While trading and post-trade processes in securities lending are more efficient than ever, one area remains stubbornly routed in the past: the credit approval and management process for signing on new beneficial owners. This is a solvable problem but requires some focus; with SFTR and other changes on the horizon, now is the right time to streamline the credit and go-live process for clients. Could we even be ready to move away from the Agency Lending Disclosure (ALD)?
Trading and post trade processes have become more transparent, more automated and more efficient than ever. Investors have unprecedented access to information about the market from agents and independent market data vendors. Agents, industry utilities and vendors have had to work hard to comply with new regulations, and to address investor concerns about the risks of participating in securities lending. As an industry and as individual firms, we faced up to the challenges.
As the global financial crisis gives way to regulatory change, investors now understand that securities lending remains not just viable but a well risk-managed, revenue producing activity. We achieved this outcome by expanding investor education and reporting, and we did yeoman work to show that securities lending – despite what investors were reading in the press – was a good business decision. Today, investors have a very positive view on lending, with 94% participation from large asset managers in the latest Finadium survey, and no firm with plans to end their programs.
On the technology side, vendors have responded to industry constraints on technology and reporting; risk management; and improving the overall efficiency of the process to ensure that the maximum benefit could be extracted from less gross revenues. Vendors have been very smart about balance sheet management optimisation as well. Overall, the level of technical and business sophistication in important parts of the business has increased.
In spite of these great strides forward, the credit approval and onboarding process for borrowers, when agent lenders sign a new client, is not working well. This seemingly innocuous piece of the business is actually impairing our ability to satisfy new clients.
ALD and the credit approval bottleneck
In our program, we often find that it takes between 30 and 90 days for new lenders to be approved by borrowers. Once on board, lenders are eager to start earning revenues in the program, yet find themselves swamped with cumbersome credit processes. This puts the brake on what was, up until now, a rosy relationship full of promise. It basically throws cold water on enthusiasm for the business as a whole until the issue is resolved.
Investors in the capital markets industry are reasonable people, so the credit process comes as no surprise. They understand the importance of credit review and appreciate that all parties take the matter very seriously; no one wants a rubber-stamp process that devalues due diligence and risk control. On the other hand, it is with some embarrassment that we need to explain to clients that credit approval is still labor intensive and largely manual. Given the level of automation in nearly every other aspect of the business, it is concerning to investors that this remains a relatively primitive process.
The framework for credit approvals in securities lending is bounded by Agency Lending Disclosure (ALD) rules. This provides the industry-wide infrastructure for the exchange of credit approval information. ALD was put in place in 2006 as an industry response to US regulatory requirements that demanded new levels of disclosure and detailed reporting around securities lending conducted under an agency agreement.
But in terms of automation, ALD does little other than to facilitate the starting point, which is the request for approval, and the end point, which is the communication of the approval or denial of credit. All the work in between remains governed by a variety of internal systems with varying degrees of sophistication. Paper documents and research performed by credit departments for credit ratings, Know Your Customer (KYC) and Anti-Money Laundering (AML) continue to dominate the landscape. Credit committees still need to meet to review data and make the final approval determination.
ALD was a product of its time. In 2006, securities lending volumes and revenues were at an all-time high. Borrowers had the resources to support large staffs across the enterprise to deal with manual processes like credit. Further, ALD was put together under regulatory duress and under a strict timetable. By design, the technology was not cutting edge; the important part was to get something into place that all firms could use, and that did not require major advances in technology infrastructure. One product manager who was involved in the design and implementation of ALD told me that there was always an intention to expand on ALD by providing greater automation. But then 2008 happened, and priorities changed.
The Opportunity of SFTR
While the Securities Financing Transaction Regulation (SFTR) has created substantial heartburn for industry participants, it could offer an opportunity to fill in the middle parts that ALD has ignored. In other words, we could take the manual credit approval processes and incorporate them in the SFTR process, thereby speeding up lender onboarding at borrowers to just a few days.
Level One requirements for SFTR ensure codification of record keeping. This means that all borrowers need to have the same information on file for disclosure purposes. This is the easy part, but it also means that every market participant is going to need to standardise the same information, hence suggesting that the transmission and storage of information too will be standardised. We’re now starting to get into the middle of the ALD process.
The technical standards for Level Two may be of less use on the surface, as they require tying the collateral to the trade. However, the process of compliance requires a substantial new data collection effort. Why not marry that effort with the credit approval process in one data effort, thereby incorporating credit approval into the SFTR process? This is not completed yet but it is a viable way to solve the lengthy credit approval process while satisfying a large new regulatory requirement.
An industry credit utility
As an industry, it is now time to reprioritize automation and efficiency in the credit approval process. Investors on both the lending and borrowing side are right to expect improvements in response time. All parties will benefit. Lenders can provide more liquidity to markets more quickly, and borrowers can have access to that liquidity as their needs increase. We see and hear many promising developments in the realm of technology that could be highly useful in this regard.
This seems like an opportunity for a vendor solution. Technology exists today that could make credit approval automation a reality. Blockchains and distributed ledgers are being applied to similar problems, such as securities issuance and the exchange of commercial trade documentation. Artificial intelligence (AI) systems are being applied to the problem of reading and understanding paper documents, website data and other sources of information that previously could only be interpreted by human beings.
From the perspective of the securities lending desk, and other parts of capital markets that are dependent on counterparty credit, an ideal state might be a centralised utility that achieves what ALD failed to achieve: a central credit repository that allows all relevant and necessary information to be aggregated proactively, readily available and easily accessible to credit departments. This is conceptually similar to vendor solutions for reconciliation, contract comparison, tri-party RQV, automated mark to market and other aspects of the actual trade. These are complex problems, as complex as credit approval, and they have been automated to a very high degree.
The importance of credit due diligence, and intelligent choices about to whom credit should be extended, should not be minimised. Investors know that all participants in capital markets are serious about credit exposure. They also expect that as an industry we are serious enough about it to make it as efficient, objective and sophisticated as trading itself. It’s time to solve an outdated process and in doing so, make our clients happier and the securities lending industry more efficient.
John Arnesen became the global head of agency lending at BNPP Securities Services in January 2011. He is responsible for implementing the strategy which includes management of trading teams, client relationship management, new business and product development. The business operates from locations in London, New York and Sydney with support activity from Paris and Chennai. Prior to joining BNP Paribas Securities Services he was a senior consultant at Data Explorers where he provided consultancy services to both buy and sell-side institutions with regard to securities finance. Prior to that he was Managing Director at The Bank of New York Mellon where he was head of securities lending for Europe, Middle East and Africa. He also held a position as head of Strategic Securities Lending at Clearstream. He holds the CFA UK level III in Investment Management and an Approved Person by the Financial Conduct Authority.