Beneficial owner direct access: a critical input for securities lending CCPs

As securities lending CCPs gain momentum, a critical feature, perhaps the most important feature at this point, is their ability to accept beneficial owners as direct participants without having to post margin or contribute to the default fund. To paraphrase Bill Clinton’s 1992 campaign slogan, “its the beneficial owners, stupid.”

The two historical arguments against securities lending CCPs by beneficial owners (BOs) have centered on costs and counterparty risk management. We agree that costs have been hard to manage; from a beneficial owner’s standpoint, the need to post initial margin on top of paying a CCP and clearing firm to execute the transaction has been a lot, ridiculous even. (We also object to the need for a clearing firm to know all positions made by a BO or their agent lender.) Really, why would be a beneficial owner lock up a certain percentage of their received cash or non-cash collateral? While the CCP might have sounded good in theory and there may even be some liquidity to capture, no way were BOs going to move in that direction with these new expenses.

Enter the Beneficial Owner Exception, or in Eurex Clearing’s case, the Specific Lender License. Eurex Clearing has worked around the need for a BO to post margin in two ways. First, The idea here is that the lender of a security is not the risk entity to worry about; the worry is really that borrowers might default. Eurex Clearing has formalized the idea that BOs under the Specific Lender License “do not create a risk position towards Eurex Clearing using the collateral pledge model and therefore are not required to post margin nor contribute to the Clearing Fund of Eurex Clearing.” That’s a huge cost savings to beneficial owners. Second, Eurex Clearing allows Agent Lenders to manage all aspects of the CCP relationship on behalf of their approved BO Specific Lender License clearing members. Agents can also become clearing members themselves. Keeping Agents in the middle of the transaction is a huge step forward to generate liquidity, otherwise most BOs could simply ignore the CCP altogether.

The counterparty risk management argument is harder to avoid. It is true that using a CCP means exposure to all clearing members, whether 10 or 120, and this is very different than selecting one counterparty for a loan. At the same time, we scratch our heads at the preference of BOs to make loans to counterparties with lower credit ratings than the CCP itself. But personal attitudes aside, new capital rules are pushing borrowers to CCPs anyhow, so the preference of selecting one single counterparty for loan exposure is becoming a moot point.

Beneficial Owners have heard for years about the dangers of CCPs, with some Agents even declaring themselves against CCPs on the ground that transparency was bad for their clients. Now however there is little possibility to avoid them; some borrowers in Europe are already saying that the CCP is the only way they can borrow most of their securities going forward. Further, while securities lending may get picked on as a low revenue game, still a whopping 91% of asset managers in Finadium’s most recent survey said that lending returns were important or somewhat important to their firms. The loss of these revenues would be felt internally. If CCPs are where borrowers want to go, it is in the BO’s best interest to get on board. The Specific Lender License dramatically lowers costs and barriers to entry, meaning that its time to take this model seriously.

This article was commissioned by Eurex Clearing.

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