UK
23 July 2019
Against a politically uncertain backdrop, the UK’s securities lending industry is seeing growth and preparing for the next wave of regulation, while the risks of a no deal Brexit continues to place pressure on financial services
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The UK’s securities lending market is currently seeing growth with new entrants regularly coming to the UK market, according to industry experts. This is, however, against the political backdrop of uncertainty surrounding Brexit, and whether or not there will be a deal or no deal Brexit.
Recently, a survey conducted at Vermeg’s Annual Collateral Management Conference found that over half, 52 percent, of delegates thought that having London outside the EU will have a negative impact on collateral management harmonisation. The survey found that 15 percent said they didn’t feel there would be a negative impact, while 33 percent said that they were unsure. Meanwhile, the upcoming Securities Financing Transactions Regulation (SFTR) is also a hot topic in the UK with firms preparing for the implementation date in April next year.
Commenting on the current state of the UK’s securities lending market, Reshad Mullboccus, acting global co-head of securities lending, HSBC Securities Services, observes: “The UK market in 2019 continues to provide stable returns to beneficial owners through stable short-interest and hedging demands, quarterly scrip dividends (HSBC, BP & National Grid) and directional names (Sirius Minerals, Blue Prism & Anglo American), according to data from IHS Markit.”
“Broadly speaking, lendable supply remained flat at US $765 billion, while loan balances fluctuated between US $40 to 43 billion in the same time period, the data shows. As a major global market and hub for Europe, the UK’s overall lending utilisation has suffered from a trend of deleveraging and re-risking across hedge funds year-to-date.”
Deal or no deal?
Despite an original Brexit deadline of 29 March 2019, the UK still remains as part of the EU with a new deadline of 31 October, ironically falling on one of the scariest days of the year, Halloween.
According to the Association for Financial Markets in Europe (AFME), a no deal Brexit is likely to have a significant impact on the financial services sector, despite the substantial work done to mitigate risks. In a paper highlighting the risks, AFME cautioned that the equivalence decision for UK central counterparties (CCPs) is currently due to expire on 30 March 2020.
AFME noted that unless certainty is provided as to the extension of recognition, UK CCPs might be required to start offboarding processes for EU27 members by the end of 2019. Elsewhere in the paper, AFME outlined its concern that EU investors may still not be able to access major pools of liquidity for a number of EU27 shares and be unable to execute trades at the best available price.
AFME recommended that the UK and EU27 authorities put in place the necessary arrangements to ensure continued access of members from both UK and EU27 to infrastructures under their supervision. The risk of disruption to EU and UK markets because of overlapping and contradictory derivatives trading obligations has not been addressed.
In the absence of equivalence, conflicting EU and UK trading obligations would prevent EU27 and UK counterparties from trading in scope derivatives with each other on either EU or UK venues, AFME explained. AFME urged authorities to continue to work together and explore all avenues to avoid overlapping trading obligations and minimise disruption.
In terms of firms’ preparedness, Mike Lambert, product director at Broadridge Financial Solutions, says: “With regard to Brexit, most firms already have deal/ no deal contingency arrangements. With so many variables to consider it’s difficult to predict any long-term outcomes.”
Trending in the UK
Discussing UK trends, Lambert highlights that trends in the UK are following the international pattern such as the focus on the SFTR and Central Securities Depository Regulation (CSDR) compliance.
Lambert continues: “Pledge and CCPs continues to make a slow advance and environmental social and governance (ESG) is now coming to the fore. What ESG means for securities lending and what we have to do about it continues to be debated but it is clear that change is coming.”
“Securities lending must become more ESG-aware and that means changes to systems and processes and even the way that firms do business.”
He adds: “As I said it is all about SFTR and CSDR compliance at present. We expect that once this round of regulations is bedded in, people will look at ways to add further automation into the trade lifecycle.”
Also discussing UK trends, Wayne Burlingham, acting global co-head of securities lending, HSBC Securities Services, says: “There are two main trends to report. The first is the growing amount of interest among potential new entrants to the market on the lending side, primarily as a result of the search for new revenue sources which can usefully offset costs, such as custody and fund administration. Year-to-date we have already evaluated more potential portfolios than we did during all of 2018.”
“The second trend is that participation is becoming very polarised. For clients that are actively engaging with their agents and responding to change, revenue levels are generally holding up reasonably well. Clients that are not engaging, however, risk being left behind and revenue will, of course, suffer. Securities lending, as a product, continues to evolve and, in our experience, clients appear to be either actively engaged or disengaged with few adopting the middle ground.” Regulatory impacts
SFTR will take legal force in April next year. Despite its complexities, some industry experts have argued that it will shine a light on the things in the industry that we sometimes shy away from. People will have to look at their trading systems and behaviours in more detail.
Reinforcing this point, Lambert says: “While challenging for the industry, SFTR will provide some benefits once the dust has settled post-go live. In particular, the use of unique transaction identifiers (UTIs) and legal entity identifiers (LEIs) will provide greater transparency in the event of a crisis. SFTR may help macro-prudential regulators and central banks to identify build ups of systemic risk and allow them to implement counter-cyclical measures.”
