How can the market know if Central Counterparties (CCPs) in securities lending are a good deal for themselves and their clients relative to bilateral transactions? Answering this question from the cost of capital perspective is the challenge of Finadiumʼs current report.
Global trends and regulatory directives mean that sooner or later in each legal jurisdiction, cost of capital challenges will force an evaluation of CCPs in securities lending as a cost management measure. Borrowers, agents and beneficial owners each have distinct concerns however, and these concerns must be addressed both by CCPs and each individual firm in order to move forward. Nowhere is this more evident than in concerns over exposure netting. While primarily affecting borrowers, a need to optimize exposure netting can push lending activity towards larger counterparties, including CCPs.
In the post-Lehman, Basel III era of financial markets, the arguments in favor of CCPs are fairly obvious: better management of regulatory costs; clear risk management and liquidation/default rules; and the elimination of credit lines between market participants. The more pressure put on financial services firms by regulators, the more attractive that CCPs become. This is not to say that CCPs are panaceas or that they themselves could not become the next too-big-to-fail institutions, but they do offer some genuine solutions given todayʼs regulatory parameters.
This report presents the factors that securities lending market participants must consider to create a cost/benefit analysis of moving transactions through a CCP from a risk weighted assets/cost of capital perspective. There are many other issues as well, including suitability, reserve fund allocations, operations and whether one or both sides must post margin. While important, these issues are outside the scope of the current project. Our immediate goal is to help the industry move forward with resolving the cost of capital issue first.
This report should be read by all participants in the securities lending industry including borrowers, agents, beneficial owners and service providers.