Taking ‘Topics in Finance’? You’ll want to read this… (Don’t worry. It’s good!)

Topics in Finance: The secret prize you didn’t know existed

DinaAs another Spring Term sets off, flashbacks of last year come to mind. I was in the third and final year of my BSc in Finance and Investment Banking degree at the ICMA Centre. ’Twas the year of incredibly high expectations, stress like you’ve never known, goodbyes, the opening of new doors and – of course – optional modules! After much consideration, I decided to go for Topics in Finance as one of them. Like me, you might have chosen this module to challenge yourself in essay-writing, but what you might not know is that it comes with a prize at the end, and I found out in the best possible way… Continue reading


No more culture shock: Adjusting to life in the UK as an international student

My name is Gao Tingting and I’m currently studying MSc International Securities, Investment and Banking at the ICMA Centre, Henley Business School.


I chose to study in the UK because I wanted to have an enriching study experience. Since starting I have seen so many new and different things here as an international student, such as the lifestyle and environment, but when I first arrived at Heathrow Airport there were a few things that I was worried about. Here’s how I got over the culture shock: Continue reading

Getting through to the UK Investment Banking Series finals

By Brandon Rodrigues, third year BSc Finance & Investment Banking student at the ICMA Centre


I had the opportunity to participate in this year’s UK Investment Banking Series (UIBS) event, and I must say it was a fun ride.

UIBS is an annual competition organized by 5 finance societies of various universities. It consists of a Sales & Trading challenge as well as an M&A challenge. My team and I registered for the trading challenge, out of curiosity (but also to get our mind off the piling workload that goes hand in hand with being third years!) Continue reading

Still fretting about re-hypothecation

There is a widely quoted paper re-use and re-hypothecation by Egemen Eren — Intermediary Funding Liquidity and Rehypothecation as Determinants of Repo Haircuts and Interest Rates (Institute of Global Finance, 2015) — which provides another example of the danger for researchers of disregarding the difference between the re-use of collateral sold in repo (re-selling) and the re-hypothecation of collateral pledged in margin lending (re-pledging). I have gone on about this confusion in several previous blogs (including a Bank of England paper that excited the financial press and one by Issa and Jarnecic).

The consequence of the confusion on this occasion is that the author misinterprets the post-crisis reduction in the recycling of collateral by dealers as an increase in repo haircuts, whereas much of this change would really seem to represent the withdrawal by hedge funds of rights of re-hypothecation on collateral pledged to prime brokers to cover margin lending and derivatives exposures. The confusion is not academic, inasmuch as the paper appears to add weight to a body of literature that tries to identify the pro-cyclicality of haircuts as the source of the Great Financial Crisis. This academic corpus originated with Gorton and Metrick (2010), who extrapolated from a time series of haircuts on exotic collateral from a single unidentified source in the US to make an ambitious inference about the origin of the entire crisis. It is fuelling regulatory interest in extending the imposition of minimum haircuts across the repo market. The consequences of such an initiative for market liquidity could be serious and should not be based on research that is not firmly grounded.

The model

Eren follows Infante (2014) in modelling the intermediation by a dealer between hedge funds supplying collateral and cash lenders supplying collateral but seeks to extend the analysis to show that the demand for funding by the dealer simultaneously determines both repo haircuts and repo rates. Implicitly, given his data, he is also trying to estimate the rates of re-hypothecation and the cost of collateral pledged in margin lending from prime brokers as well as the haircuts on collateral posted against derivatives exposures.

The proposition is that the dealer in the model obtains funding from the spread between the haircuts paid on repos to cash investors and the haircuts received on reverse repos from hedge funds. This ‘haircut spread’ is seen to provide an alternative source of funding to the dealer’s his own cash holdings or fire sales of illiquid assets (all sales of illiquid assets are assumed to be fire sales). As haircuts expose hedge funds to the risk of dealer default, it is argued that an incentive is required to persuade them to agree to repo (and to give rights of re-hypothecation). The incentive proposed is lower repo interest rates.

The model assumes that the haircut spread is determined by the volume of lending available from cash investors and the dealer’s need for funding, while repo rates are determined by the adequacy of the terms offered by the dealer to hedge funds and their outside options (ie alternative sources of funding, including from other dealers). The conclusions are that haircut spreads are narrow when funding is abundant and wide when funding is scarce.

