Margin lending

SFTR Anatomy™ Regulation on Transparency of Securities Financing Transactions and of Reuse (2015/2365/EC (EUR Lex)), aka the securities financing transactions regulation →Go uptown A blueprint for margin lending, yesterday 3(10) ‘margin lending transaction’ means a transaction in which a counterparty extends credit in connection with the purchase, sale, carrying or trading of securities, but not including other loans that are secured by collateral in the form of securities; Primary source The ludicrous industry-standard title transfer disclosure document Articles | 3(8) | Buy-sell back transaction | 3(9) Repurchase transaction | 3(10) Margin lending transaction | 3(11) Securities financing transaction | 3(12) Reuse Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

A margin lending transaction is one where one party lends money to another so it can buy or sell securities. The lender will lend up to a certain value of the securities. If the securities fall in value, the lender may ask the borrower to post margin to cover the value of the margin loan.

Usually the borrower lets the lender hold the securities as collateral for the margin loan. The borrower may also allow the lender to use those securities in the market to offset its funding costs of making the margin loan.

This is the classic prime brokerage trade. I’m a hedge fund, and I am all about Vega — the Greek that denotes leverage.

How do I get my spectacular returns? Alpha Leverage, that’s how. I buy securities “on margin”. This means I buy the security, and you, dear prime broker, pay for it.

Well, strictly speaking, you lend me the funds I need so I can pay for it, but in practice, you will be settling the transaction directly with the executing broker and taking delivery of the security on my behalf, under our margin loan. That’s right: in return for lending me the money, you get to “look after” the shares for me, so you can both (i) take security over them to secure the loan, and (ii) reuse those shares — usually using them as collateral when you borrow treasuries in the stock loan market which you can give to your treasury department to offset the funding costs they charged you to to finance the margin loan you made to me in the first place.

I must pay you initial margin as cover should the value of my new asset decline against repayment value of the outstanding margin loan.

The steps, in order, are:

1. The PB acquires a credit line from its own treasury department. Business being business, and capital charges being capital charges, this is eye-wateringly expensive.
2. The PB lends that money to its hedge fund client in a margin loan.
3. The HF buys a security with that money.
4. The HF settles the security into its custody account with the PB. From the PB’s perspective the deal is this: I pay for (most of) your asset; you settle the asset to me, where I can (i) look after it for you, (ii) hold it as collateral for your Margin loan, and (iii) reuse it to reduce my funding costs.
5. The PB accordingly does reuse the asset. It “rehypothecates” it (takes title to it, basically) and uses it as collateral to a stock borrow loan ...
6. ...under which it has borrowed high-quality bonds from the market that meet its treasury department’s exacting standards, whereupon it
7. Delivers the borrowed bonds to Treasury for them to use in their treasury operations. They are so pleased they give the prime broker a credit on its eye-watering financing rate it charged it under step 1.

Easy.

See also

• Prime brokerage
• Rehypothecation
• Greeks