Finadium’s Investors in Securities Lending (FISL) conferences are bringing together a wide spectrum of participants in the securities finance market, and you can follow the major issues discussed at the inaugural NYC launch here on SecFinMonitor and on Twitter @Finadium with the hashtag #FISL_NYC.
Keynote speaker: Able Markets’ Irene Aldridge
Is big data overhyped? The short and long answer is no. Irene Aldridge shared strategies on using big data in finance.
— Irene Aldridge (@irenealdridge) April 3, 2017
Aldridge: Real-time risk factors such as institutional flow and aggressive HFT are brand new #FISL_NYC
— Anna Reitman (@annareitman) April 3, 2017
AudienceQ: big data availability+more hft firms chasing same strategies=efficiency for liquid securities? Aldridge: I think so #fisl_NYC
— Anna Reitman (@annareitman) April 3, 2017
Read more of Aldridge’s work here.
Changes in cash and non-cash collateral
Beneficial owners are still focused on intrinsic value lending, with one estimate showing that over 70% are looking at the value derived from lending securities versus the collateral space.
Trends in the last six months have been heavily driven by money fund reform, which had a massive impact on cash and securities lending markets as some trillion dollars moved from prime to government-only vehicles.
Future trends might be showing a shift back however. To the degree that there’s opportunity for participation on the lower end of the spread spectrum, there’s expectations clients could come back into GC lending.
Other expectations for the future mentioned were: continued financial product innovation; ETFs as tools to transform and transport risk potentially; further exploration of structural solutions to alleviate some of the pressure points for borrowers, for example, pledge structures, particularly in Europe; central clearing again to reduce risk weights between bilateral trading; and potential broadening of collateral acceptability in the US.
It was a cynical crowd, with one audience question asking: who really benefits? Beneficial owners (an insurance company for example) or agent banks? One panelist noted that for an insurance company with a global portfolio in equities there are certain markets in which maximizing utilization necessarily means using non-cash. This could be as simple as using treasuries, and though agent banks are indeed making more money so too is the beneficial owner. Another added that though the goals of the firm’s securities lending program should be the top consideration, taking advantage of securities lending to its fullest may involve taking non-cash as collateral.
There is a massive laundry list of regulations impacting securities finance. At the top of the list are contractual stay rules, described as “hitting the pause button” following a bank insolvency so that regulators can effect more orderly liquidation. In the US, the finger on the button is the Orderly Liquidation Authority, while in Europe it’s the Bank Recovery Resolution Directive.
What investors need to be aware of, said one panelist, is that they may be subject to new regimes that they were not subject to previously. Not a scare tactic, but a reality. In many cases this means one more day for a liquidation process. Another panelist explained that the motive, ultimately, is to make sure that there is an orderly queue with equal opportunities for everybody. Key quote: “I think it’s healthier for the market overall”.
Next on the list were transparency initiatives. The SEC report modernization act is a comprehensive overhaul of the reporting process in the US, of which securities lending is only one part. You can read SecFinMonitor’s analysis when it was announced here.
In Europe meanwhile, the mandatory reporting requirement, SFTR, has four parts: disclosure around collateral rehypothecation, periodic disclosure to UCITS and AIF, more qualitative prospectus-based disclosure, and mandatory reporting to central repositories of all transactions every day. Much of the data required under SFTR is housed and warehoused by the agent lender, and one panelist believes the direction of travel will be towards a dedicated reporting service, not unlike EMIR reporting, in which an agent lender will provide services on behalf of their clients and build the necessary protocols. Entering this space are fintech firms, which are building products to make sure data is standardized and compliant.
It was noted that the US and Europe are travelling very different roads: Europe wants transaction by transaction on an every day basis, whereas the US is looking at it on an exposure by exposure basis. Ultimately that means two different sets of technology bills for agent lenders. One speaker remarked that the data is out there, but there’s a question mark whether it’s getting steered in the right direction.
Another major issue is the use of equities as collateral in the US. Collaboration among industry associations SIFMA and RMA has made significant headway to getting approval from the SEC. SIFMA and RMA have been working with the SEC’s Trading and Markets division in drafting two pieces: a collateral order allowing equities for collateral as loans for equities, and a technical piece (most important for borrowers) ensuring that there’s a debit in the reserve formula for that collateral. The collateral order and interpretative order have been drafted, agreed to by both of the industry associations, as well as the SEC internally, and it’s being considered for approval. With many changes in personnel at the SEC, the timing is “really up in the air”, however.
Current dynamics in the securities lending industry
Conversations with beneficial owner clients are changing dramatically. Many of those discussions revolve around how clients can participate in generating or using securities finance as an alternative source of revenue and liquidity. These conversations are underpinned by a “secular shift” in the asset management industry as passive investing continues to grow and puts pressure on those sitting out of the business.
Existing clients meanwhile are getting more engaged on what they can do to generate revenues that have dwindled from traditional trades. Investment managers who have traditionally opted out of the business are being asked to revisit those decisions. Panelists also shared some of their favourite structured trades that generate some 20bps potentially, with the caveat that such trades need to match risk appetite.
Indemnification could go from a commodity to a truly valued asset, with agents starting to get paid “properly” for providing it. The “one size fits all” pricing structure, said one panelist, has no future because the cost and dynamics of the business are changing so rapidly.
What is changing for clients and lenders, who are under significant return pressures and cost constraints, is paying attention to the cold hard numbers, even for trades of smaller levels of return. As one client of a panelist recently said of smaller returns adding up: “$20 million pays a lot of bills”.
— Michael Ross (@mikeross321) April 3, 2017