EU Buy-In Regime Threatens Securities Lending Liquidity

Europe’s securities lending market could face a significant shortage of liquidity as a result of incoming rules on failed trades, the International Securities Lending Association (ISLA) has warned.

In a response to a consultation on the rules ISLA, which represents custodians, broker-dealers and buy-side firms, said forcing market participants to complete failed securities lending trades could cause serious disruption to markets.

Set out under the Central Securities Depository Regulation (CSDR), it enforces a buy-in regime for both securities and short-term financing transactions such as repo. This means the lender of a security will have to enter the market to buy back the security on loan if the borrower has failed in the transaction.

“With the CSDR regime creating new and potentially significant risks there is a real possibility that the regime will result in serious disruption to markets, as existing participants that supply liquidity by making their securities available for lending may reconsider to what extent they will continue to do so,” ISLA stated in the response.

“Perversely these effects are likely to be greater for less liquid securities where investors will perceive that the risk of being exposed to a buy-in is greater and will therefore avoid lending these in the first place.”

Tensions are currently rising in European repo markets as a result of the European Central Bank’s (ECB) quantitative easing programme, and the buy-in regime could exacerbate these tensions.

“When attempts are being made to make European capital markets more attractive as a source of financing, this [buy-in] effect would seem extremely undesirable,” ISLA adds.

“Lower liquidity results in higher transaction costs, more risk and volatility for investors which will surely result in less attractive borrowing terms for issuers.”