The Impact of Interest Rate Changes on Securities Lending Cash Reinvestment Revenue

In light of the recent Federal Reserve rate rise, the team at EquiLend Data & Analytics looked back over recent years of data to analyze any the trends associated with such rate changes. 

Approximately 90% of all cash collateral received in the securities lending market is in U.S. Dollars, which means that rate changes in the U.S. can have a significant impact on revenue, as shown in the chart above.  

When cash is provided as collateral against lent securities, the borrower receives a rebate rate on this cash. The rebate is typically quoted in reference to a benchmark rate, which for U.S. Dollars is the Overnight Bank Funding Rate (OBFR). The more in demand a security is, the lower the rebate rate. Agents will reinvest the cash collateral received into reverse repurchase transactions or short-term money market instruments. The yield on the investment minus the rebate paid results in the return on the loan.  

The loan leg of the transaction is typically overnight, whereas cash collateral can be invested in a mix of instruments with varying maturity dates, allowing for some duration mismatch between the loan and the cash reinvestment legs. As a result of this, spreads tend to widen when rates are cut, as the rebate rate resets immediately while the yield on the cash reinvestment fund continues to benefit from longer-dated investments and tighten when rates rise.  

The corresponding impact on cash reinvestment revenue can be clearly seen in the chart above. The red arrows indicate a rate cut, and the green arrows show rate hikes. In all cases, the revenue in the month following the rate movement fell after a rate hike and rose after a rate cut. 

The Federal Reserve has announced a rate increase of 0.25% following their two-day meeting on March 15-16, 2022. DataLend will continue to monitor cash reinvestment revenue following the Fed move.  

Federal Funds rate changes sourced from: https://www.federalreserve.gov/monetarypolicy/openmarket.htm.