Securities financing transactions (SFTs) play a vital role in fostering liquidity, mobilizing collateral and supporting the smooth functioning of derivatives markets. But during periods of stress, secured funding markets often come under pressure just when they’re needed most, with reduced availability amplifying external shocks and increasing the reliance on public-sector intervention. Addressing certain regulatory and structural frictions that contribute to these dynamics is increasingly becoming a priority to improve the resilience and availability of SFTs in all market conditions.

Since the global financial crisis, mandatory central clearing of standardized derivatives and margining of non-cleared derivatives have improved market resilience and reduced systemic risk. These reforms have also deepened the interconnectedness between derivatives and SFT markets. An uptick in demand for high-quality collateral in the derivatives market has increased market participants’ dependence on SFTs, especially repo markets.

In short, SFTs are a lifeline that enables market participants to quickly generate cash and high-quality liquid assets to meet their derivatives margin calls – during periods of stress, they are absolutely critical to keeping markets functioning smoothly. To ensure the continued availability of this lifeline in all market conditions, we need to improve the calibration and risk sensitivity of the regulatory framework for SFTs.

In a new whitepaper published this month, ISDA identifies the key regulatory and structural issues that affect the availability of secured funding and sets out a series of targeted adjustments that would support resilient, efficient and well-supervised SFT markets. These are issues on which we have been advocating in the US for several years as the Basel III endgame and Treasury clearing mandate have made their way through the policymaking process.

One example is recognition of cross-product netting in the US capital framework. With the Securities and Exchange Commission’s clearing mandate for US Treasury repo transactions just over a year away, the Fixed Income Clearing Corporation and CME Group are working to extend their cross-margining service – previously available only to dealers – to clients. Once approved, this will allow a broader swath of market participants to benefit from risk-reducing offsets across cleared Treasury repos and derivatives, lowering initial margin requirements and better aligning collateral with risk.

The problem is there is no equivalent recognition under the capital framework. Under the standardized approach for counterparty credit risk (SA-CCR), banks must calculate their exposures on a single-product basis, preventing the offsetting of repos and derivatives even when they sit within the same netting set. Cross-margining means firms would face even higher capital requirements because of the lower initial margin held against the portfolio, reducing balance sheet capacity just as US Treasury repo clearing volumes increase. To address this issue, ISDA proposes an extended SA-CCR methodology, which treats repo collateral as a forward derivatives contract and allows SFTs and derivatives to be recognized together under qualifying cross-product master netting agreements.

Other adjustments are also needed to strengthen the resilience and efficiency of secured funding markets. These include improvements to the standardized approach for credit risk to recognize the short-term nature of SFT exposures, the exclusion of SFTs from the credit valuation adjustment framework, and revisions to the Basel III liquidity ratios. These targeted amendments would be a vital step forward in making sure the availability of SFTs to support liquidity and collateral for derivatives transactions is not constrained by capital, liquidity and leverage rules, especially during periods of stress.

Improving the regulatory framework is not all that’s needed. There is also an opportunity to more closely align the legal framework for derivatives and SFTs, leveraging ISDA documentation to capture derivatives, repos and stock loans in a single close-out netting arrangement under the ISDA Master Agreement. And we can use industry initiatives such as the Common Domain Model to develop harmonized, machine-readable representations of trade lifecycle events across SFTs, derivatives and other financial products, opening the door to greater alignment and efficiency.

Given the vital role SFTs now play in the provision of liquidity, financing and collateral in the derivatives market, we must make the case for these targeted changes to reduce the systemic fragilities that have emerged during episodes of stress and improve overall market resilience.

Read the ISDA whitepaper: Safe, Efficient Markets for SFTs