“The regulation should also drive greater standardisation in the industry and lead to increased scope for automation that improves market efficiency. Finally, it will be a new source of data that could provide rich new analytics to inform decision making in the front office.”
Burlingham also agrees that SFTR can provide benefits, he says: “The driver of the regulation is the need for regulators to have full insight into market activity, particularly on the shadow banking side. Given the issues suffered by a number of different firms in the financial crisis of 2008/9, including borrowers, some agent lenders and beneficial owners, there is a good case for supporting any regulatory initiative that could prevent reoccurrence.”
Discussing the deadline date, and how many firms will get it right, Lambert expects most firms will get over the line in time to meet the deadline. Many firms, however, have not yet defined a detailed and robust operating model for SFTR and to help with this Broadridge has launched a consulting service to help firms comply, says to Lambert.
He states: “It is likely that matching rates will initially be very low. Counterparties who do not provide timely accurate data will create additional operational overhead for those who do, for example, breaks. Once live, the trade repository reconciliations will highlight these breaks, and inevitably some firms will do better than others. Even at this early stage it will become apparent to a firm and its counterparties if they have serious issues.”
In terms of the abundance of data that will come with SFTR, Lambert comments: “With derivatives reporting under European Market Infrastructure Regulation (EMIR), regulators are already dealing with incredibly large volumes of data. The question is, will the regulators be able to make sense of the data? Is the data rich enough to allow them to see the market interconnectivity and collateral velocity data they seek?”
“In my view, the answer to that is ‘not in this phase’. That’s why I think we can look forward to ‘SFTR Phase 2’ at some point in the future—once the regulator has had a chance to bed in and analyse the ‘Phase 1’ data.”
Looking to the future
Looking at the UK’s securities lending horizon for the next five years, Lambert predicts that we will see more electronic trading and more automation in future.
He affirms: “Smarter, more efficient trading and operations are the only way that firms will be able to deal with the increasing costs driven by regulation and still maintain profitability.”
“This includes compliance costs for SFTR and CSDR, and future iterations of these rules (SFTR Phase 2 etc).”
Burlingham predicts: “In line with the rest of the financial services and other industries, it’s all about digital and data.”
“The growth in trade automation continues apace and with even more information becoming available (think SFTR for example) those providers that are able to exploit new opportunities will ultimately prevail.”
“Within five years there is real potential for trading to be almost completely fully automated with machine learning and artificial intelligence replacing the role of traders.”
He adds: “Machine to machine has to be viewed as the natural evolution but this of course requires significant investment and a significant number of people will need to adapt to a totally new way of thinking and working.”
Recently, a survey conducted at Vermeg’s Annual Collateral Management Conference found that over half, 52 percent, of delegates thought that having London outside the EU will have a negative impact on collateral management harmonisation. The survey found that 15 percent said they didn’t feel there would be a negative impact, while 33 percent said that they were unsure. Meanwhile, the upcoming Securities Financing Transactions Regulation (SFTR) is also a hot topic in the UK with firms preparing for the implementation date in April next year.
Commenting on the current state of the UK’s securities lending market, Reshad Mullboccus, acting global co-head of securities lending, HSBC Securities Services, observes: “The UK market in 2019 continues to provide stable returns to beneficial owners through stable short-interest and hedging demands, quarterly scrip dividends (HSBC, BP & National Grid) and directional names (Sirius Minerals, Blue Prism & Anglo American), according to data from IHS Markit.”
“Broadly speaking, lendable supply remained flat at US $765 billion, while loan balances fluctuated between US $40 to 43 billion in the same time period, the data shows. As a major global market and hub for Europe, the UK’s overall lending utilisation has suffered from a trend of deleveraging and re-risking across hedge funds year-to-date.”
Deal or no deal?
Despite an original Brexit deadline of 29 March 2019, the UK still remains as part of the EU with a new deadline of 31 October, ironically falling on one of the scariest days of the year, Halloween.
According to the Association for Financial Markets in Europe (AFME), a no deal Brexit is likely to have a significant impact on the financial services sector, despite the substantial work done to mitigate risks. In a paper highlighting the risks, AFME cautioned that the equivalence decision for UK central counterparties (CCPs) is currently due to expire on 30 March 2020.
AFME noted that unless certainty is provided as to the extension of recognition, UK CCPs might be required to start offboarding processes for EU27 members by the end of 2019. Elsewhere in the paper, AFME outlined its concern that EU investors may still not be able to access major pools of liquidity for a number of EU27 shares and be unable to execute trades at the best available price.
AFME recommended that the UK and EU27 authorities put in place the necessary arrangements to ensure continued access of members from both UK and EU27 to infrastructures under their supervision. The risk of disruption to EU and UK markets because of overlapping and contradictory derivatives trading obligations has not been addressed.
