Looking to the future
04 September 2018
In the run-up to the SFTR deadline, and through the midst of differing balance sheet considerations, the beneficial owner’s world is beginning to change
Image: Shutterstock
Unfortunately, unlike Marty McFly, the securities lending industry doesn’t have the ‘doc’, or the DeLorean to help correct the past, or indeed, see into the future. But as beneficial owners look ahead, past the challenges of regulation, and the quagmire of constraints borrowers and agent lenders are currently under, what do beneficial owners need to consider? How can they prepare for the future?
As James Day, head of securities finance for Europe, the Middle East and Africa at BNY Mellon, states: “The first thing that beneficial owners should understand, is the major binding constraints that borrowers and agent lenders are operating under–namely capital requirements, leverage ratios and balance sheet considerations. Understanding these dynamics and tailoring a lending programme that enhances the returns for beneficial owners should be the focus.”
As it stands, the Securities Financing Transactions Regulation (SFTR) ruling states trade repositories will need to create a trade-state report, on top of a reconciliation status report, as well as a rejections report, and indeed, a missing collateral report. The SFTR ruling is set out clearly, in that, to some extent, the same rules have to be followed by everyone.
But with respect to a beneficial owners lending programme, the guidance and structure that should be set is not always so clear.
Mark Jones, head of securities lending for Europe, the Middle East and Africa (EMEA) at Northern Trust, states: “The definition of a successful lending programme varies widely across different beneficial owners.”
“For some, a low-risk programme with modest returns that offset other asset servicing costs is sufficient, whereas others will be seeking to maximise revenue with a more aggressive attitude to risk. With the diversification of potential routes to market increasing, beneficial owners must decide which strategies fit their objectives and then challenge their providers to implement a programme that fits those objectives.”
As a spokesperson for State Street reiterates: “Whether a beneficial owner adopts a principal, agency, exclusive or under an indemnity, will depend entirely on their own bespoke parameters, mandate and risk profiles.”
The State Street spokesperson adds: “How they adopt these, like agents and borrowers themselves, will depend on their own binding constraints and their motivations for lending.”
Opportunity knocks
The current securities lending landscape uncovers a rocky, yet golden path of opportunity. These opportunities lay within emerging markets and finding new, inventive ways of routes to these markets, or re-approaching existing ones.
Northern Trust, for one, is implementing new markets such as Saudi Arabia. As Jones says: “We encourage our beneficial owners to be leaders in the industry by implementing flexible programme parameters, by lending in new markets and by adopting new routes to market as long as those new strategies fit into their internal risk framework.”
According to a panel at the Finadium Investors in Securities Lending conference in London earlier this year, technology is another opportunity within the securities lending landscape, for the benefical owners taking.
At the conference, one panellist was asked: “With the advancement in technology does it make it harder or easier for the beneficial owner to directly access the market?”
A panellist answered: “Technology makes it easier for beneficial owners to access the market, in theory, it should be easier to access without a service provider.”
Preparation
Although there are always elements that can bring opportunity, inevitably, there is always a risk. During a panel at the IMN’s 24th Annual Beneficial Owners’ International Securities Finance and Collateral Management conference, panellists advised beneficial owners on how to safeguard their assets and avoid such unnecessary risk.
One panellist said indemnity is critical to consider before starting the securities lending programme because agent lenders don’t always specify what is covered in the indemnity.
It was also discussed another important element for a beneficial owner to deal with is whether cash or non-cash will be accepted as collateral. Setting the duration of lending is another issue not to neglect, as panellist agreed, the responsibility lies in the hands of the beneficial owner.
The aforementioned, however, could be considered more of a ‘starter-pack’ for beneficial owners entering the industry. What further advice is there for established beneficial owners who are looking to update their lending programme?
According to Harpreet Bains of J.P. Morgan, reacting to counterparty demand is another factor beneficial owners should take into account.
