The only certainty about securities finance is that the market is going through a major transformation. And though regulations may have been the driver for adopting technology to tackle the resulting challenges and opportunities, it seems the industry’s ready to take over and lead into the future.
In somewhat of a “perverse” way, regulation on all of the industry has driven innovation, said one speaker: “We’ve been forced as an industry to come up with new ideas for clients to make revenue to accommodate both the borrower capital concerns as well as the bank indemnification capital concerns. Clients are going to seek out the cost structure, the indemnification structure, that’s best for them.”
Market forces, meanwhile, are pushing cash and collateral providers into different time zones in a traditionally conservative risk environment.
“One side is being forced to shorten up when they get to the money market space, and dealers and others are being pushed by regulation (like from LCR to NSFR) to the longer,” said Peter Diminich, Managing Director and Global Co-Head of GSF Fixed Income, ING Financial Markets, adding that the cash versus non-cash mindset requires some flexibility.
“Maybe that conservative investment strategy is OK, however, you have to start thinking about increasing your duration a little bit and allowing yourselves to go down, because that’s how the market is trending (and) that’s really what the forces at play are looking for,” he said.
Identifying and predicting revenue and demand trends is tricky business and requires granular level data. Such data presented at Finadium’s Investors in Securities Lending NY conference show that 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 spiked 50% this year, corporate bond revenue remained flat, while equities went down over 20%. For the last five years, Q2 revenues have been trending down significantly, and looking at regional breakdowns, there’s expectations that Asia will be down in revenue about 15%, US about 23% and Europe about 38%.
Some speakers were optimistic about future prospects, and that the current US administration’s disruption, and the markets’ perception of that disruption, could create a better environment for securities lending: “This is not a political commentary, but I do think we are going to see some better activity going forward. Regulatory softening is going to be good for borrowers…I am not predicting this is going to be a great year or two years, but I do think it’s going to be coming off of a trough. There’s opportunity for us to do a little bit better and gross revenue can improve a little bit based on that.”
Others were less-than optimistic: “I don’t anticipate industry-wide revenue growing drastically in the near term, in fact it could shrink slightly over the next two years” said Paul Wilson, Global Head of Agent Lending Product & Portfolio Advisory at J.P. Morgan. “This increases the likelihood that lenders and borrowers will spend time and resources exploring alternatives like new technologies, which could potentially change the dynamics of the industry.”
Blockchain has interesting characteristics that have the potential to change the dynamics of the business, and banks are certainly keeping a close eye on developments in distributed ledger technologies. 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.
J.P. Morgan’s Wilson also noted that data and analytics in “near-time” are becoming “absolutely critical” for clients.
The use of data needs to be considered through the mindset of “what’s meaningful to me”, which can vary widely depending on what kind of fund and strategy are in play, said Matt Johnson, Head of Enhanced Custody Trading, North America at State Street.
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,” said Johnson, adding that risk merger arb funds are similar albeit with more of a focus on modelling.
By contrast, quant funds want all the data. They generally don’t care as much about a single name, they want all the names, he added: “Quant funds are interested in collecting data points and feeding them into models,” he said.
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? Johnson said: “You are trying to get yourself 95-98% of the way there to then make an informed investment decision”.
This puts securities lending is in the big data technology universe, with millions of transactions and trillions of dollars on loan and in lendable on a daily basis. Cynics need to start waking up as decades-old techniques backed by solid research make inroads into finance, said one speaker: “Big data is extremely powerful and it applies to lending specifically, also to collateral management. There’s been some questions about insurance: it will help you manage your portfolios more efficiently, faster, better (and) manage your risk in real-time. It’s all covered by big data, believe it or not.”
Securities finance is getting the same shake-up as virtually all other asset classes and markets in the 21st Century, and it has massive implications for operations.
“There’s going to be more electronic trading,” said Bill Mascaro, Head of International Equity Trading at Citi. “It’s been a big benefit for our program, it’s enabled our traders to focus on more corporate actions trading, strategic structured trades, whether it be HQLA, or other types of transactions so that we are able to think a little bit more on the desk by handling more of the automated flow behind the scenes,” he said.
CCPs, he added, are inevitable: “There are going to be clients that have different relative values from a borrowing perspective. Normalizing that trading through a central clearing house or counterparty is a logical way to proceed…looking forward five years many more transactions will take place on a CCP.”
The resulting competition around platforms and infrastructures is fierce, and it’s difficult to predict who the winners will be. Speakers dropped names like NGT, EquiLend’s multi-asset class trading platform for securities finance, and for CCPs: OCC in the US, Eurex in Europe, and GSCC in Asia. But the fight is far from over.
In terms of Peer to Peer lending, the battle between alternative distribution channels and prime brokers is just heating up. Jeff Kidwell, Director and Head of Direct Repo at AVM said that “the pathway to liquidity is broken” as traditional channels adapt to the new regulatory and market environment. Going direct also has the added benefit of yield, diversification of counterparties, and being able to choose desirable tenors. He also noted that electronic trading in this space is just around the corner.
Keith Haberlin, Head of Global Securities Lending at Brown Brothers Harriman said that more specialization is in the cards: a trend observed in the prime broker to hedge fund business as primes decide which segments or strategies they are best placed to support, sometimes due to regulations that have shifted priorities. Such a mentality may extend to the agent lender community as increased costs and regulations make it hard to be all things to all people, Haberlin noted.
He added that no one model will come in and disrupt the entire industry, though developments such as Peer to Peer lending and CCPs will have their place in the market and become more relevant to beneficial owners.