SLT takes a look at the last 12 months in the securities lending industry: the latest trends, the changing borrower behaviour under different market pressures, challenging regulations, as well as thoughts on the future
Overall, it has been a positive 12 months for the European securities lending industry, with industry participants noting that the industry has seen new entrants coming into the market, emerging hedge fund manager clients being considerably more active, as well as a big borrower trend around capital efficient solutions.
Not only has it been a fairly stellar year, there are also pockets of opportunity for the industry’s future as Mike Lambert, securities lending product manager of Broadridge, notes that there is a golden opportunity in sight for the securities lending industry to standardise its data model.
Lambert also highlighted the positives of the past 12 months, “We have seen new entrants coming into the market, with beneficial owners being one source of demand for new technology systems”.
Lambert added: “High-quality liquid asset trades are driving the industry, with many new lending programmes being fixed income-based.”
Massimo Labella, head of multi-asset execution sales at GPP, commented: “With the markets more turbulent at the turn of the year, we saw a lot of our emerging hedge fund manager clients being considerably more active on the short side.”
“Overall short balances increased, as did the level of personal interaction on hard-to-borrow names. We certainly noticed clients taking a more involved approach to manage their short book—both on rates and quality of supply.”
Meanwhile, James Day, head of securities finance for Europe, the Middle East and Africa at BNY Mellon, noted that ahead of Basel III regulations coming into force, the big trend for borrowers is around capital efficient solutions, so the big change there is the pledge of collateral under Global Master Securities Lending Agreements.
Under pressure
Different market pressures can sometimes change and affect borrower behaviour. Elaborating on this, Labella, said: “Borrowers appear to no longer be driven by pure fee-based decisions, especially for general collateral activity as there are a lot of implications from other factors such as credit, netting and capital impact.”
He added: “A number of borrowers are reducing their breadth of coverage to focus on core activity and internal netting opportunities as well as reciprocity from their clients.”
“However, we are expanding the breadth of our coverage as a result of client-driven demand.”
Day commented: “Central funding desks are looking to optimise balance sheets, capital, and liquidity across the entire business.”
“Borrowers are looking at the resources that they deploy, making sure that they have got capital efficient solutions and the flexibility of posting collateral, which can help with their balance sheets, term structures, and liquidity profiles.”
Regulatory challenges
Following the implementation of the second Markets in Financial Instruments Directive (MiFID II), Securities Financing Transactions Regulation (SFTR) is set to be the next biggest regulatory change and it is expected to have a significant impact on the industry.
Highlighting this, Labella noted the extensive preparation for MiFID II, but continued to say that there is an opportunity given the industry’s position in the market.
He said: “Banks seem to have now absorbed the impact of Basel related regulation. From our perspective, this has been an opportunity for business growth in the smaller and emerging hedge fund manager space.”
Commenting on what has been some of the most challenging regulations in the last 12 months, Lambert said: “SFTR continues to be challenging for the industry, with the recent slippage in the timeline. Also, market participants are in various stages of the process with a wide range of states of ‘readiness’.”
“Some firms have yet to get a project off the ground. Broadridge is continuing to take a proactive approach to the regulation rather than a wait and see view and we are working with clients, industry associations and other market participants to ensure a smooth transition.”
Lambert added: “Central Securities Depository Regulation is also coming more into focus, and we can anticipate the workload increasing significantly over the next few months.”
Also discussing SFTR, Juliette Kennel, head of securities and foreign exchange markets at SWIFT, said: “In the EU, regulation such as the SFTR and Markets in Financial Instruments Regulation (MiFIR/MiFID II) involve reporting of some kind and the use of ISO 20022 standards.”
“From a regulator’s perspective, it is critical that all reporting entities interpret the specification of the data to be reported in the same way—hence the requirement for using ISO 20022.”
“Without this consistency, data from different entities cannot be meaningfully compared or aggregated, and the policy goals of the regulation can become difficult or impossible to achieve.”