Bains says: “As an agent lender, we continue to react to changes in counterparty demand as a result of borrowers’ need to comply with regulations, and it’s key that the market dynamics as it relates to borrower demand preferences are understood by beneficial owners.”
“Those that are willing to work with their agents to adjust programme structures, take a fresh look at non-traditional structures, and be open to re-evaluating their risk appetite to take advantage of non-cash and cash collateral reinvestment strategies, can position themselves to monetise market opportunities and optimise revenue.”
As well as following changes in counterparty demand, beneficial owners should be mindful that borrowers are looking for greater collateral flexibility in an ever-changing market, Bains adds.
She says because of this “it’s important that beneficial owners consider both kinds of collateral and adjust their parameters and guidelines accordingly”.
“This is especially true given the continued demand from borrowers for less balance sheet-intensive loans against non-US—non-cash collateral, as well as increased yields which create new opportunities for lenders to reinvest cash using different strategies to earn better returns in a risk-controlled manner.”
Another concern is changing clients as they seek out “balance sheet relief”, according to Bains.
Bains states that as a consequence of this, beneficial owners in certain jurisdictions are no longer lender of choice for a borrower, and in light of this “counterparty diversification becomes a necessary consideration for beneficial owners”.
A bit of faith
Although there are many bumps in the road, let’s not forget that there are capital efficient solutions coming to market, as Day discusses.
Day states that moving forward, “broad collateral acceptance and eligibility will enable clients to maintain high utilisation levels as the makeup of available collateral on the street changes over time”.
He uses the example of accepting collateral under a pledge structure rather than a title transfer, which can, he states “enable clients to increase utilisation rates and revenue”.
Jones further adds at Northern Trust, “[we] are working with our beneficial owners to support capital efficient transactions such as collateral pledge [...] At Northern Trust, we are proud of the flexibility our programme offers and our ability to meet the whole spectrum of beneficial owner requirements”.
To be fit for the future, Jones suggests “beneficial owners must decide which strategies fit their objectives and then challenge their providers to implement a programme that fits those objectives”.
Ultimately, it seems embracing technology, enabling collateral flexibility, exercising an openness to pledge structures and CCPs, will ensure beneficial owners lending programmes remain current in an ever-changing market landscape—knowledge and preparation should eradicate the need for a time machine.
As James Day, head of securities finance for Europe, the Middle East and Africa at BNY Mellon, states: “The first thing that beneficial owners should understand, is the major binding constraints that borrowers and agent lenders are operating under–namely capital requirements, leverage ratios and balance sheet considerations. Understanding these dynamics and tailoring a lending programme that enhances the returns for beneficial owners should be the focus.”
As it stands, the Securities Financing Transactions Regulation (SFTR) ruling states trade repositories will need to create a trade-state report, on top of a reconciliation status report, as well as a rejections report, and indeed, a missing collateral report. The SFTR ruling is set out clearly, in that, to some extent, the same rules have to be followed by everyone.
But with respect to a beneficial owners lending programme, the guidance and structure that should be set is not always so clear.
Mark Jones, head of securities lending for Europe, the Middle East and Africa (EMEA) at Northern Trust, states: “The definition of a successful lending programme varies widely across different beneficial owners.”
“For some, a low-risk programme with modest returns that offset other asset servicing costs is sufficient, whereas others will be seeking to maximise revenue with a more aggressive attitude to risk. With the diversification of potential routes to market increasing, beneficial owners must decide which strategies fit their objectives and then challenge their providers to implement a programme that fits those objectives.”
As a spokesperson for State Street reiterates: “Whether a beneficial owner adopts a principal, agency, exclusive or under an indemnity, will depend entirely on their own bespoke parameters, mandate and risk profiles.”
The State Street spokesperson adds: “How they adopt these, like agents and borrowers themselves, will depend on their own binding constraints and their motivations for lending.”
Opportunity knocks
The current securities lending landscape uncovers a rocky, yet golden path of opportunity. These opportunities lay within emerging markets and finding new, inventive ways of routes to these markets, or re-approaching existing ones.
