In a move that has both marketing and political implications, SL-x hired Promontory Financial Group, staffed with a substantial number of senior ex-regulators, to write a white paper in favor of a securities lending CCPs (“Bank Regulatory Capital Requirements for Stock Loan Transactions”). While we entirely agree with some of the points made, the 97% figure raises some questions as to its validity and assumptions. But so what: this is a marketing job for senior compliance and regulatory officers and the point gets made that Qualified CCPs (CCPs, for short) are a good deal. Let’s see what the paper actually said.
First, here are the main take-aways, which we think are generally agreed on throughout the industry:
1) The amount of capital that banking organizations will have to set aside to cover exposures in the stock lending market will generally increase; and
2) Stock loan transactions cleared by a QCCP will receive favorable risk-based capital treatment relative to those transactions that are bilaterally settled.
The paper goes through the background of various Basel regs and cost of capital methodologies with a focus on US variations. A lot of time is spent on agent lenders, which is interesting because the whole issue with agents is indemnification. Change indemnification practices for any other reason and this part of the conversation goes away. But Promontory’s analysis runs through the numbers and finds a potential savings of up to 97.18% from using a CCP. The same example for prime brokers showed a savings of 95.98%.
The hook to both analyses is that they pertain to risk-based capital requirements only. Otherwise, supervisors need to grant CCP transactions an exemption to the Leverage Ratio, which we all agree has shaped up as a potentially major limiting factor in securities finance transactions broadly. According to Promontory: “As both examples illustrate, the bank’s overall leverage requirement often drives it capital requirements. While banks may be able to achieve risk-based capital savings through use of QCCPs, the ability of all banks to benefit might be lost unless the supervisors determine that balance sheet assets representing exposures cleared by QCCPs qualify for an exemption from leverage requirements.”
To be sure, this is a good and interesting analysis, and we learned a few things by reading it. We agree, as we argued in a September 2013 research report, “A Cost/Benefit Analysis Roadmap for Securities Lending CCPs,” that CCPs are likely to be a better deal than bilateral transactions. Eurex Clearing has an example showing an 80% cost of capital benefit over bilateral transactions. But we also think that the exact benefits will be very dependent on the lender or borrower, their specific circumstances and their individual portfolios. Each firm will need to run their own numbers using their own models to find out what that benefit is going to be.
Here’s the marketing and political piece: Promontory speaks well to the regulatory and compliance world, and their analysis will be listened to in those quarters if only because so many big names are attached to the firm. This paper will appeal to regulatory and compliance non-specialists in securities lending that may seize on the 95% and 97% numbers without much further analysis. That would not be a good idea – there are too many moving parts – but SL-x has made their point: arguing for CCPs goes higher than the trading desk and those people need to be convinced of the CCP model. If senior compliance and regulatory capital people at banks buy into the CCP concept, its going to be an easier sell. This follows closely on the heels of the August 2013 FSB paper that (Recommendation 10) asks regulators to look at CCPs for repo, and we expect securities lending CCPs will follow closely as well.
The Promontory white paper is available here.