Embracing the unknown
27 June 2017
SFTR dominated ISLA’s 26th Annual Securities Finance and Collateral Management Conference, but there was also room for MiFID II, Brexit, equities as collateral and more. Drew Nicol was there to report on the highlights
Image: Shutterstock
As representatives from the global securities lending industry gathered in Berlin for ISLA’s 26th Annual Securities Finance and Collateral Management Conference, many of this year’s hot topics came with more questions than answers.
The practical implications of the fast approaching deadline for the second Markets in Financial Instruments Directive (MiFID II), along with the final form and timeline of the Securities Financing Transactions Regulation (SFTR), and several other market disruptions were dissected by panellists and speakers.
I don’t predict a riot
For the securities lending industry, market disruption comes in several guises. Emerging technology, such as blockchain and peer-to-peer (P2P) platforms that allow for direct lending, are chief among these as both allow end users to bypass the traditional transaction chain.
The rise of P2P lending was described by panellists as a two-headed beast. From the point of view of banks, P2P lending in the repo space provides welcome relief from what are otherwise financing services that put great pressure on the balance sheet. For securities lending, however, the disintermediation that direct lending would allow represents potential lost revenue for those that position themselves in the middle of the trade.
However, in both cases, the resources required for beneficial owners to lend directly and remain in compliance with their own risk management rules and the various regulatory requirements means that only a small subset of the largest lenders will be able to engage in this new trading avenue.
Regarding the application of blockchain and distributed ledger technology more generally, much lip service was paid to the potential disruption that such a technology could cause to traditional lending models. But the conference hall seemed united in its belief that it was simply too early to say how it could affect the market in practice.
Brexit, Brexit everywhere but not a fact to think
After technological disruption, the next most discussed hurdle on the horizon was Brexit, which featured to different degrees in most panels throughout the three days.
Last year’s ISLA conference concluded on the day the people of the UK went to the polls for the Brexit referendum, meaning that last week’s gathering was held just shy of 12 months after the the leave result was set. Despite this, there were precious few facts to discuss in terms of how Brexit might affect market participants—in London or elsewhere—during last week’s sessions.
A poll of audience members asked whether Brexit would affect their business and the overwhelming response was that it was too soon to say. Conference co-chair John Arnesen predicted that Brexit will end up being a central topic of next year’s conference, when there will hopefully be some actual details of what a post-Brexit world will look like.
In one such discussion, a panellist representing a European bank was unphased by Brexit and mused that the only issue was where to move his UK sales team to in the EU. A US-based pension fund panellist described Brexit as merely “a distraction”—those hailing from the UK disagreed.
Caution: Reporting ahead
The draft regulatory technical standards (RTS) of SFTR were released in March, meaning that by the time market participants met in Berlin, they had had enough time to digest the implications of what will most likely be the final form of the reporting requirements.
The three-month review window for the draft RTS is meant to close at the end of the month, but the industry was warned that the European Commission is likely to miss this deadline. A speaker close to the process predicted that the remaining timeline for implementation will likely be delayed by six months, which may come as a relief to the small section of the audience that admitted to not having started work on compliance with the new rules yet.
Discussions around the challenges posed by MiFID II were much more straightforward. The directive comes into force on 3 January 2018 and the industry appeared to be well underway with preparations to meet this deadline. The persistent work of ISLA was highlighted repeatedly as being central to successfully guiding the industry to this stage.
During discussions on the burdens of more reporting requirements and emerging sources of market disruption, a common theme emerged—that it will be smallest market participants that will be hit the hardest.
SFTR’s reporting rules put the onus for compliance on the beneficial owner, not the agent lender. For smaller pension funds and family offices, this may prove too onerous to justify the potential incremental revenue of lending out securities. For the rest of the market, this a problem because those smaller lenders bring a disproportionate amount of the hard-to-source specials that often dominate revenue streams.
At the same time, for UK lenders, the loss of passporting that a hard Brexit may bring will cripple those without the ability to shift lending activities to offices in the eurozone.
All aboard the T2S express
Audience members were updated on the progress of the Target2-Securities (T2S) platform, which is on track to achieve 95 percent compliance with EU post-trade harmonisation standards by the final September deadline.
The T2S project is currently in its final phase of bringing financial markets online. Volumes on the platform had risen significantly as previous waves brought in larger EU markets. The fourth wave saw the German market go live, which contributed significantly to overall volumes on the platform.
The last phase will see central securities depositories (CSDs) in Estonia, Latvia and Lithuania brought onto the platform by the final 18 September deadline, bringing the overall project to nearly full compliance.
The seventh Harmonisation Progress Report, which was published in January, first highlighted that full compliance of T2S markets would not be reached by the fifth wave deadline.