Northern Trust, for one, is implementing new markets such as Saudi Arabia. As Jones says: “We encourage our beneficial owners to be leaders in the industry by implementing flexible programme parameters, by lending in new markets and by adopting new routes to market as long as those new strategies fit into their internal risk framework.”
According to a panel at the Finadium Investors in Securities Lending conference in London earlier this year, technology is another opportunity within the securities lending landscape, for the benefical owners taking.
At the conference, one panellist was asked: “With the advancement in technology does it make it harder or easier for the beneficial owner to directly access the market?”
A panellist answered: “Technology makes it easier for beneficial owners to access the market, in theory, it should be easier to access without a service provider.”
Preparation
Although there are always elements that can bring opportunity, inevitably, there is always a risk. During a panel at the IMN’s 24th Annual Beneficial Owners’ International Securities Finance and Collateral Management conference, panellists advised beneficial owners on how to safeguard their assets and avoid such unnecessary risk.
One panellist said indemnity is critical to consider before starting the securities lending programme because agent lenders don’t always specify what is covered in the indemnity.
It was also discussed another important element for a beneficial owner to deal with is whether cash or non-cash will be accepted as collateral. Setting the duration of lending is another issue not to neglect, as panellist agreed, the responsibility lies in the hands of the beneficial owner.
The aforementioned, however, could be considered more of a ‘starter-pack’ for beneficial owners entering the industry. What further advice is there for established beneficial owners who are looking to update their lending programme?
According to Harpreet Bains of J.P. Morgan, reacting to counterparty demand is another factor beneficial owners should take into account.
Bains says: “As an agent lender, we continue to react to changes in counterparty demand as a result of borrowers’ need to comply with regulations, and it’s key that the market dynamics as it relates to borrower demand preferences are understood by beneficial owners.”
“Those that are willing to work with their agents to adjust programme structures, take a fresh look at non-traditional structures, and be open to re-evaluating their risk appetite to take advantage of non-cash and cash collateral reinvestment strategies, can position themselves to monetise market opportunities and optimise revenue.”
As well as following changes in counterparty demand, beneficial owners should be mindful that borrowers are looking for greater collateral flexibility in an ever-changing market, Bains adds.
She says because of this “it’s important that beneficial owners consider both kinds of collateral and adjust their parameters and guidelines accordingly”.
“This is especially true given the continued demand from borrowers for less balance sheet-intensive loans against non-US—non-cash collateral, as well as increased yields which create new opportunities for lenders to reinvest cash using different strategies to earn better returns in a risk-controlled manner.”
Another concern is changing clients as they seek out “balance sheet relief”, according to Bains.
Bains states that as a consequence of this, beneficial owners in certain jurisdictions are no longer lender of choice for a borrower, and in light of this “counterparty diversification becomes a necessary consideration for beneficial owners”.
A bit of faith
Although there are many bumps in the road, let’s not forget that there are capital efficient solutions coming to market, as Day discusses.
Day states that moving forward, “broad collateral acceptance and eligibility will enable clients to maintain high utilisation levels as the makeup of available collateral on the street changes over time”.
He uses the example of accepting collateral under a pledge structure rather than a title transfer, which can, he states “enable clients to increase utilisation rates and revenue”.
Jones further adds at Northern Trust, “[we] are working with our beneficial owners to support capital efficient transactions such as collateral pledge [...] At Northern Trust, we are proud of the flexibility our programme offers and our ability to meet the whole spectrum of beneficial owner requirements”.
To be fit for the future, Jones suggests “beneficial owners must decide which strategies fit their objectives and then challenge their providers to implement a programme that fits those objectives”.
Ultimately, it seems embracing technology, enabling collateral flexibility, exercising an openness to pledge structures and CCPs, will ensure beneficial owners lending programmes remain current in an ever-changing market landscape—knowledge and preparation should eradicate the need for a time machine.
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