In the absence of equivalence, conflicting EU and UK trading obligations would prevent EU27 and UK counterparties from trading in scope derivatives with each other on either EU or UK venues, AFME explained. AFME urged authorities to continue to work together and explore all avenues to avoid overlapping trading obligations and minimise disruption.
In terms of firms’ preparedness, Mike Lambert, product director at Broadridge Financial Solutions, says: “With regard to Brexit, most firms already have deal/ no deal contingency arrangements. With so many variables to consider it’s difficult to predict any long-term outcomes.”
Trending in the UK
Discussing UK trends, Lambert highlights that trends in the UK are following the international pattern such as the focus on the SFTR and Central Securities Depository Regulation (CSDR) compliance.
Lambert continues: “Pledge and CCPs continues to make a slow advance and environmental social and governance (ESG) is now coming to the fore. What ESG means for securities lending and what we have to do about it continues to be debated but it is clear that change is coming.”
“Securities lending must become more ESG-aware and that means changes to systems and processes and even the way that firms do business.”
He adds: “As I said it is all about SFTR and CSDR compliance at present. We expect that once this round of regulations is bedded in, people will look at ways to add further automation into the trade lifecycle.”
Also discussing UK trends, Wayne Burlingham, acting global co-head of securities lending, HSBC Securities Services, says: “There are two main trends to report. The first is the growing amount of interest among potential new entrants to the market on the lending side, primarily as a result of the search for new revenue sources which can usefully offset costs, such as custody and fund administration. Year-to-date we have already evaluated more potential portfolios than we did during all of 2018.”
“The second trend is that participation is becoming very polarised. For clients that are actively engaging with their agents and responding to change, revenue levels are generally holding up reasonably well. Clients that are not engaging, however, risk being left behind and revenue will, of course, suffer. Securities lending, as a product, continues to evolve and, in our experience, clients appear to be either actively engaged or disengaged with few adopting the middle ground.” Regulatory impacts
SFTR will take legal force in April next year. Despite its complexities, some industry experts have argued that it will shine a light on the things in the industry that we sometimes shy away from. People will have to look at their trading systems and behaviours in more detail.
Reinforcing this point, Lambert says: “While challenging for the industry, SFTR will provide some benefits once the dust has settled post-go live. In particular, the use of unique transaction identifiers (UTIs) and legal entity identifiers (LEIs) will provide greater transparency in the event of a crisis. SFTR may help macro-prudential regulators and central banks to identify build ups of systemic risk and allow them to implement counter-cyclical measures.”
“The regulation should also drive greater standardisation in the industry and lead to increased scope for automation that improves market efficiency. Finally, it will be a new source of data that could provide rich new analytics to inform decision making in the front office.”
Burlingham also agrees that SFTR can provide benefits, he says: “The driver of the regulation is the need for regulators to have full insight into market activity, particularly on the shadow banking side. Given the issues suffered by a number of different firms in the financial crisis of 2008/9, including borrowers, some agent lenders and beneficial owners, there is a good case for supporting any regulatory initiative that could prevent reoccurrence.”
Discussing the deadline date, and how many firms will get it right, Lambert expects most firms will get over the line in time to meet the deadline. Many firms, however, have not yet defined a detailed and robust operating model for SFTR and to help with this Broadridge has launched a consulting service to help firms comply, says to Lambert.
He states: “It is likely that matching rates will initially be very low. Counterparties who do not provide timely accurate data will create additional operational overhead for those who do, for example, breaks. Once live, the trade repository reconciliations will highlight these breaks, and inevitably some firms will do better than others. Even at this early stage it will become apparent to a firm and its counterparties if they have serious issues.”
In terms of the abundance of data that will come with SFTR, Lambert comments: “With derivatives reporting under European Market Infrastructure Regulation (EMIR), regulators are already dealing with incredibly large volumes of data. The question is, will the regulators be able to make sense of the data? Is the data rich enough to allow them to see the market interconnectivity and collateral velocity data they seek?”
“In my view, the answer to that is ‘not in this phase’. That’s why I think we can look forward to ‘SFTR Phase 2’ at some point in the future—once the regulator has had a chance to bed in and analyse the ‘Phase 1’ data.”
Looking to the future
Looking at the UK’s securities lending horizon for the next five years, Lambert predicts that we will see more electronic trading and more automation in future.
He affirms: “Smarter, more efficient trading and operations are the only way that firms will be able to deal with the increasing costs driven by regulation and still maintain profitability.”
“This includes compliance costs for SFTR and CSDR, and future iterations of these rules (SFTR Phase 2 etc).”
Burlingham predicts: “In line with the rest of the financial services and other industries, it’s all about digital and data.”
“The growth in trade automation continues apace and with even more information becoming available (think SFTR for example) those providers that are able to exploit new opportunities will ultimately prevail.”
“Within five years there is real potential for trading to be almost completely fully automated with machine learning and artificial intelligence replacing the role of traders.”
He adds: “Machine to machine has to be viewed as the natural evolution but this of course requires significant investment and a significant number of people will need to adapt to a totally new way of thinking and working.”
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