Optimising securities lending in dynamic times
02 October 2018
A close relationship between lenders and agents remains the focal point of a successful securities lending programme in today’s ever-changing environment. Mary Jane Schuessler from RBC Investor & Treasury Services elaborates
Image: Shutterstock
Changing demand landscape
The regulatory focus on liquidity coverage following the financial crisis has increased demand for high-quality liquid assets (HQLA), effectively switching the majority of securities lending balances from equity to fixed income. As the demand for HQLA increases, a growing proportion of revenue is generated by fixed income loans, which tend to provide a relatively stable revenue stream. This stability is proving attractive to both new and existing lenders, who are looking for opportunities to drive incremental alpha on their idle assets.
In addition, interest in structured lending opportunities, including term loans, is on the rise. While borrowers are seeking HQLA, they are also looking for defined loan periods and willing to pay premium fees. Collateral flexibility is essential in these situations and the acceptance of lower-grade collateral, such as equity, is generally required in order for beneficial owners to optimise the benefits of term loans.
Despite changing demand dynamics, equities remain a significant component of on-loan balances. Demand for general collateral persists and the returns from specials continue to make a significant contribution to the revenue profile of a balanced asset mix. In Canada, for example, the cannabis sector has played a prominent role in the warm and hot space during the lead up to cannabis legalisation, which is scheduled for 17 October.
Collateral flexibility
As the borrower community looks to allocate their collateral balances where it makes the most economic sense, conversations between agent lenders and beneficial owners around collateral flexibility have become increasingly important and more frequent. Wider collateral acceptance can lead to higher lending volumes and premiums on structured term lending opportunities. However, decisions to expand the collateral matrix are largely dependent on a beneficial owner’s risk appetite. Striking the right balance between risk and collateral acceptance is key to optimising a securities lending programme.
Regulatory constraints may limit the ability of a lender to accept certain types of collateral. Efforts are underway by industry organisations such as the Canadian Securities Lending Association and the US-based Risk Management Association to level the regulatory playing field and provide beneficial owners with greater collateral flexibility. As borrowers continue to demand wider collateral profiles, these industry initiatives will take on even greater importance, providing potential to increase the attractiveness of a beneficial owner’s portfolio.
Understanding the risks and maintaining oversight
Securities lending is not a ‘one size fits all’ scenario. As beneficial owners tailor their programme, it is important that they have a comprehensive understanding of the inherent risks and how agent lenders can help. This requires a close working relationship between both parties and providing the agent lender with a good understanding of the beneficial owner’s risk tolerance is key. While the conversation around demand drivers and collateral options has shifted in recent years, the risk discussion remains at the forefront.
In addition, topics such as data visualisation, agile thinking and robotic process automation have recently surfaced within many facets of the financial services industry, including the securities finance sector. Initiatives in these areas are expected to take on increasing prominence as they offer beneficial owners the potential for increased transparency and the ability to take a regular pulse on their lending activity.
Engaging with agent lenders
It is important for beneficial owners and their agents to spend time together reviewing programme objectives, discussing the inherent risks based on the lender’s risk tolerance and sharing information on lending performance. Such ongoing engagement provides lenders with the comfort that their portfolios are being optimised in line with the agreed risk appetite. It also enables agent lenders to balance the changes in beneficial owners’ investment portfolios with evolving requirements of the borrowing community.
While ongoing discussions around risk management and performance tracking are essential, the conversation also needs to cover the impact of changing regulatory regimes on lending activities. An important role for agent lenders is to work with the various industry and regulatory bodies on behalf of both the beneficial owner and borrower communities, which often share common goals.
The securities lending market continues to evolve largely based on a changing demand landscape, which is driving calls for increased collateral flexibility through regulatory change. As these discussions progress, the close working relationship between beneficial owners and agents will be even more important.
The regulatory focus on liquidity coverage following the financial crisis has increased demand for high-quality liquid assets (HQLA), effectively switching the majority of securities lending balances from equity to fixed income. As the demand for HQLA increases, a growing proportion of revenue is generated by fixed income loans, which tend to provide a relatively stable revenue stream. This stability is proving attractive to both new and existing lenders, who are looking for opportunities to drive incremental alpha on their idle assets.
In addition, interest in structured lending opportunities, including term loans, is on the rise. While borrowers are seeking HQLA, they are also looking for defined loan periods and willing to pay premium fees. Collateral flexibility is essential in these situations and the acceptance of lower-grade collateral, such as equity, is generally required in order for beneficial owners to optimise the benefits of term loans.
Despite changing demand dynamics, equities remain a significant component of on-loan balances. Demand for general collateral persists and the returns from specials continue to make a significant contribution to the revenue profile of a balanced asset mix. In Canada, for example, the cannabis sector has played a prominent role in the warm and hot space during the lead up to cannabis legalisation, which is scheduled for 17 October.
Collateral flexibility
As the borrower community looks to allocate their collateral balances where it makes the most economic sense, conversations between agent lenders and beneficial owners around collateral flexibility have become increasingly important and more frequent. Wider collateral acceptance can lead to higher lending volumes and premiums on structured term lending opportunities. However, decisions to expand the collateral matrix are largely dependent on a beneficial owner’s risk appetite. Striking the right balance between risk and collateral acceptance is key to optimising a securities lending programme.
Regulatory constraints may limit the ability of a lender to accept certain types of collateral. Efforts are underway by industry organisations such as the Canadian Securities Lending Association and the US-based Risk Management Association to level the regulatory playing field and provide beneficial owners with greater collateral flexibility. As borrowers continue to demand wider collateral profiles, these industry initiatives will take on even greater importance, providing potential to increase the attractiveness of a beneficial owner’s portfolio.
Understanding the risks and maintaining oversight
Securities lending is not a ‘one size fits all’ scenario. As beneficial owners tailor their programme, it is important that they have a comprehensive understanding of the inherent risks and how agent lenders can help. This requires a close working relationship between both parties and providing the agent lender with a good understanding of the beneficial owner’s risk tolerance is key. While the conversation around demand drivers and collateral options has shifted in recent years, the risk discussion remains at the forefront.
In addition, topics such as data visualisation, agile thinking and robotic process automation have recently surfaced within many facets of the financial services industry, including the securities finance sector. Initiatives in these areas are expected to take on increasing prominence as they offer beneficial owners the potential for increased transparency and the ability to take a regular pulse on their lending activity.
Engaging with agent lenders
It is important for beneficial owners and their agents to spend time together reviewing programme objectives, discussing the inherent risks based on the lender’s risk tolerance and sharing information on lending performance. Such ongoing engagement provides lenders with the comfort that their portfolios are being optimised in line with the agreed risk appetite. It also enables agent lenders to balance the changes in beneficial owners’ investment portfolios with evolving requirements of the borrowing community.
While ongoing discussions around risk management and performance tracking are essential, the conversation also needs to cover the impact of changing regulatory regimes on lending activities. An important role for agent lenders is to work with the various industry and regulatory bodies on behalf of both the beneficial owner and borrower communities, which often share common goals.
The securities lending market continues to evolve largely based on a changing demand landscape, which is driving calls for increased collateral flexibility through regulatory change. As these discussions progress, the close working relationship between beneficial owners and agents will be even more important.
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