‘Building on the past’ is a whitepaper by Pierpoint reviewing operational efficiency in securities finance. What is the key message you want readers to take on board?
The paper comes in three parts. The first part describes the history of the industry, particularly in Europe, its operating environment and how it developed. The second paper explores the technology that is readily available to solve many of the issues facing post-trade services. The third will be dedicated to a reimagining of the industry and how it may look in the next five years. The key message is that change is inevitable, and you can only develop by getting the fundamentals right today.
The paper argues that the operational inefficiencies that are still prevalent have the potential to stifle further market growth. What these sticking points and how are they affecting the current climate?
In researching the paper, it became clear that despite the myriad post-trade services developed to improve the processes, many firms are not utilising them consistently.
Securities finance is nuanced in that trade execution is one action in a multiple of further actions taken during the life-cycle of the loan. Maintaining accurate records between lender and borrower over time can be challenging, given the sheer number of steps that must be taken. After an agent reallocation, for example, if the borrower fails to reflect this change in their books, the return trade may fail due to wrong standing settlement instructions.
The month-end billing will also not reconcile so you have to use resources to untangle the errors. This is both inefficient and unnecessary, given the tools to assist the market are already there to use.
How can the market reach its full potential?
An optimal model remains a goal as any process can be improved. There have been vast improvements over the years to implement trading efficiencies and all of the post-trade services that are described in the paper.
As trading over platforms like EquiLend’s NGT has improved the volume and speed of trading, there are improvements that the industry can make in post-trade activities that will address the inefficiencies we identified in our research. The tools are there, but you have to use them or face higher headcount, costs or risks (or all three).
As Andrew Dyson, CEO of the International Securities Lending Association (ISLA), mentioned in a recent webinar series, by now, we ought to have a handle on these error-prone processes. Dyson is right. To even start thinking about more standardisation as a foundation for automation, we have to improve the basics.
What additional problems are facing the securities lending industry in light of new regulations and what can be done to fix them?
Regulations have shaped the industry since 2008 and whether despite them or in light of them, securities finance has continued to attract investors, reach record supply and generate significant revenue. Clearly, there are additional costs for borrowers, in particular, the cost of capital and risk-weighted assets, and that has led to a change in focus on margin posting and counterparty credit quality.
The latest regulations, Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) will be absorbed into market practice in very much the same way. The market will find a way to comply.
SFTR is noteworthy in that it required industry collaboration like never before during the consultation phase and its implementation. Of more interest to me is that it brings standardisation that the market could now leverage in other areas.
You conducted interviews with market participants to identify how they operate and where improvements are still needed. What was the key feedback?
There is widespread recognition and awareness that resources are limited. Given that, what are the tools needed to meet the demand in the growth of volume or complexity without increasing resources? As described in the paper, the days of throwing people at an increase in growth are no longer acceptable or granted easily, and the pre-trade, trade and post-trade solutions are there to address this.
The frustration lies in a deterioration in universal use of such tools that creates a drag on resources. Ironically, the arrival of SFTR has led some firms to hire additional staff, even if temporarily, to deal with the expected queries that will arise during the matching process. For a regulation without a commercial benefit, this will be painful.
What is the key to achieving rapid sector growth?
Technology has always accompanied the growth in the industry. In the paper, we refer to the creation of Pirum Systems that provides a platform to address the needs of a loan life-cycle and all of its moving parts. EquiLend developed to provide a platform to exchange vast amounts of securities in a more organised fashion. Some 20 years later, both providers have gone from strength-to-strength in the services they provide.
While growth in supply has been mostly successful, there is plenty more to do. Some institutional investors are still not involved and are missing out on a low-risk, compounding annuity revenue stream. Given the cloud-based technology available today, there are so many routes to market that these investors could consider.
How has the securities finance market shifted since the formation of ISLA?
ISLA, which formed in 1989, has just turned 31. In the early years, it was a meeting point to discuss relevant issues. Today it takes a leadership role representing industry views and offers considerable services and output for its members today. The association grew in line with demand, but a turning point is when it hired full-time staff to address members needs. They expanded that further in recent years to meet the needs of increased regulatory interaction, expansion of member benefits, the formation of multiple user groups and encouraging greater beneficial owner engagement. That balanced the needs of the industry as a whole and produces meaningful output day in, day out. The legal opinions, for example, are an invaluable resource when conducting due diligence on a new market.
ISLA’s collaboration with other trade bodies, under the weight of regulatory initiatives, has also enabled better dialogue with regulators and has unequivocally got everyone through the complexities of SFTR.
What can we expect for the future of securities lending in the following papers?
I’d loved to tell you, but you will just have to wait and see; watch this space. We would also like to encourage those that want to share their views with us to get in touch.
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