It also noted that a further 2 percent faced obstacles that may stop full compliance being reached, but this demographic now appears to be on track.
The report stated that 70 percent of T2S markets were fully compliant in January, with a further 23 percent categorised as facing no further obstacles to full compliance.
Euroclear Finland will be the missing piece of the puzzle in September following an announcement in January that it had postponed its Infinity Release 2, which would have prepared it for access to T2S. It’s currently unclear how long after September Euroclear Finland will go live.
The EU-centric agenda did allow some time for delegates to glance over the pond at a time when the US market could be on the cusp of a seismic shake up of financial market regulation. Relating directly to the stock loan market was the continued whispers of reform to SEC Rule 15c3-3 to allow equities to be used as collateral.
Negotiations for reform have already seen lengthy discussions between industry stakeholders and regulators, but there was some hope voiced that the end is now in sight, one way or the other.
Experts at BNY Mellon recently wrote of the excitement among collateral providers in the US, “because, on the surface, the rule change potentially reduces their financing costs, as they’re naturally long in equities”.
“Given that most equity collateral-driven businesses are based outside the US, with the highest concentrations being in Europe, Asia Pacific and Canada, Rule 15c3-3 will likely result in a shift back towards the US.”
A poll of the audience in Berlin showed that a significant share believe that such a shift could occur, although speakers cautioned against getting too excited.
It is understood that eligible collateral would be restricted to Russell 1000 and S&P 500 equities under the changes to Rule 15c3-3, which would limit their effect on trading around the world.
There was also a prediction that changes to Rule 15c3-3 would be counterproductive, putting a squeeze on cash in the US market, and scepticism as to whether they would displace business from markets such as the UK, where there are no restrictions on collateral type.
Attendees were also advised to keep a close eye on the filling of the remaining vacancies for the Federal Reserve board, including the replacement of Janet Yellen next year, which could remove the final obstacles keeping the Dodd-Frank Act from getting axed in its entirety.
Out with the old
A new voluntary code of conduct for the securities lending market, known as the UK Money Markets Code, was unveiled with the whole industry encouraged to incorporate its standards into their day-to-day activities.
Industry representatives, including ISLA, drafted the code in partnership with the Bank of England (BoE) to replace the previous guidance, which has been judged to be outdated.
The new code aims to rebuild trust and confidence after the 2008 financial crisis.
Although the code was official released prior to the conference, nearly half of those in attendance were unaware of its publication when polled during the session. Those directly involved in the drafting of the securities lending portion were hopeful that the dedicated session will boost its profile and help make its standards common practice in the near future.
The practical implications of the fast approaching deadline for the second Markets in Financial Instruments Directive (MiFID II), along with the final form and timeline of the Securities Financing Transactions Regulation (SFTR), and several other market disruptions were dissected by panellists and speakers.
I don’t predict a riot
For the securities lending industry, market disruption comes in several guises. Emerging technology, such as blockchain and peer-to-peer (P2P) platforms that allow for direct lending, are chief among these as both allow end users to bypass the traditional transaction chain.
The rise of P2P lending was described by panellists as a two-headed beast. From the point of view of banks, P2P lending in the repo space provides welcome relief from what are otherwise financing services that put great pressure on the balance sheet. For securities lending, however, the disintermediation that direct lending would allow represents potential lost revenue for those that position themselves in the middle of the trade.
However, in both cases, the resources required for beneficial owners to lend directly and remain in compliance with their own risk management rules and the various regulatory requirements means that only a small subset of the largest lenders will be able to engage in this new trading avenue.
Regarding the application of blockchain and distributed ledger technology more generally, much lip service was paid to the potential disruption that such a technology could cause to traditional lending models. But the conference hall seemed united in its belief that it was simply too early to say how it could affect the market in practice.
Brexit, Brexit everywhere but not a fact to think
After technological disruption, the next most discussed hurdle on the horizon was Brexit, which featured to different degrees in most panels throughout the three days.
Last year’s ISLA conference concluded on the day the people of the UK went to the polls for the Brexit referendum, meaning that last week’s gathering was held just shy of 12 months after the the leave result was set. Despite this, there were precious few facts to discuss in terms of how Brexit might affect market participants—in London or elsewhere—during last week’s sessions.
A poll of audience members asked whether Brexit would affect their business and the overwhelming response was that it was too soon to say. Conference co-chair John Arnesen predicted that Brexit will end up being a central topic of next year’s conference, when there will hopefully be some actual details of what a post-Brexit world will look like.
In one such discussion, a panellist representing a European bank was unphased by Brexit and mused that the only issue was where to move his UK sales team to in the EU. A US-based pension fund panellist described Brexit as merely “a distraction”—those hailing from the UK disagreed.
