in 1990 by the establishment of one of the most efficient options and futures markets in Europe. The access to the German options and futures exchange (DTB) was widely open to banks who then started to develop their securities lending operations. Short selling became legal according to German regulations and the domestic securities lending market became one of the most liquid and most efficient markets in Europe. Today, most of the German banks are quoting on public screens (Reuters), introducing a level of transparency unique in this market. The substantial interest of other kinds of institutions such as investment funds and insurance companies, backed by regulation modifications, contributed considerably to the liquidity of the market and consequently to the drop of the fees.

On the other hand, in Germany, the repo market is unfortunately undeveloped because of major legal constraints. The minimum reserve introduced by the central bank penalizes all banks entering into a repo transaction.

Legal framework

In Germany, all securities lending transactions or repo transactions are covered by a very clear and dedicated regulation.

Under a security loan, the title to the lent securities is transferred to the borrower. At the end of the regular term of the loan or upon early termination, the borrower has to retransfer title and possession of securities of the same kind. The lender receives a consideration which is calculated as a percentage per annum of the market value of the securities. The lender remains, during the whole period, the economic owner of the securities.

Collateral can be cash, securities or bank guarantees. Cash collateral is usually provided in form of a deposit made by the borrower to an account with the lender or any other third party recognized as a credit institution, which is then hedged to the lender. If the collateral is constituted by securities, these are delivered to a securities account of the borrower maintained with the lender or a third party. Under German law, the pledged securities cannot be used by the lender for any other purposes. Under a repo transaction the securities are sold subject to the obligation to repurchase them on a predetermined date.

Repo transactions are not very developed in Germany today, because they are subject to a minimum reserve imposed by the Bundesbank. In fact, the Bundesbank considers the purchase price paid by the buyer as a deposit maintained with the seller. Such a deposit is subject to a minimum reserve requirement unless the buyer is a German credit institution and is itself subject to the minimum reserve requirement.

The Deutscher Kassenverein (dkv) and the settlement system

In Germany, all transactions in debt securities and shares listed on the Frankfurt stock exchange are cleared through DKV. The Kassenverein is simply debiting an account to credit the account of another counterparty.

As a contribution to facilitate the liquidity of the market, DKV offers a system to facilitate securities loans among its participants, acting as intermediary, and receiving a fee. The DKV, which is backed up by a consortium of banks, can ensure a relatively efficient exchange between its participants. Each bank can lend or borrow through DKV.

The Kassenverein is set to be able to organize some individual accounts for stocks available and make sure that the loans are allocated in a fair way, which is only a proportion of the total required, and the Kassenverein will ensure that this collateral always remains sufficient.

By establishing these automatic lending & borrowing programs at the central depository, the DKV is playing a very similar role as a safe custody bank.

However, for price reasons (Bonds 0.5% to 1% – Equities 1% to 1.5%), the DKV lending & borrowing system is usually used as the last resort.

The securities lending market

At the opposite end the German interbank securities lending market is very active.

Most of the banks, which provide custody and clearing programmes to domestic or non-domestic customers have to participate actively in this market.

The banks are usually acting as principal and propose to their custody clients that they should participate in automatic lending programmes of various forms. One of the most common programmes used by custody clients is a discretionary programme where, to avoid any costs of booking, a separate account is opened in the name of the client and a mandate is given to the bank to enable it to borrow from this account. Some banks are also proposing a global lending account (pool) where the lending fees are allocated according to a basic profit sharing ratio. The same kind of automatic programme is set up for borrowers who are clearing through the German banks. Due to the very high volumes developed on the DTB market, these kinds of programs allow substantial volumes in securities lending transactions between clients of lending programmes and clients of clearing programmes, as well as a very active and intense interbank market. In Germany most of the securities lending transactions between customers and banks or between two banks are completed without any collateral. If collateral is required, cash, securities or guaranties can be used. However, minimum reserve requirements for cash collateral, in the case of a non-bank, and the pledge in separate account of securities, does not contribute to introduce a systematic collateralizing of transactions. So, even the interbank market continues to transact in an uncollateralized way.

The liquidity of the market will continue to grow tremendously because of the more and more active role of insurance companies as well as investment funds. The securities lending regulation permitted the German insurance companies to lend securities from their cover funds and most of them are in close relation with their main German banks to enter into automatic programmes to enhance their revenues. This flow of liquidity has depressed rates, but the counterbalance is rising by an intense growth in demand due to DTB activity. New laws concerning capital investment companies started to appear in August 1994, and continue to be updated to comply with market demand. Capital investment companies can now lend securities worth 10% of their assets to one counterpart on an open basis and 15% of their assets on a fixed term basis not exceeding 30 days. In the case of capital investment companies, all transactions have to be collateralized, usually with debt securities or guarantees. The German securities lending market acquired a level of liquidity, volume, and efficiency, which is rather unique in Europe today. The rigorous approach of the German banks and institutions to manage their activities is an ideal ground to continue to improve the efficiency and transparency of the lending market. DTB traders require more and more information about costs of borrowing at different maturities than the open basis. But to be able to quote publicly rates other than “open basis”, banks will need to continuously increase their capacity to borrow very large volumes, and increase their number of clients. German regulation is going this way and should allow most of the German assets to be able to participate.

Outlook

The German lending and repo market organized itself to be able to represent its interests as a group of traders and members of the Association of German Money Traders and are organized as a sub group of this organization. They contribute to structure the market and represent a credible interlocutor to the German authorities. Their action is already concluded on the establishment of a German standard master agreement and should contribute to the evolution of the securities lending as well as the repo market in Germany. These efforts, backed by the evolution of the regulation of insurance companies and investment funds, as well as capital adequacy should allow us to see a different side of these markets in the next months and years. Efficiency and liquidity should be enhanced and will definitely lead the sophistication of these markets in Europe.