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: Robert Swan, OBE
Robert is a Polar explorer, environmental leader & inspirational speaker. He is the first person in history to walk to both Poles. He explained to beneficial owners why no insurance company will take him: his team made the longest unassisted march anywhere on earth in history, and everybody said they were going to die. The experience ultimately led him on a 50-year mission dated to 2041 to do better in the environment and preserve the planet.
Key quote: “We know the inconvenient truth, the convenient solutions should be on the table and it should make good business sense to you”.
— Anna Reitman (@annareitman) April 4, 2017
Prime brokers and hedge fund service providers on borrowing demand and future trends
Hedge funds want to see more from their dealers. If possible, they’d like to see ROA metrics from the onset of the trade. One of the biggest challenges in a treasury and portfolio finance role is managing the broker wallet, with some of the larger funds navigating dozens of PBs and ISDA counterparties, hundreds of executing brokers while trading nearly every asset class.
Ultimately, automated and systematic pre-trade ROA metrics will help make an intelligent decision about where business should be allocated. It’s a big ask requiring IT resource and a lot of data, but the more PBs can provide such information the better partner and client they will get back.
Technology investment is heavy, and expected. Some “trust banks” are keeping a close eye on developments in blockchain. So far, consortiums haven’t yielded too many results as many actors try to agree on technical terms. That’s why internalization will probably be the first iteration of blockchain implementation, said one panelist, adding that it may be early days but it will transform the industry. Key quote: “If you think about a securities lending transaction, it goes from the custody bank to the agent lender to the principal to the end user. If you can eliminate that whole process or make it extremely more efficient, I think that’s a natural starting place for a lot of organizations.”
Other technology dollars are invested in making sure that there is an understanding of the exact impact of a client on a PB’s balance sheet. Key quote: “It’s very powerful to have some of the information at your disposal to be able to explain…how you look on our balance sheet. And the pricing has changed significantly over time. So we can choose to do something like subsidize if we think that the relationship is worth it, and there are some really significant streams of revenue that we are getting from a multi-product perspective, but when that doesn’t exist you have to have those difficult conversations.”
One specific example is the advance of the Direct or Peer to Peer lending market, which was identified as being a competitor, particularly when “there is capacity on the street”. If PBs are getting cut out of financing, there will just be increases elsewhere, said one panelist, either in clearing fees, corporate access, cap intro, in depth research, etc.
When it comes to the PB-client relationship, there’s no such thing as a free lunch.
Global Investor dropped in, read their view
— Andy Neil (@Andrew__Neil) April 4, 2017
Direct and Peer to Peer lending
The case for alternative distribution channels for repo has never been stronger as banks pull back from traditional activities and create opportunities for providers connecting cash and collateral providers directly. Two models are emerging: Peer to Peer (aka Direct) and All to All. A2A necessarily requires a CCP to mitigate counterparty risk. P2P, explained one panelist, is a bit like the social network LinkedIn: everybody can join but your network expands based on who is allowed in. In the future, electronic trading is expected to be available for participants.
The benefit to the spread is impressive. One set of figures shows that trading at the mid-market rate over the last year would have saved: 10 bps on taking treasuries overnight and a little higher on term; 10-20 bps for agency mortgage backed securities; 20-30 bps on corporate bonds; 40-50 bps on municipal bonds; 15-25 bps on sovereigns and supranationals; and 50-60bps on AAA and AA RMBS and CMBS. In some cases, said one panelist, the savings are higher than the yield.
The big question in the audience was: “how do I sell this to my credit committee?” One way is through higher margins: on mortgaged-backed securities, between 5% and 7%, for corporate and municipal bonds, 10% to 15%. Moreover, due diligence is mandatory no matter how you trade. In some cases, participants signing up for P2P are conducting the exact same paperwork. The panel identified the biggest risk as counterparty default, but it was pointed out that this is a risk across the industry no matter what distribution channel is being tapped.
The fact is that there’s municipalities having difficulty finding collateral because nobody wants to do overnight repo, and plenty of money funds that can’t find government collateral. Key quote: “the pathway to liquidity is broken”. One panelist remarked: “Why not take on your own destiny and pick the counterparties you want to face rather than having a broker dealer pick a 100 different counterparties (like failed hedge fund LTCM) and whomever on the other side, and you don’t know until it ends up in the Wall Street Journal. And you also get added yield, diversification of counterparties and the tenor that you want.”
Securities lending data for investment management
Securities lending data is big data, with millions of transactions and trillions of dollars on loan and in lendable on a daily basis. But what’s meaningful? How can it be used and be a differentiator in investment decisions? That depends on what kind of fund and strategy are in play.
Long-short directional funds are keyed in on specific names and want to know what’s happening from a short interest perspective before entering a position. They tend to do a lot of pre-work, and want to know about scale. That’s similar to risk merger arb funds, which are also interested in scale, though more typically conversations are focused on modelling. By contrast, quant funds want all the data, they don’t care about a specific name, they want all the names. Quant funds are interested in collecting data points and feeding them into models.
There are caveats to the use of data as a predictive indicator, particularly when it comes to having a complete picture. Not all counterparties feed data to third party vendors, so it’s important to collect different data points, for example, what is the average short interest across several sources? Key quote: “You are trying to get yourself 95-98% of the way there to then make an informed investment decision”.
Beneficial owners are interested in a particular metric: securities lending return on lendable. One panelist emphasized that it’s not just about getting the highest fee, and should be combined with on-loan balances and utilization. In closing remarks, one panelist noted that data is becoming more important and the trend is going to be towards a lot more data driving decisions, not just in securities finance but across portfolio management, trading, operations, and risk.
Great panel on sec lending data for long and short investors #FISL_NYC. More audience ?'s than the panel had time to answer. Thanks panel!
— Richard Stinchfield (@rickstinchfield) April 4, 2017
The US, Europe and Asia: changing regional bank regulations and the impacts for securities finance
Basel III: win some, lose some. On the winning side, banks are safer post-financial crisis. It might have been scary at the beginning but banks have adjusted, they are well capitalized and Basel III has really succeeded in its mission. A number of stats back that up, for example, from a sample of 94 banks, 84% can meet the NSFR requirements. Now, the focus is turning to profitability: how can banks actually grow their businesses? On the other hand, Basel III has failed to create a “level playing field”. There is substantial disagreement amongst regulators about what that even means, and further regionalization of regulation, in other words, a further breakdown of the level playing field idea, would have a massive impact on bank balance sheets and competition in 2017 and going forward. Anti-regulation US Republicans have an option, the Financial CHOICE act, but even if repealing Dodd-Frank isn’t in the cards, regulators had already been discussing actions that would free up securities finance.
Anti-regulatory US republicans could drive a new capital standard for other national regulators on "watch and wait" mode #fisl_NYC
— Anna Reitman (@annareitman) April 4, 2017
The State of Securities Lending: a data-driven perspective
— Anna Reitman (@annareitman) April 4, 2017
Interesting revenue and demand trends emerge when looking at granular-level data. Based on presented data gathered over a decade: inventory is up, utilization is down, demand is relatively flat, and revenue, which had been trending up, is pointing down this year. Breaking out trends by asset class: government bond revenue has spiked 50% this year, corporate bond revenue is flat, while equities is down over 20%. Q2 revenues have been trending down for five years fairly significantly, and looking at regional breakdowns (extrapolating from Q1): Asia will be down in revenue about 15%, US about 23% and Europe about 38%. Also, short interest is increasing and hedge funds are shorting more of the stock, while hedge funds long the stock are probably selling.