Eurex Clearing conducted an interview with Josh Galper of Finadium to discuss the recent Finadium research report, “A Cost/Benefit Analysis Roadmap for Securities Lending CCPs.” Given the recent market interest in this topic and the white paper released last week by Promontory Financial Group via SL-x (reviewed by us here), we thought this short conversation would offer useful information for Securities Finance Monitor readers.
Eurex: You recently published the report “A Cost/Benefit Analysis Roadmap for Securities Lending CCPs”. Why did you initiate that report now?
Josh Galper: The securities lending landscape is becoming more complex, driven by financial regulations and also the changing attitudes of beneficial owners and hedge funds. For intermediaries, the lending business must respond to bank-wide initiatives and capital requirements that are often far greater than the scope of lending itself. As a result, agent lenders and borrowers need to be creative, flexible and smart about how they respond to broad changes that impact their business.
Alongside options to change counterparty exposures, internalize lending opportunities or modify client terms, agent lenders and borrowers need to assess the opportunities and challenges posed by securities lending CCPs. While not every market participant may agree, regulators look to CCPs for risk mitigation. As a result, the cost of capital of using CCPs in general is expected to be less than the same transaction on a bilateral basis.
For securities lending participants, now is an ideal time to map out a strategy for how each firm wants to interact with CCPs as and when necessary. While the decision to use a CCP or not can have a broad range of inputs, our report has focused on one of the most critical strategic aspects – the cost of capital. We initially tried to find firms that could already tell us how much benefit a securities lending CCP would have on their capital cost. We were unable to gather that information as the firms that spoke with us themselves did not have a concise viewpoint. As a result, we turned to assessing how the information could be produced and what were the biggest constraints and concerns for agent lenders and borrowers. We hope that this report will assist market participants in building their strategies for bilateral and CCP borrowing going forward.
Eurex: What are the key findings of your report and in specific are the roles of CCPs viewed beneficial?
Josh Galper: We found that market participants are most concerned about netting of counterparty exposures. How this is calculated, what are the inputs and how to do it technically is a principal challenge, and this also determines how firms can conclude if securities lending CCPs offer them benefits or not. We also found that for agent lenders, CCPs offer an additional business model challenge in determining whether the CCP is equivalent to agent lender indemnification, or whether this is something else entirely. The question is critical to client satisfaction and in agent lender pricing models. Lastly, we found that the CCP market structure and presumed capital benefits may produce new requirements for benchmarking and market data that vendors must build; this will not be a quick process.
So far, the greatest argument for the cost of capital benefit of CCPs comes from the CCPs themselves. There is no one right answer for how securities lending CCPs add value; each market participant will need to conduct a cost of capital analysis themselves to determine the value.
Eurex: What future trends have you been observing which will impact the industry?
Josh Galper: Securities lending trends are primarily a subset of broader Basel III and domestic capital and leverage requirements. Aside from occasional reports such as the Financial Stability Board’s Shadow Banking review, securities lending market participants must evaluate each new capital regulation in the context of their legal structure, their assignment as a SIFI or G-SIB, their clients and their parent company’s requirements. For certain, the securities lending market can expect to see further changes in the years ahead as greater capital requirements are enforced. CCPs can help mitigate some of these challenges, so long as market participants are able themselves to ascertain clearly defined cost of capital benefits.
More on this topic is available from Eurex Clearing on their website.