The adequacy of the terms offered by the dealer to hedge funds is modelled by a comparison between:

  • the returns from the investments being funded by the hedge funds plus the value of bonds pledged by the hedge funds but not re-hypothecated by the dealer and instead lodged for safekeeping with a custodian less the costs of repo funding; and
  • the cost of the outside options available to hedge funds.

On this basis, if hedge funds have a net liability to the dealer at maturity, for a given haircut, repo rates will depend only on hedge fund returns and outside options (what they can afford to pay given their investment return). On the other hand, if the dealer has a net liability to the hedge funds at maturity, repo rates will also depend on the probability of the dealer’s default.

The author makes bold claims for his model, stating that it can provide an explanation for all of the empirical evidence about haircuts and re-hypothecation before, during and after 2008.

Empirical evidence

Evidence for the model is adduced in the form of the survey of haircuts in June 2007 and June 2009 conducted in 2010 by the BIS Committee on the Global Financial System (CGFS). Dealers are assumed to the ‘prime’ parties in the survey and hedge funds are assumed to be the ‘unrated’ parties. The implied haircut spreads across all securities increased between June 2007 and in June 2009, which seen as being in line with the predictions of the model.

In addition, it is noted that, in the second quarter of 2008, the fair value of collateral that Lehman Brothers was permitted to ‘repledge’ and the fair value of collateral that it did ‘repledge’ were around a half their values in the first quarter and the second quarter of 2008. Moreover, it is implied from financial reporting of collateral received and ‘repledged’ that, in the third quarter of 2008, that Goldman Sachs needed a haircut spread of 7.2% and Morgan Stanley needed a haircut spread of 7%, while in the fourth quarter, Goldman Sachs apparently needed a haircut spread of 11.2% for Goldman Sachs and Morgan 22%, which is taken to support the model prediction of a sharper reduction in lending to hedge funds by riskier Morgan Stanley than by safer Goldman Sachs.

Is the model and evidence credible?

The problem with the conclusions of this paper is that the haircut spread on repos specified by the author and implied from the investment bank data on re-pledging actually includes the withdrawal of rights of re-hypothecation on margin lending and haircuts on derivatives collateral. In practice, margin lending and derivatives are far more important for hedge funds that repo, which tends to be used for transactions with dealers other than prime brokers. But the withdrawal of re-hypothecation rights by hedge funds is ignored in the analysis.

There are other weaknesses in the paper:

  • The idea of a reduction in repo rate compensating for the exposure of hedge funds to the increasing haircut spread imposed by increasingly risky dealers is based on the assumption of risk neutrality. In reality, as noted by the CGFS and others, parties responded to the crisis, not so much by raising prices and haircuts as by rationing credit. Academics tend not to realise that counterparty credit risk is the primary risk faced by dealers given that collateral does not provide a perfect hedge.
  • On haircuts, the paper offers only ordinal proof (direction of change) rather than cardinal proof (degree of change).
  • The model does not ‘pin down repo haircuts and interest rates jointly’. There is no empirical proof of interest rate behaviour. And the repo rate estimated by Eren is not the market rate but an internal hurdle rate for hedge funds.
  • Looking at the “volume of lending by cash investors and dealers’ balance sheets as determinants of haircut spreads” is too narrow a perspective. Collateral price volatility is a key determinant. Collateral price volatility and cash supply/demand are arguably both driven by risk perception and aversion. So a linear chain of causation is unrealistically simple.

However, the hypothesis underlying the paper is not without any foundation. US dealers do appear to impose haircut spreads. So the real problem may be that the paper is too US-centric. This is certainly one conclusion suggested by the work of Issa et al (2016). On the basis of far more compelling data, these authors contradict both Eren and Infante by showing that haircut spreads in the Australian repo market actually narrowed during the crisis. In repo markets such as Europe, there is anecdotal evidence of occasional trade-offs between repo rates and haircuts but only in particular circumstances and under normal conditions. There is no evidence of a widespread or strong relationship between haircut spreads and repo rates. The two are fundamentally different. Haircuts primarily reflect collateral quality and thus price volatility, whereas repo rates primarily reflect counterparty credit risk. Both will be affected by supply/demand for funding and competition but in different degrees, given that haircuts are less transparent and more under dealer control, while the repo rate is largely exogenous.

The paper’s conclusion is that, “The financial system is still vulnerable to liquidity dry-ups and wild increases in haircuts. This paper highlights the need for further theoretical and empirical research that will be of interest to both academics and policy makers to develop tools to mitigate risks in the financial system.”

