Securities lending used to be a relationship driven business to the point where if you didn’t know someone, you could not borrow a security if the world depended on it. New forces have entered the market however and the old order has seen its influence reduced. We wonder though, how much has really changed vs. how is the status quo of the mid-2000s holding on? Here’s what we are seeing:
1) The role of IT. There is a clear movement towards greater technology in the securities lending process. EquiLend’s NGT is one example; SunGard’s Loanet Centralized Order Management Solution is another. It takes some intuitive sense of how to work technology and how to process information to get the most out of these systems; the more comfort that traders have with technology in general, the more the parent firm is going to get from a big installation effort. Technology takes the relationship out of the game by offering borrowers and lenders a central source to view (real) available inventory and pricing. When all inventory is transparent and on the table, all it takes is access to one of these systems to be in the game. By this metric, an old guard without as much technology skills would have less influence than new employees right out of school with no connections.
2) The role of credit and capital ratios. Since the global financial crisis, the new emphasis on credit exposure from internal risk managers and cautious bank regulations like Dodd-Frank’s 165(e) and the Large Exposures rule in the Capital Requirements Directive IV mean that it doesn’t matter who your buddy is, he or she won’t get the loan if that puts counterparty exposure limits in question. A first priority of banking has always been to not go afoul of regulators. As such, monitoring single counterparty exposure limits across all business lines (OTC derivatives, repo and securities lending included) will happen before anyone does business in any capacity. Likewise, any business that negatively affects capital ratios like the LCR will be looked at unfavorably.
3) Data transparency. In an age of SunGard Astec Analytics, Markit Securities Finance and DataLend, pretty much everyone who needs to can track securities loan rates. Quiet, off the books trades between counterparties to do a favor, or our personal favorite of “we don’t pay negative rates” can’t exist under the spotlight of transparency. These trades are now audited and monitored for best execution, either at the moment of trade or in aggregate after the fact.
Items 1, 2 and 3 above suggest that the relationship aspect of securities lending is declining, but the story does not end there.
4) Counterparty preferences. There is no question, and by that we mean none at all, that securities lending traders still have substantial power to select counterparties for individual trades. Every CCP system allows for a selection of counterparty and a rejection of any counterparty that the borrower and lender specifically preference. Hard to borrow stocks can still go to a bilateral counterparty of choice. The rates might be more transparent and could be balanced against duration of the trade, and these factors will be measured. Still, the choice of counterparty can be flexible. There is also the scenario of structured trades that include a cash purchase of repo or other borrower collateral; these deals rely on trust and friendship.
In sum, relationships still matter. While professionals using technology may have the upper hand for volume business, and new tools are adapting to their favor, counterparties are especially important when negotiating any type of complex trade. The common family names on Wall Street and elsewhere may be less frequent, but the theme of a small group working together holds true. Mostly anyone can now play in the big securities lending sandbox but a small corner is still reserved seating only.