Ahead of Finadium’s Investors in Securities Lending conference (FISL), we speak with our panelist experts from eSecLending and State Street on what everyone should know about the markets backdrop and regulatory realities facing banks and beneficial owners.
The market has seen a robust start to 2023 and good returns year-over-year, said Craig Starble, chief executive officer at eSecLending, who will be speaking on the “Optimizing Demand – agent lenders on supporting client needs” panel“. The team is seeing value on high yield corporates as well as both corporate and sovereign emerging bonds, while the US equities market is generating significant revenue from specials — results that are in line data from S&P Global Market Intelligence.
Starble added that in the current market environment cash reinvest clients are getting a steeper curve and credit spread widening opportunity, and are therefore able to get more value from lending both specials and general collateral.
Capturing the value of those trades is underpinned by automation trends, and eSecLending uses EquiLend’s NGT platform for all general collateral transactions. Moreover, the firm conducts auctions for securities portfolios to support traditional market access with large discretionary on-demand trading.
He also noted that one of the major topics for clients is related to bottom line impacts as a result of bank capital requirements and consequent focus on RWA costs, which raise concerns over providing indemnification.
“Regulations are requiring banks to hold more capital for this indemnification as a result of Basel implementation on a look-forward basis,” he said. “It’s up to the agent lenders and the borrowers to resolve the industry’s RWA challenges and we as agent lenders need to come up with solutions in order to do that. And those solutions are varied.”
eSecLending has had insurance for more than two decades to support client indemnification, which charges a fixed fee versus a per transaction capital charge, he explained. What this translates to are real benefits for clients seeking lower margin, higher volume trades – typical for cash reinvest.
Basel III and banks
Industry-wide, there are active discussions about how to best manage indemnification charges, Starble said: “Some clients will choose to forgo indemnification (but) most clients will find it really challenging to give up – not because they don’t believe in the risk-return structure of securities lending, and it is a well margined, well maintained, risk averse product – but the reality is many clients have policies in place that require them to have indemnification.”
At the current costs of indemnification, it’s hard to see how long businesses can continue to support it, particularly for large US banks that are under the standardized approach under Basel III rules, said Glenn Horner, managing director and chief regulatory officer at State Street Global Markets, who will be speaking on the “Transparency and Regulatory Reporting” panel.
However, that could change if the Basel III endgame rules come out as anticipated with changes to Exposure-at-Default calculations: “We will then be looking at a business on an indemnified basis (that is) worthwhile to maintain, invest in and grow.”
In the US, a Basel III proposal is expected at the end of Q2 as the regulatory agencies iron out disagreements over remaining points, he explained. But there are already some positive indications for banks, he noted: “For the standardized approach for securities finance, we will see a great benefit in changes to the formula that will be used, taking into account diversification and correlation.”
How that combines with existing US legislation is still up in the air, and banks could land in a situation where there are multiple calculations for RWA with the most conservative being prescribed. Even under that scenario, however, securities financing can be expected to be one of the businesses benefiting most from the approaching changes. The businesses hardest hit will be those that are “heavily operationally influenced”, such as custody and investment management divisions, he added.
10c-1 and BenOwners
Basel implementation is coming at a time when numerous regulations are shaping markets. In securities lending, transparency obligations related to 10c-1 are still getting a lot of attention from banks and beneficial owners alike. The rule is expected to be finalized in Q3, although Horner noted that there could be “slippage” because of a heaving agenda from the Securities and Exchange Commission (SEC).
The two main 10c-1 issues being raised are: the 15-minute window for reporting trades; and the reporting of availability to lend. On the former, there is widespread agreement that t+1 makes sense for the market. On the latter, there are yet definitions and metrics to agree on, as well as fears that some beneficial owners would stop lending altogether.
“If you are lending through an agent lender, the agent lender will presumably do all this reporting on your behalf as they do for SFTR today,” he said. “But anybody that’s doing their own lending, if they are a beneficial owner or mutual fund complex, etc, they would have to do the reporting on their own, setting up those data fields and pipes, and making sure they can do things on the time requirements put out by the SEC.”
Globally, transparency regulatory requirements do not overlay well. In the US, the SEC is more reasonable on the amount of data fields, but there remains the specter of excessive burden on beneficial owners and agent lenders, warned Horner: “Because it’s not coordinated amongst the different jurisdictions we are really being faced with the worst of all worlds potentially, because each jurisdiction is coming up with something that is onerous in a different way,” he said.
Craig and Glenn will be joined on their panel discussions by colleagues from BlackRock, BNY Mellon, Citi, Fidelity, Goldman Sachs, Invesco, J.P. Morgan and S&P Global Market Intelligence for FISL, which takes place in New York City from May 17 to May 18. It is our 7th annual conference bringing together a broad cross-section of the industry to share expert insights and is free for qualified buy-side firms including asset owners, asset managers, insurance firms and hedge funds. Register here.