Tred Talks: Central counterparties in 2016
06 December 2016
Tred McIntire, formerly head of Goldman Sachs Agency Lending and a member of the RMA executive committee, gives his thoughts how central counterparties in the securities lending market have evolved so far
Image: Shutterstock
The interest in using central counterparties (CCPs) for securities lending transactions in equities was largely driven by the need to address new regulations introduced after the 2008 financial crisis. As regulators required agents to quantify the potential risks around offering indemnification against borrower default and set aside capital for new risk-weighted asset (RWA) calculations and single counter counterparty limits (SCCLs), CCPs were viewed by some as the ‘silver bullet’ response.
In the US broker-to-broker lending market, OCC’s stock loan/hedge programme has gained a lot of traction and is generally viewed as a success. However, agent lenders and their beneficial owner clients have not yet found consensus around an attractive product to address their needs.
Current state of play
OCC’s CCP product for agent lenders is still under development and will require more work before it can look forward to replicating the success of its broker-to-broker product. Unlike Eurex, OCC has not yet come to market with a ‘specific lender licence’ structure to offer beneficial owners a suitable means to access its platform.
It’s currently working with key market players to develop a margining structure to meet the needs of beneficial owners and agent lenders while also maintaining its credit standards.
Additionally, in the US, any CCP is faced with an unclear regulatory landscape. They wrestle with a bit of a ‘chicken and egg’ situation. Without a fully developed CCP model, it is difficult to seek specific regulatory approval. The Risk Management Association has introduced the topic of CCPs with both the US Securities and Exchange Commission (SEC) in regard to ’40 Act funds and CCP regulation and the Department of Labor with respect to Employee Retirement Income Security Act plans. However, these discussions are still at a relatively early stage.
In Europe, Eurex’s CCP went live in 2012, covers five markets and has the backing of Deutsche Börse. Since its inception, Eurex has made substantial progress in developing its product, including:
•Introduction of the ‘specific lender licence’ to allow agents to participate in a manner that mirrors the traditional bilateral lending model without posting margin;
•Gaining the support of some of the largest players in the market including Morgan Stanley, State Street, and BNY Mellon and BlackRock;
•Establishing communication links with Pirum and EquiLend;
•Offering cross-netting with other cleared products; and
•Establishing collateral arrangements with Clearstream and Euroclear with the expectation that BNY Mellon’s triparty programme will join as a collateral agent by year-end.
Eurex also plans to add the UK market in June 2017, and it is working on adding Italy, Spain, Portugal, Finland and the US.
A phased approach to entering the US market would allow for several benefits, including: allowing US beneficial owners to transact in European securities; European asset managers to transact in US securities; and US managers to transact in US securities.
Although Eurex clearly has the most developed model and has made significant progress since its inception, at some point, they will need to generate positive returns for its parent organisation.
Recent developments
EuroCCP—the most recent development is the expected launch of a new CCP competitor in Europe. EuroCCP is rumored to have plans to cover as many as 15 markets as well as having the support of major players in the securities lending market. Unfortunately, it appears that this venture is still at a relatively early stage as it is not prepared to discuss specifics at this point.
Politics and regulation—the global political landscape is clearly undergoing a sea change. With the recent election of Donald Trump, and the impending elections in France, Italy and Germany, will the regulatory climate that has impacted the markets begin to moderate? President-Elect Trump has vowed to dismantle the US Dodd-Frank Act, and he has already appointed Paul Atkins, a former SEC commissioner, to “flesh out the new administration’s plans for remaking the financial rule book”.
During his campaign, Trump also promised that for every new federal regulation, two existing regulations would have to be eliminated.
One specific area of interest in the US is the SCCLs. There is currently no specific timeframe for implementation of the SCCLs, however, uncertainty about the future direction of regulation would seem to be a new obstacle to be overcome.
How much of what Trump said during his campaign will actually find its way into law and regulation remains to be seen, however, he will have a Republican majority in both houses of Congress so there is a greater likelihood that he can move forward his agenda.
Questions surrounding possible regulatory change may slow progress on CCP development as well as acceptance by the regulatory establishment and among market participants.
In terms of disruptive technology, will blockchain or other distributed ledger technologies change the landscape of how financial transactions are structured and business is conducted?
This possibility is probably at least three to five years away, given the need for regulatory buy-in as well as market acceptance and trust for such a significant change to the flow of business. However, blockchain does offer a potential alternative, or even threat, to CCPs.
