The European securities lending market continues to go through profound change as regulation and competitive pressures push firms to streamline their operations. Whichever way the market turns, we must remember that people are central to what makes our industry work and this may create new opportunities for the future. A guest post from CACEIS.
The traditional European securities lending marketplace was competitive but communal: firms sought to win client business but also recognised that they needed each other and the cooperation that firms could provide to execute business. A similar dynamic was also found in repo, OTC derivatives and other markets in which traders interacted on a direct basis. Industry associations and networks based on trust and shared interest have grown strong on the basis of that experience.
Securities lending may have been seen as opaque, but at the same time it has functioned extremely well. Even through the financial crisis, securities lending delivered its robust human and technological infrastructure in the service of clients and counterparties. The same cannot be said of all markets, including some of those that offer the greatest transparency in the world.
The drivers of fundamental change
The headlines of change in the securities lending industry are not only well known, they can be recited by nearly all market participants in unison: the Securities Financing Transaction Regulation (SFTR), the drastic decrease of yield enhancement trades, MiFID II and best execution, UCITS V and Leverage Ratio constraints. Regulation writ large has forced securities lending to re-examine its basic business practices, pick the best counterparties for risk exposure and netting opportunities, and ask for its allocation of balance sheet at capital conscious firms. These are all new trends in the last eight years.
This influx of change has been seen across the organisation, from front to back office and support teams. As with all parts of financial markets, securities lending market participants are asked to implement technology to complete and enhance human activity. Some of this is straight-forward, for example connecting to better pre- and post-trade processing systems to improve settlement rates and reduce fails. Other aspects are more complex, as banks work to move their artificial intelligence projects out of the innovation department and into business units. When we talk about transformational change in securities lending, we are often talking about transformational change across the bank, with securities lending impacted as much as any other business unit.
The need for new types of regulatory reporting bears special mention, since reporting must be accomplished no matter what, but nearly all firms lack the required information today. SFTR in particular requires firms to know the whereabouts of over 150 data fields; industry participants view the number as high but all the same, the fields are required. These requirements are pushing us to use technology: trades start off in an electronic system, are processed electronically and all the data is captured internally or in partnership with industry utilities and vendors.
A vision for the next iteration of securities lending
As more firms increasingly automate securities lending, other changes begin to gather steam. A move to electronic platforms increases Straight-through Processing, reduces the need for human interaction with a trade, and perhaps most importantly, encourages the use of electronic trading platforms in place of telephone, email or Bloomberg messages. Features of the market like yield enhancement are fast disappearing due to global harmonisation and coordination, while some large lenders are still slow to engage in Emerging Markets. But in a world where 80% of transactions are already automated, how many value-added trades are there left to execute? The answer is likely to be not that many, but this is why we still need skilled traders.
As some staff become less required in daily securities finance transactions, we find that there are exciting new opportunities ahead when individual skill sets can stay up to speed with changing markets. We see the reallocation of sales traders to other disciplines, including working with quantitative teams who know algorithms but not the subject matter, and in client-facing roles. There are few people better positioned to explain transactions to clients and manage internal processes. Vendors see the value in these people as well, as witnessed by ongoing hires worldwide of former bank securities lending staff.
A reduction in the number of people required for sales trading, combined with a greater utilisation of trading platforms today and artificial intelligence tomorrow, translates into a palpable change in the way that securities lending works. That said, we are still in a world where the shared interest of individuals is paramount, and we will still need the skills of senior managers and industry professionals to participate in the growth of the market.
The process of optimisation will continue to impact securities lending and will result in cross-asset trading desks that are able to meet client objectives in a variety of ways. For example, an asset could be lent in a securities loan, used as collateral in a repo transaction or form the underlying in a swap transaction. Some firms have already operationalised cross-product trading opportunities, for example merging equities and fixed income trading desks, or securities lending and repo. In the future, securities lending will be one product among many, and people who understand that will have a valued role in financial institutions.
One constant in the future securities lending industry is the relationship between service provider and client. Although there are fewer people working at asset holders, for the same reason as banks are realigning headcount, the assets are still there and need to be serviced. People still make the final decisions about risk and who to do business with; no one is ready to cede fiduciary responsibility to computers. This means that bank relationship managers who can walk clients through the business of securities lending, not to mention asset servicing as a whole, will continue to be in strong demand. The importance of the relationship manager increases if they can discuss both the business and technology that drives it, effectively translating the complex realities of securities lending to the non-specialist. The market will still be about people, but people will need additional skills to deliver strong value to clients.
We have already seen a net positive benefit to the large-scale transparency from securities lending regulation and automation, combined with strong relationship management: clients are more interested in conducting business. When securities lending was seen as outside the banking system, clients were uncertain what they were getting into. With required reporting and regulatory oversight, clients are assured that securities lending is the low risk transaction that it always was and can comfortably report to their clients and internal management that transactions are recognised and captured by Trade Repositories. Transparency breeds trust, and trust brings in business.
Implications for the broader markets
A more technologically enabled securities lending market has features that are common to listed markets worldwide: tighter spreads, more transparency and greater commoditisation of the product. Securities lending is likely to follow this trend due to regulatory necessity, balance sheet constraints that have changed profitability patterns, and broader market trends that encourage technology implementation.
Prior experiences in the markets, when commissions fell dramatically, showed that volumes can increase substantially when trades are moving to electronic platforms. That may happen in securities lending as well, resulting in thinner spreads but more volume in transactional activity and more tailor-made transactions with cross-product value. To make this happen, financial institutions will need their own visions about the future of the industry and will likewise need people with the right skills to deliver a collateralised front-to-back office transaction. While regulators may be pleased to see more transparency in the markets as a result of electronic trading, securities lending market participants will still emphasise the people as key market participants. At its heart, this is what makes securities lending work.
Dan Copin is Head of Securities Finance at CACEIS and has over 15 years’ experience in the securities finance industry. He has a successful track record of managing trading teams and streamlining front-to-back office activities, as well as a thorough understanding of the IT systems involved in the activity. Dan focuses on building strong relationships with clients by designing profitable tailor-made solutions based on cutting-edge technology within a risk-controlled environment. He is a graduate of ESLSCA (University of Applied Business Science) in Paris.