Unfortunately, the assertion is not proved, which ironically makes the recommendation for more research all the more apposite but only if that future research is based on a better understanding of the legal differences between re-sale of repo collateral and re-hypothecation of pledged collateral.




Academics, you re-hypothecate at your risk!

In a blog in May 2015, I tried to explain that, outside the US repo market, it was incorrect to use the term ‘re-hypothecation’ to describe the use of collateral purchased in a repo by its buyer. Such use is usually termed ‘re-use’ but would be better called ‘re-sale’. The crux of the matter is that re-hypothecation is a right to dispose of collateral that can be given to a pledgee by a pledgor but such a gift is at the discretion of the pledgor. In contrast, the re-use of repo collateral is the proprietary right of the buyer of collateral to dispose of that collateral. This fundamental difference arises because pledged collateral remains the property of the pledgor (giver), whereas purchased collateral becomes the property of the buyer (receiver).

Recognising the distinction between re-use and re-hypothecation is important because of the confusion over what happened to the collateral that was re-hypothecated to Lehman Brothers International Europe (LBIE) by its hedge fund clients in 2008 in order to secure margin lending and derivatives exposures. The inability or unwillingness of regulators to distinguish between re-hypothecation and re-use has had serious unintended consequences for the European repo market.

Barking up the wrong tree

But it is not just regulators who have difficulty recognizing or accepting the difference between re-hypothecation and re-use. In an interesting paper on ‘Collateral Reuse as a Direct Funding Mechanism in Repo Markets’ by George Issa and Elvis Jarnecic of the University of Sydney, the authors kindly refer to my blog last year but then summarily dismiss the substance on the grounds that, ‘Although they are technically different…, the terms “collateral reuse” and “rehypothecation” are used interchangeably to refer to the use of posted collateral in a source transaction to secure a separate transaction.’

The authors are in fact correct to say that the terms ‘are used interchangeably’ but that widespread usage is incorrect, as I tried to explain. Their failure to see the difference leads the authors to propose an invalid reason for the decline in the re-use of collateral in the Australian repo during the Great Financial Crisis (GFC).

The authors argue, ‘… the exploratory analysis showed that collateral reuse experienced a fairly sudden and permanent decline at the start of the GFC. This is consistent with the statement that collateral providers increasingly demanded segregation of their collateral during the GFC due to concerns about credit risk and the possibility that their collateral would not be returned…Following the shock to financial intermediaries from late-2007, a larger fraction of collateral providers then demand that their collateral be segregated due to an increase in the risk that collateral cannot be returned when requested. Hence, even though dealers have a greater need to reuse collateral to ease their funding constraint, the segregation constraint leads to an overall sharp decline in the repo rate spread. A likely reason for the subsequent persistence of a low repo rate spread is higher risk aversion – and therefore a higher likelihood of collateral segregation requests – relative to pre-GFC levels: not only is collateral more scarce due to regulatory requirements…but also repo market participants are more concerned about counterparty risk due to continued liquidity pressures in global financial markets… although dealers have a greater demand to rehypothecate during crisis periods, the reuse rate declines dramatically at the start of the GFC, reflecting increased demand by source party repos for collateral segregation.’

By segregation, the authors mean no commingling with the assets of the prime broker and, most importantly, no re-hypothecation.

The problem with this explanation for the decline in re-use is that sellers in a repo cannot control what buyers do or do not do with the collateral. Because legal and beneficial title to the collateral is sold to the buyer, it becomes the buyer’s unencumbered property. That is the very essence of a repo.

There was indeed a demand by clients for collateral to be segregated (and the widespread withdrawal of the permission to re-hypothecate) but this was by hedge fund clients to their prime brokers in respect of collateral pledged under prime brokerage arrangements, where the collateral had been pledged to secure exposures arising from derivatives transactions and margin lending, and where the hedge funds had previously given their prime brokers permission to re-hypothecate. It was not in respect of repo collateral and legally could not have been.