“The rigour and precision of the definitions found in the ISO 20022 business model make it an excellent resource through which to ensure that data elements specified in a regulatory reporting context are interpreted consistently by implementers.”
Kennel continued: “At the same time, the ISO 20022 standard is appealing to regulatory initiatives because it is an open and transparently governed standard that is platform neutral, and free to download, implement, and extend.”
“Reporting entities need to ensure not only that their systems are capable of extracting and collating all the relevant data for each reportable transaction, but also for converting it into the required ISO 20022 format, validating it and sending it within the strict deadlines set out in the regulations.”
“While for some market participants the transition to ISO 20022-based reporting may be a significant transition, the standard is rapidly being adopted by regulators the world over for trade and transaction reporting.”
Noting further challenges besides regulation, Labella highlighted the challenges surrounding technology and platform integration. Adding that ‘plumbing-in’ the various platforms has not been without its challenges.
Key factors and disruptors impacting the market
Discussing the key factors that will disrupt and impact the market for this coming year, Lambert noted that an in-production blockchain solution with a reasonable degree of participation could become a reality this year with Eurex HQLA segment.
“It will be interesting to see how that develops. We can expect more similar blockchain initiatives.”
“Peer to peer, all to all and other new trading platforms have been promoting their products this year with no immediately obvious front-runners appearing. We continue to watch this area with interest.”
Similarly, Kennel also listed technology as a key factor in the market. She said: “The phenomenal growth in digitalisation and connectivity has revolutionised business and stimulated unprecedented economic growth in recent years.”
“However, our increased dependency on information and communication technology has also introduced new threats and risks—not least the dramatic rise in cybercrime.”
For Day, the focus will be looking at people who are talking about the winding up of quantitative easing by global central banks.
He said: “There will be increased volatility out there, so I think that’s one of the areas that could disrupt the wider marketplace and impact the securities lending business.”
Moreover, Day discussed the areas in which agent lenders are perhaps feeling the biggest squeeze, he elaborated on this by saying that the industry continues to be competitive.
“We have to continue to focus on delivering solutions for our clients, and extracting value out of their assets”, Day said.
Ongoing developments
Looking to the future, in the next two years, further growth is expected in the securities lending market. Lambert said that Broadridge expect to see particular growth in HQLA trades, as the need to source collateral for derivatives margin increases with more firms falling under the uncleared margin rules.
“SFTR will drive firms to examine their securities lending infrastructure, and ensure that technology solutions are fit for purpose before the regulatory deadlines.”
“In-house builds are falling out of favour and there is more interest in mutualising compliance costs by using vendor solutions. More utility services could also arise to mutualise costs across the industry.”
He continued: “Once SFTR is out of the way and greater standardisation in place, then firms will look to process improvement and intelligent automation to achieve further cost savings and hit profit and loss targets.”
As well as this, Lambert noted that an increasing ecosystem connectivity will continue to gather pace, and all of these trends will be driven by technology.
Continuing on the point of technology, Labella said: “We’re seeing a more open-minded attitude towards technology. This could help further disrupt the dominance of incumbent securities lending providers, the bulge-bracket banks.”
Labella added: “Platforms focusing on automation and peer-to-peer lending seem likely to gain traction. This could have wide-scale benefits for end-clients like hedge funds in terms of increased supply and lower rates. Furthermore, the efficiency gains arising from these technologies should reduce overall operating costs, making hedge funds more attractive to end-investors from a cost perspective.”
“This would, in theory, benefit emerging hedge fund managers proportionately more so than the billion-dollar club, who already enjoy extremely low operating expense ratios.”
Further focusing on technology, Kennel said that it is expected that the industry will look to how it can use new technologies to help alleviate operational pain points and streamline the post-trade process.
Day added: “Participants in Europe are focused on the wider adoption of pledge models.”
Concluding on a positive note, Lambert said: “Transaction reporting mandates in other jurisdictions should also start to appear on the horizon.The securities finance industry now has a golden opportunity to standardise its data model if it is to achieve some benefits from SFTR and other reporting mandates.”