What to watch for
Will any of the existing CCP offerings make substantive progress with product developments or gain support from market participants?
What happens on the regulatory front that encourages or facilitates broader adoption of CCPs for securities lending?
Perhaps most importantly, over the next several months, will we see indications of how the political winds may affect regulation as Trump’s agenda comes into sharper focus, and political forces in major European countries begin to coalesce?
In the US broker-to-broker lending market, OCC’s stock loan/hedge programme has gained a lot of traction and is generally viewed as a success. However, agent lenders and their beneficial owner clients have not yet found consensus around an attractive product to address their needs.
Current state of play
OCC’s CCP product for agent lenders is still under development and will require more work before it can look forward to replicating the success of its broker-to-broker product. Unlike Eurex, OCC has not yet come to market with a ‘specific lender licence’ structure to offer beneficial owners a suitable means to access its platform.
It’s currently working with key market players to develop a margining structure to meet the needs of beneficial owners and agent lenders while also maintaining its credit standards.
Additionally, in the US, any CCP is faced with an unclear regulatory landscape. They wrestle with a bit of a ‘chicken and egg’ situation. Without a fully developed CCP model, it is difficult to seek specific regulatory approval. The Risk Management Association has introduced the topic of CCPs with both the US Securities and Exchange Commission (SEC) in regard to ’40 Act funds and CCP regulation and the Department of Labor with respect to Employee Retirement Income Security Act plans. However, these discussions are still at a relatively early stage.
In Europe, Eurex’s CCP went live in 2012, covers five markets and has the backing of Deutsche Börse. Since its inception, Eurex has made substantial progress in developing its product, including:
•Introduction of the ‘specific lender licence’ to allow agents to participate in a manner that mirrors the traditional bilateral lending model without posting margin;
•Gaining the support of some of the largest players in the market including Morgan Stanley, State Street, and BNY Mellon and BlackRock;
•Establishing communication links with Pirum and EquiLend;
•Offering cross-netting with other cleared products; and
•Establishing collateral arrangements with Clearstream and Euroclear with the expectation that BNY Mellon’s triparty programme will join as a collateral agent by year-end.
Eurex also plans to add the UK market in June 2017, and it is working on adding Italy, Spain, Portugal, Finland and the US.
A phased approach to entering the US market would allow for several benefits, including: allowing US beneficial owners to transact in European securities; European asset managers to transact in US securities; and US managers to transact in US securities.
Although Eurex clearly has the most developed model and has made significant progress since its inception, at some point, they will need to generate positive returns for its parent organisation.
Recent developments
EuroCCP—the most recent development is the expected launch of a new CCP competitor in Europe. EuroCCP is rumored to have plans to cover as many as 15 markets as well as having the support of major players in the securities lending market. Unfortunately, it appears that this venture is still at a relatively early stage as it is not prepared to discuss specifics at this point.
Politics and regulation—the global political landscape is clearly undergoing a sea change. With the recent election of Donald Trump, and the impending elections in France, Italy and Germany, will the regulatory climate that has impacted the markets begin to moderate? President-Elect Trump has vowed to dismantle the US Dodd-Frank Act, and he has already appointed Paul Atkins, a former SEC commissioner, to “flesh out the new administration’s plans for remaking the financial rule book”.
During his campaign, Trump also promised that for every new federal regulation, two existing regulations would have to be eliminated.
One specific area of interest in the US is the SCCLs. There is currently no specific timeframe for implementation of the SCCLs, however, uncertainty about the future direction of regulation would seem to be a new obstacle to be overcome.
How much of what Trump said during his campaign will actually find its way into law and regulation remains to be seen, however, he will have a Republican majority in both houses of Congress so there is a greater likelihood that he can move forward his agenda.
Questions surrounding possible regulatory change may slow progress on CCP development as well as acceptance by the regulatory establishment and among market participants.
In terms of disruptive technology, will blockchain or other distributed ledger technologies change the landscape of how financial transactions are structured and business is conducted?
This possibility is probably at least three to five years away, given the need for regulatory buy-in as well as market acceptance and trust for such a significant change to the flow of business. However, blockchain does offer a potential alternative, or even threat, to CCPs.
What to watch for
Will any of the existing CCP offerings make substantive progress with product developments or gain support from market participants?
What happens on the regulatory front that encourages or facilitates broader adoption of CCPs for securities lending?
Perhaps most importantly, over the next several months, will we see indications of how the political winds may affect regulation as Trump’s agenda comes into sharper focus, and political forces in major European countries begin to coalesce?
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