The rest of the paper

However, the mistaken explanation for the decline in re-use in the Australian repo market should not detract from the quality of the research underlying the paper. The authors use a Furfine-type algorithm to detect overnight repos from securities settlement data and compile a transaction time series. They use this time series to test the hypothesis proposed by Infante (2014) and Eren (2014) that repo dealers acting as intermediaries impose a higher haircut on reverse repo than on matched-book repos, ie they pay less cash for collateral through a reverse repo than they receive for that collateral in a matching repo. In this way, collateral re-use provides net funding to intermediating dealers. Importantly, Infante further suggests that the higher haircut imposed on the reverse repo is an incentive on the seller to run in the event of a deterioration in the credit of the dealer. The data compiled by Issa and Jarnecic conclusively rejects this hypothesis!

There may of course be local reasons why haircut spreads are negative in Australia and future studies of other markets may discover positive spreads. But there is an important lesson to be learned: not all repo markets are the same. FRBNY and FSB please take note!

Finally, a point of detail worth noting is that Issa and Jarnecic estimate re-use in the Australian repo market at 3.56%, a similar order of magnitude to the estimate of re-use in the Swiss market by Furher et al (2014).

My unforgettable first week in a brand new environment 

zhu-xuefei-92By Xuefei Zhu, China, MSc International Securities, Investment and Banking

When I first arrived in the UK, almost everything was new to me. I came from China to study here and it was my first time studying in a new country. But despite that I had an amazing first week, and several things impressed me from the very start! Continue reading

Career switch: From International Relations to a Masters in Finance

brozman-martin-63-v2My name is Martin and I’ve just started studying MSc International Securities, Investment and Banking at the ICMA Centre, part of Henley Business School.

Making the switch

I previously studied European Studies and International Relations but (as many people do) I decided that I needed a career change. Even though I don’t have an academic background in finance, the ICMA Centre takes on people from a variety of fields. I was worried at first, in particular because of the Maths requirements, but they do provide support for this during the initial weeks of the course to prepare those worried about their academic numeracy for what´s coming up. (They also offer some English classes in case you or the staff think you might need them). Continue reading

Kind of a big deal: AT&T and Time Warner acquisition

antypas-nikolaos-400x267– by Nikolaos Antypas, ICMA Centre PhD student

There is a major acquisition in the making, which may have dominated your business news stream: AT&T (2nd largest mobile network provider in the U.S.; acquirer) has reached an agreement with Time Warner (4th largest content provider in the U.S.; target; also, Na na, Na na Na na Game of Thrones) for a deal valued at $85.4 bil (premium of 35% over the recent trading price).

That is a huge deal with material repercussions for the market. For instance, regulators (and Netflix, Hulu, Amazon etc.) are concerned with whether the combined entity will charge for the mobile data used on competitors, while charging nothing for Time Warner’s content. Considering the position of AT&T in the market of content distribution, this practice may impede competition, hurting the consumer in the long run.

Nevertheless, the deal may not be quite profitable for AT&T shareholders, as suggested by Bharat Anand, professor at HBS (Harvard Business School, not Henley!). You can read his blog here.The only expected origin of benefits is from synergies, although the sources of synergies seem ambiguous after closer examination. He argues for the new status quo of modern economy, where “complement” products (those accompanying/facilitating the sale of core products) have become increasingly important for technology giants such as Apple (partnership with HBO), Amazon (Prime Video as standalone business), Twitter (live feed of NFL games). In the new context, the cheaper the complements, the more value is added to the core business. This view of reality is in contrast to the significant premium paid by AT&T for the cash flows of Time Warner content.

We may also need to consider the scenario of AT&T distributing exclusive content on its mobile network. If this is enough to attract more data subscribers, then it would be more profitable to expand its content portfolio (e.g. TV series) on either quality, quantity, or both. Note that the “video-on-demand” industry (Netflix, Hulu etc.) does not have a pricing structure allowing for the winner to reap overwhelming benefits against the followers, as people can afford and do actually pay for more than one subscriptions simultaneously. However, it is improbable that the same holds for mobile plans: it is more likely for people to have a unique data provider, as the individual contracts are relatively pricey. We should consider whether AT&T plays the acquisition move not just to survive the advent of unconventional content providers such as Facebook, but also to strengthen its position in its own core industry.

Written by Nikolaos Antypas, ICMA Centre PhD student pursuing research in analysis of merger waves, takeover target prediction and corporate governance. View his profile on the ICMA Centre website.

3 tips for getting a career in Finance – by alumnus Ben Deverell

ben-deverell-rdMy name is Ben Deverell, and I’m a career commercial banker with roles spanning operations, risk, strategy and business management. I’m currently a senior member of our Financial Institutions business, supporting clients with their financing, investment, risk management and banking needs.

