We spoke with IHS Markit’s managing director and global head of securities finance Paul Wilson about what calculating a “risk overlay” on securities lending performance might look like. Wilson is spearheading an ISLA industry working group tasked with establishing global standards around securities lending performance measurement. Better benchmarking will be a key topic of discussion at the Finadium Investors in Securities Lending Conference in Paris on 24 September 2019.
The term “risk overlay” comes from ISLA’s chief Andrew Dyson during an interview with Securities Finance Monitor. While a definition for what that means in practice is still in the works using a principles-based approach, Wilson said that quantifiable risk is an integral part of implementing any emerging framework.
Beneficial owners in securities lending, he noted, are focused primarily on program oversight, governance and controls, with performance measurement being somewhat lower on the list of priorities. Moreover, indemnification provides a great deal of comfort and protection. In our just-released 2019 survey of asset managers in securities lending, we showed that the commitment of asset managers to counterparty default indemnification has never been stronger.
But what there should be more focus on, said Wilson, is using statistical and VaR models to calculate, on a frequent basis, the true value at risk. In other words, how can beneficial owners know the amount of quantifiable risk in a lending program generating some basis points of return?
“On the one hand you are looking to generate a reasonable amount of return, number two, you are looking to have in place the right level of program, governance, oversight, and control and then number three, there should be a quantifiable risk,” said Wilson.
As IHS Markit rolls out new product aimed at beneficial owners, the data provider is working to supply exactly that kind of tangible data to measure securities lending programs in specific and quantifiable terms, along with qualitative assessments. One would expect that the ratio of risk to return to come out in favor of securities lending programs and quantifiable results can go a long way in explaining to boards or committees why they should be maintained, or even expanded in some way.
Wilson noted that IHS Markit is separating VaR from capital calculations, and based on work with clients so far using a proprietary algorithm, the risk number is sometimes lower than 10% of the return number: “You have high quality collateral with margin, with high quality counterparties, and therefore, you would tend to expect that based upon that, the amount of actual risk would be relatively small,” he said.
Loan and collateral portfolios are also stress-tested using eight to ten different scenarios – like the Lehman crisis or Russian financial crisis – to show clients what anticipated results look like in another market meltdown: “Our belief is that we are putting quantifiable data in the hands of our clients that allow them to make better and informed decisions around their lending programs,” Wilson said.
Wilson describes ISLA’s working group on securities lending performance measurement as global and collaborative, and outcomes are expected to move forward at a pace that contends with other highly anticipated mandates: in particular the Securities Financing Transactions Regulation (SFTR) coming into effect April 2020. Considering such priorities, a best practices working draft is expected by the end of this year, followed by some months of consultations and revisions with a view towards implementation and adoption by the end of 2020.
“Whilst the securities finance industry has significantly evolved and changed since pre-financial crisis, the concept of performance measurement really hasn’t kept up with the level of change that has come in the lending industry,” said Wilson. “There should be an industry-wide global standard, and whether you are a data provider, agent or beneficial owner, everybody is working to a same set of rules.”
“And whilst different agents would have different performance, and different data providers will have different datasets, the fundamentals that go into the process would mean that there would be a greater deal of trust in the outputs,” he added.
Please join us for the Finadium Investors in Securities Lending Conference in Paris on 24 September 2019. This programme, free for asset managers and asset owners, will deliver best in class education and peer discussions for optimising securities lending programs. IHS Markit will be at the FISL Europe conference presenting “Best practices for benchmarking securities lending performance”.