What’s the difference between repo and margin lending?

Specifically, what is the difference between repo and margin lending for the purposes of SFTR?

SFTR defines margin lending as ‘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 ‘. This excludes borrowing to finance expenditures unrelated to the collateral securities. The problem is that repo can also be used in this way. The result is confusion about the perimeter of SFTR-reportable margin lending.

Repo is, of course, a sale of securities and a simultaneous commitment to repurchase equivalent securities at a future date or on demand for the same value plus a premium (or discount).

A key difference with margin lending is that it does not involve a sale. There is no transfer of title to the collateral in margin lending. Instead, margin loans are collateralised by an interest attached to the securities, typically, a pledge. The borrower therefore retains ownership of the collateral.

Moreover, margin lending creates a debt, whereas repo does not. Consequently, a default by the borrower in margin lending would typically be captured by the insolvency regime.

And in contrast to the buyer in a repo, the secured lender in a margin loan has no automatic right of use of the collateral. The lender has to get the borrower to give him a right of rehypothecation, which might be subject to regulatory limits (eg Federal Reserve Regulation T and SEC Rule 15c3-3, which limit the amount of a client's assets which a prime broker may rehypothecate to the equivalent of 140% of the client's net liability to the prime broker).

The differences that stem from the fact that repo is a sale but margin lending is a loan are pretty fundamental and are the obvious thing to look for. Unfortunately, this distinction cannot be used when reporting under SFTR because ESMA subscribes to the oxymoronic fiction called a ‘pledged repo’. It is rather amazing that any regulator should do this. A ‘pledged repo’ is really a secured loan mislabelled as repo, essentially to mislead investors.

But if one cannot use the sale-versus-loan difference to distinguish between a repo and margin lending, it is necessary to fall back on a practical difference.

Perhaps the clearest practical difference between repo and margin lending is that margin lending between two parties is constituted as single transaction that is increased or decreased in size, perhaps many times a day, rather than being multiplied in number by discrete new transactions under the same legal agreement. Margin loans are therefore reported with one UTI and then updated with modification (MODI) reports. It is theoretically possible to replicate this structure with an open repo but, in practice, one is highly unlikely to have only one repo under a legal agreement.

There are lots of ancillary differences to look for as well. For example, if there’s a prime broker, he will be responsible for settling transactions. And the prime brokerage agreement won’t be a GMRA or GMSLA but a bespoke agreement that will allow other asset classes to be traded, notably derivatives.