Timing is everything, they say. Whether it’s competing in the Olympics, launching a political career or just proposing to your partner, it’s only going to work if the stars are aligned. And that’s most certainly the case for Quadriserv.
While its products have been developed over several years, the industry wasn’t too sure of the benefits it was going to bring, admits Greg DePetris, co-founder of the company. “I think that prior to some of the challenges people faced in recent years it was considered a solution in search of a problem,” he says.
“But as it turned out we built what was needed. After the [financial crisis] different user groups found we could solve some of their issues. It was a good solution for agent lenders as they looked to maximise the intrinsic value of securities on loan, for broker dealers it worked by responding to their shrinking balance sheets and need for more risk controls, while for hedge funds, it provided market access and gave them options they never had before.”
The priority for the development has always been economic, explains DePetris: “It’s always been about overcoming the challenges of the market, but fundamentally participants are always going to ask if they can make comparatively more money on AQS than with another more traditional route.”
The right place
The development involved all sectors of the market, who all had an input into how a centralised market operated by a regulated entity would eventually function. The key, says DePetris, was making sure that all participants got exactly what they needed out of it, adding that “our first version was around 60 per cent off the mark, but we succeeded because we invested the time and money to get people onto the system.”
This is key, he says, when listing the company’s achievements: “We were willing to be wrong a lot - we were wrong more than right for much of the development, but we adapted, did the work and stayed connected to our members. We had to make sure we were solving a real problem for the market. We also needed to make sure we made it easy and cheap for people to gain access to the solution, and that’s where our collaboration with SunGard has helped not only AQS but the industry broadly - the new functionality works with systems people already have.
“We had to incorporate the whole industry and make sure we understood their needs - banks, brokers, hedge funds, market makers and so on were all part of the design process. There was a view that this is an insular market and one of our crowning achievements was to get everyone involved.”
The recent economic conditions make it difficult to understand whether the business that Quadriserv is generating is taking activity away from other areas of the market, or whether it is able to encourage new participation in the securities lending industry.
“A primary purpose of what we do is to grow the pie,” explains DePetris. “And the way you do that in any sector with interdependencies is to allow it to interact with other markets and invite new participants to join. Our collaboration means that people treat the market as a new liquidity source and an alternative route to market. We’ve introduced a lot of new people to the securities lending business.”
But a new service isn’t enough. One of the most common criticisms of securities lending is that not enough people - particularly beneficial owners - understand how securities lending works, and how it can benefit them They are unsure of the risks, and they don’t understand where they can fit.
“One of the most important aspects of our marketing strategy was in education,” explains DePetris. “In a way we were the beneficiaries of the structure we built. Using a CCP feels less risky to many players, and having a public market operated by a regulated entity, with deals being done transparently also feels more like the way that major market participants do business in financial products.
“We started as a reputable public market, and that demystifies the process. Everyone is treated the same, and it increases the amount of information available, which reduces risk. There’s only one set of guidelines, which simplifies everything.”
However, an exchange-like system is unlikely to become the de facto standard. There have been questions raised about an exchange model’s ability to manage specials, but DePetris says this is a red herring. “Proportionally, we process just as many specials as OTC,” he says. “They are not inherently more complex than other trades. Specials really are more likely to trade in an environment where the interaction between one and many is more efficient - you’re essentially dealing with one market rather than having loads of different one way discussions, and this is likely to improve liquidity.
“However I do think it’s unhealthy to have only one way of doing things. Certain securities lending activities don’t belong in this market and I don’t think an electronic market can service everybody. It’s all about growing the pie.”
The right time
Electronic trading and CCPs may be about to come of age. The new Dodd Frank legislation is calling for greater transparency in the markets over the coming years and it appears that the favoured method is the increased use of CCPs. While DePetris says that the company is following the regulatory debate closely, and contributing where appropriate, he says that it would be a shame if the only reason companies moved to this model was to fulfil their obligations.
“At the end of the day you want the business case to stand on its own merits,” he says. “We want to advocate things that are good for the market. I think the regulatory changes will encourage people to look at new ways of doing securities lending, but whether they go down this route will be about whether it is right for them.”
But as the success of Quadriserv grows, there is likely to be growing competition. Lendex is due to launch a service that some have seen as a direct rival to Quadriserv, while other firms are also looking at how they can enter the market. This, says DePetris, can only be healthy.
“Every good market has several liquidity pools,” he says. “In Europe, there is competition and that works well. Without competition, there is no incentive to build a better solution.”
Challenges
The securities lending industry is recovering from the downturn, but it’s not out of the woods yet. Volumes remain down, and available assets are sometimes still scarce. Regulation means that participants are weighed down by the costs and time of implementation, and there remains a general market nervousness about the future.
But this, says DePetris, is an opportunity. “We give people the opportunity to integrate and give them the leverage to reduce the costs of implementing new rules. We can increase liquidity through encouraging new entrants and we can help people focus on their businesses, not the challenges of doing business.”
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