Caution: Reporting ahead
The draft regulatory technical standards (RTS) of SFTR were released in March, meaning that by the time market participants met in Berlin, they had had enough time to digest the implications of what will most likely be the final form of the reporting requirements.
The three-month review window for the draft RTS is meant to close at the end of the month, but the industry was warned that the European Commission is likely to miss this deadline. A speaker close to the process predicted that the remaining timeline for implementation will likely be delayed by six months, which may come as a relief to the small section of the audience that admitted to not having started work on compliance with the new rules yet.
Discussions around the challenges posed by MiFID II were much more straightforward. The directive comes into force on 3 January 2018 and the industry appeared to be well underway with preparations to meet this deadline. The persistent work of ISLA was highlighted repeatedly as being central to successfully guiding the industry to this stage.
During discussions on the burdens of more reporting requirements and emerging sources of market disruption, a common theme emerged—that it will be smallest market participants that will be hit the hardest.
SFTR’s reporting rules put the onus for compliance on the beneficial owner, not the agent lender. For smaller pension funds and family offices, this may prove too onerous to justify the potential incremental revenue of lending out securities. For the rest of the market, this a problem because those smaller lenders bring a disproportionate amount of the hard-to-source specials that often dominate revenue streams.
At the same time, for UK lenders, the loss of passporting that a hard Brexit may bring will cripple those without the ability to shift lending activities to offices in the eurozone.
All aboard the T2S express
Audience members were updated on the progress of the Target2-Securities (T2S) platform, which is on track to achieve 95 percent compliance with EU post-trade harmonisation standards by the final September deadline.
The T2S project is currently in its final phase of bringing financial markets online. Volumes on the platform had risen significantly as previous waves brought in larger EU markets. The fourth wave saw the German market go live, which contributed significantly to overall volumes on the platform.
The last phase will see central securities depositories (CSDs) in Estonia, Latvia and Lithuania brought onto the platform by the final 18 September deadline, bringing the overall project to nearly full compliance.
The seventh Harmonisation Progress Report, which was published in January, first highlighted that full compliance of T2S markets would not be reached by the fifth wave deadline.
It also noted that a further 2 percent faced obstacles that may stop full compliance being reached, but this demographic now appears to be on track.
The report stated that 70 percent of T2S markets were fully compliant in January, with a further 23 percent categorised as facing no further obstacles to full compliance.
Euroclear Finland will be the missing piece of the puzzle in September following an announcement in January that it had postponed its Infinity Release 2, which would have prepared it for access to T2S. It’s currently unclear how long after September Euroclear Finland will go live.
The EU-centric agenda did allow some time for delegates to glance over the pond at a time when the US market could be on the cusp of a seismic shake up of financial market regulation. Relating directly to the stock loan market was the continued whispers of reform to SEC Rule 15c3-3 to allow equities to be used as collateral.
Negotiations for reform have already seen lengthy discussions between industry stakeholders and regulators, but there was some hope voiced that the end is now in sight, one way or the other.
Experts at BNY Mellon recently wrote of the excitement among collateral providers in the US, “because, on the surface, the rule change potentially reduces their financing costs, as they’re naturally long in equities”.
“Given that most equity collateral-driven businesses are based outside the US, with the highest concentrations being in Europe, Asia Pacific and Canada, Rule 15c3-3 will likely result in a shift back towards the US.”
A poll of the audience in Berlin showed that a significant share believe that such a shift could occur, although speakers cautioned against getting too excited.
It is understood that eligible collateral would be restricted to Russell 1000 and S&P 500 equities under the changes to Rule 15c3-3, which would limit their effect on trading around the world.
There was also a prediction that changes to Rule 15c3-3 would be counterproductive, putting a squeeze on cash in the US market, and scepticism as to whether they would displace business from markets such as the UK, where there are no restrictions on collateral type.
Attendees were also advised to keep a close eye on the filling of the remaining vacancies for the Federal Reserve board, including the replacement of Janet Yellen next year, which could remove the final obstacles keeping the Dodd-Frank Act from getting axed in its entirety.
Out with the old
A new voluntary code of conduct for the securities lending market, known as the UK Money Markets Code, was unveiled with the whole industry encouraged to incorporate its standards into their day-to-day activities.
Industry representatives, including ISLA, drafted the code in partnership with the Bank of England (BoE) to replace the previous guidance, which has been judged to be outdated.
The new code aims to rebuild trust and confidence after the 2008 financial crisis.
Although the code was official released prior to the conference, nearly half of those in attendance were unaware of its publication when polled during the session. Those directly involved in the drafting of the securities lending portion were hopeful that the dedicated session will boost its profile and help make its standards common practice in the near future.
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