We’ve come across several ideas in our travels lately that we thought were worth noting on these pages. They speak in particular to the needs of our clients in figuring out next steps in an uncertain regulatory environment and with changing client needs.
1) Keep costs low but don’t cut off your nose to spite your face. We’re seeing firms cut staff close to the bone and occasionally cutting into the bone too. Its one thing to focus on cost-cutting, its another to eliminate vital services or staff because it looks good on paper. Two days or two months later managers find themselves calling back up the same people and asking for help. Its a well-traveled cycle in the financial services industry but its especially dicey these days. Too much cutting and people will gravitate off to other directions. Everyone understands about the short-termist view of returns and stock prices, and cost cutting directly factors into that. Even so, cutting costs this quarter to see them jump the next is a really bad way to run a business.
2) Plan for higher interest rates in the US. The interest rate environment of the last six years has been nothing but terrible for securities finance. The ECB’s QE and negative rates make matters all that much worse. In the US though, there is a reasonable expectation that rates should rise in the reasonable future. This week’s job figures showing labor gaining an edge in wage increases is another step in that direction. Looking at historical figures, its clear what a massive anomaly this low rate environment has been. Any believer in a reversion to the norm should expect higher rates to come. The next interesting question is how spreads will change in financing. Can US securities lenders keep rates about steady for GC and eke out a bit more in the cash reinvest? Can prime brokers keep their own loans at constant rates and get a bit more in between? The higher the US interest rate, the more room to maneuver since any rebate rate will be positive. That will be a relief to all parties.
3) If one channel doesn’t work, try another one. We’re not suggesting regulatory arbitrage, but it makes sense to aggressively pursue the paths of least capital resistance to getting a trade done. The area we are thinking about most is extracting securities lending activity from an agent lender then doing a trade elsewhere. We have to be circumspect about the details here, but it is possible. We’ve been public about our thinking that securities lending may be in for a hard time but securities finance has a big life ahead of it. In another example, a colleague told us about a new trade that takes advantage of beneficial owner assets that are not in a securities lending program from a custody account for a specific benefit. CCPs should be actively considered in this mix because that’s where the balance sheet savings could happen. Beneficial owners are not going to leap headfirst into futures in place of securities loans, and they aren’t going to be huge buyers of private label CMO or ABS repo. Just ain’t gonna happen. So its worth everyone’s time to work within the existing parameters of what’s possible to see what could be possible a little further down the line.
4) Be open to new ideas. We remain very appreciative of new ideas surfacing in the market. Bloomberg ran a story on Thursday April 30 about peer to peer loans being made into derivatives. We’ll cover that in a SecFinMonitor article shortly. While we choked on the collateral analytics that will be required, the fact is that these could be interesting investment ideas. We feel the same way about collateralized commercial paper. These markets require buyers and sellers. There are few shortages of sellers. What sometimes gets missed though is that the buyers can be part of the same parent company. For example, derivatives based on peer to peer lending receivables could be bought by hedge funds needing a place to park their cash. It will take effort, but new ideas could be a great benefit to financing, collateral and asset servicing.
5) Outsourcing remains viable but is not always a final answer. There is much talk in the market about reducing costs through outsourcing. Its a good idea and one that we will evaluate more closely in our June 2015 research report. Outsourcing is no panacea however; the real draw is client-side business or a robust role as an intermediary. Its worth considering outsourcing from multiple angles before pulling a trigger.
These are tough times. Most firms are hunkering down for a spell to see how the market will play out. We’ll have more on this in our first Securities Finance Monitor Magazine, out in June 2015 (make sure your contact details are up to date here for your free copy). In the meanwhile, its good to remember that there are options for proactive decision making out there.