To any current students looking to start a career in finance: the financial industry is a great place to work and I commend you for your decision!

However, for a multitude of reasons, it is also fraught with challenges and risks. My advice would be to take a leaf out of several books (some from other contexts) and apply. In particular, I would stress three points:

  1. Diversification

Diversification is the most useful of risk management tools so apply this to your career path. Specialising in one area at an early age could mean you become an expert in yesterday’s product.

  1. Keep learning and changing

The cliché from Darwin rings true; those that can reinvent themselves, prove adaptable, can learn and change quickly, are more likely to have a fruitful, productive and enjoyable career.

Developing skills via study is a crucial element. I studied the MSc Investment Management at the ICMA Centre, part of Henley Business School, graduating in 2016. Obtaining an MSc was both a personal goal of mine and considered important to progress my career. With Henley being a highly ranked business school and clearly linked with industry via the ICMA, then the decision came to the course. I chose IM for three reasons:

  • Intellectual stretch; whilst I had some prior learning in a few areas of finance, many of the topics were either completely new or introduced considerable stretch.
  • Relevance: the syllabus was highly relevant to my role and the agenda of my clients. The breadth was attractive too; I enjoyed and valued both the pure technical (in particular Portfolio Management and Corporate Finance) andthe non-technical modules (Ethics and Regulation).
  • Credentials: allied to the first two points, the landscape for qualifications in finance continues to expand. Having a good quality MSc from a regarded business school carries credibility. The fact that this degree was accredited via CISI and, for FT students, allied to CFA, only added to the appeal.
  1. Finance is a people business

This is probably the most important point. Finance is based on developing trust between humans, despite the data revolution that is occurring – which is unlikely to change.

My time at the ICMA was excellent. In addition to the formal course, I enjoyed the trading simulation terminals (and, of course, revisiting student bars), but some of my favourite experiences were when I was working in teams with other students from many varied walks of life. So, be ethical, truthful and respectful and hone your people skills as much as technical. And, if you can be personable and fun, so much the better!

Emailing the CEO of Deutsche Bank and asking for a hug… – by Cameron Pfiffer

pfiffer-cameron-128Cameron Pfiffer, studying MSc Corporate Finance at the ICMA Centre, blogs about his first weeks at the ICMA Centre and using the Bloomberg Terminals for good and evil.

One of the reasons I chose to come to the ICMA Centre was the facilities – the building and the neighboring Henley Business School (which the ICMA Centre is a part of) are both architectural marvels. The ICMA Centre building in particular is simultaneously businesslike and warm, thanks to the bustling coffee bar and walls of windows looking out onto old trees. As an American coffee lover, it’s one of the few places in England that makes actual good coffee for an insanely reasonable price.

Of the great things about the ICMA Centre, the Bloomberg Terminals are perhaps one of my favourite after my first week of studying. There are twenty or so of them in the centre.

What’s a Bloomberg Terminal?

If you don’t know what a Bloomberg Terminal is and you love all kinds of data, you are in for the treat of a century. The terminal is chock full of any data you could ever want about anything.


Screenshot: map of wind farms in Germany

Want to see a map of wind farms in Germany? Here you go. Here’s a map.

Want to see all cargo ships and oil tankers in real time? Better yet, here’s all the ships waiting to pass through the Panama Canal.

In the market for a luxury yacht? Type POSH and maybe you’ll find one for sale.

Want to send an email to John Cryan (CEO of the embattled Deutsche Bank) and ask him if he wants a hug? He’s right there on the terminal. You can instant message him or email him on his own terminal. Obviously, I would highly recommend you don’t do this. But all I’m saying is it is possible.

Bloomberg hires a boatload of people full time to scour the world over for databases, write real-time news, and perform analysis. It’s all available for anyone with a terminal with a few swift key presses. You might have heard of Bloomberg the news agency, but not the terminal. You might not also know that 75% of Bloomberg’s revenue comes from the rental income from Bloomberg terminals. The news portion of the company is heavily subsidised by the terminals, and they produce some excellent articles.

I’m loving the experience with the terminals so far. I’m currently rooting around a database that lists municipal bond issues in my home state of Oregon (it’s the one above California, but it’s better) by underwriter. Maybe I can find a research project in the data by November, when our research proposals are due. Even if I don’t find anything worth writing about, I’m still having a blast!