The stories and anecdotes are all around us: while regulatory change is painful, some good will come out of it. This article takes a look at some of our data points and conclusions thus far.
“Looking at it holistically, whenever there’s this amount of change, it also brings greater opportunity for those focused on it. Our eyes are fixed on what lies ahead, not back on what we can’t change.” – James Slater, in the FTSE Global Markets Jan 2014 US Securities Lending Roundtable.
We think that James has it right. The more we investigate expected changes in the securities finance markets, the more we tend to think that the opportunities are outweighing the downsides.
Let’s take counterparty default indemnification as one example. It looks great on paper but the first defense against a counterparty default is the collateral; indemnification really adds minimal value. We are happy to see an explicit charge for the service to make clear the utility that beneficial owners will receive. If the cost whether in fee split or an invoice is higher than the insurance is worth, beneficial owners will pass on indemnification. If the cost is worth it, they will continue. Either way, from an economic point of view, the cost will be made explicit and no longer provided in a vague bundled package. Boards should know what they are buying; clarity on the matter is an upside.
We are interested in the growing demand for contingent liquidity services. eSecLending’s deal with the OCC to provide auctions in the event of a default is one example; another is the slowly growing interest of large institutional investors to be their own banks. (We’d like to see some guarantees for liquidity provision in case of a default too, but we can’t have everything at once.) At our IMN panel in Austin, TX, we said that creating contingent liquidity may create risks but the financial benefits can be apparent. This is a step that some institutions perhaps should have taken years ago. Increased costs due to regulation will now push investors in the right direction.
We note a range of startups created by the push towards central clearing across multiple products. This market a burgeoning mini-industry of its own, including CloudMargin, SL-X and just recently a press release from Quartet on its collateral management offering. We are preparing a research report to document some of what we are seeing.
Lastly, we are interested to see securities lending and repo out of the Shadow Banking rubric. Its a terrible label and does no service to anyone except reporters who hate financial services firms. A trade repository will be a painless way to make securities loans and secured funding transactions less scary. (Painless to all except for the people who have to explain their data to regulators – to them we really apologize. Call us – we’ll buy you a beer.)
We still have some real concerns about selected issues. For example, we think that a repo resolution authority could be a real mess. In a crisis, it doesn’t matter who holds the collateral; the liquidity still won’t be there for corporate bonds or other products with iffy liquidity to begin with. As a panelist at the Federal Reserve’s October fire-sale conference noted, there’s only so much liquidity to go around.
But in general, we are optimistic that while the new world order still requires transition, the light at the end of the tunnel remains bright.