Keeping it current
09 April 2019
Simon Lee of eSecLending discusses potential considerations for beneficial owners and their securities lending programmes
Image: Shutterstock
Revenue optimisation
One of the main themes in 2018 for beneficial owners to optimise their programme revenue was for more emphasis to be placed on improvement in meeting borrower demand. Those lenders whose programmes were closer to a broad ‘ideal’ would inevitably outperform those lenders at the other end of the spectrum. It is the undeniable understanding that portfolio composition (quality and quantity) is the primary driver in determining the revenue opportunity available to an individual lender. However, increasingly, decisions concerning route to market, acceptable collateral, and ability to enter term trades are affecting programme performance to an ever-greater degree.
With regulatory expenditure growing across the industry, cost-management becomes an even more important feature of the business in 2019, thus driving this focus on optimising the supply/demand dynamic for beneficial owners. The differential in borrower demand for lendable supply deemed of higher quality will increase. This will provide an opportunity to enhance performance for those lenders that can develop their programmes accordingly, yet hindering those lenders whose programmes are deemed less attractive due to portfolio composition, collateral requirements, or otherwise.
For beneficial owners, the name of the game remains constant—structuring their securities lending programmes within a robust governance framework, ensuring their service providers are delivering on their goals and objectives, and that the risk/reward equation is appropriately managed.
New entrants/new supply
Last year saw several new beneficial owners coming to market, either lending for the first time or re-entering after a hiatus. Many absences even stretched back to the financial crisis in 2008. The reasons behind this are relatively consistent; an increasingly competitive fund management sector that recognises the boost to funding performance that securities lending revenue can provide, and for other asset owners, a greater appreciation of the revenue opportunity that may be left on the table by sitting on the sidelines.
This scenario is expected to continue through 2019, supported by a combination of factors. These include the continued downward pressure on fund management fees and consequential impact on profitability. Additionally, further growth in the passive and exchange-traded funds sector—funds for whom securities lending is often an integral strategic component—and more subjectively, the level of comfort investors have around securities lending—seemingly rising every year—we are removed from 2008; helped by the increase in regulation, education, and transparency in the industry.
With new lenders, there is new lendable supply, which could have a potentially dilutive effect on the performance of individual lenders in the more liquid asset classes and markets. While it is true that the market evolves and identifies new opportunities from lending in new markets to enhanced operational efficiencies through automation, beneficial owners should be cognisant of any potential impact on their individual programme. This may be more the case for those lenders that participate in a pooled programme structure, for whom programme performance is oftentimes relative to other lenders in the pool, and therefore more obviously influenced by the dilutive effect of increased lendable supply within the pool. Going back to previous comments on revenue optimisation, we see further benefits for beneficial owners in considering how programmes may be enhanced to push to the front of the pack. For new entrants, this is another factor to take into the decision-making process when deciding how to best access the market.
Regulation
No article that looks at how the coming year is shaping up is complete without the mention of regulation. Though for our purposes in this article, we will limit our discussion to observations of how beneficial owners are dealing with regulatory change, the potential impact to lending programmes that beneficial owners should be mindful of, and the questions to be asked of service providers in 2019.
Securities Financing Transactions Regulation (SFTR) is the four-letter acronym that will be getting the most airtime from market participants in 2019, with the current expectation that the requirement to report will be live during 2020. While beneficial owners domiciled outside of the EU may not have a reporting requirement per se, their borrowing counterparties and agent lenders will likely be impacted to varying degrees, which for many organisations will require significant human and financial resources. Those beneficial owners not directly impacted by SFTR requirements should still be aware of how their service providers and counterparties may be impacted to avoid any consequential negative impact on their individual programme provision and performance.
Another piece of European regulation, the Central Securities Depositories Regulation (CSDR) will be receiving attention from securities lending market participants this year and next, for the impact that delayed settlement of securities lending transactions in the EU may have on the costs associated with this piece of regulation. The focus for lenders will be on settlement efficiency for new loans, recalled loans, and most importantly for beneficial owners, ensuring timely settlement of sales trades of securities that were on loan at the point of trade and necessitate a market recall.
While market participants lending in emerging and Asian markets are well versed in the risks associated with failed settlement in these markets and associated costs, operational efficiency will come under increasing scrutiny through this coming year, thanks to CSDR.
Although no longer a topic that is considered new, the cost of regulatory capital on the business remains as relevant today as it ever was, even as the impact on securities lending programmes continues to develop. As we noted at the outset, beneficial owners that best meet the evolving borrower demand dynamic will stand to profit most from enhanced programme performance. These shifts in demand are in part a product of the regulatory costs faced by borrowers. So, to comprehensively examine this topic, we need to look at the key regulatory costs facing agent lenders and most importantly indemnification costs, which is potentially the biggest impact on beneficial owners.
Again, while the topic is one that has been a talking point among agent lenders and beneficial owners for some time, the discussion does not stand still. As other regulatory costs come to the forefront, existing costs like indemnification provisions must get reviewed in a new context, and programmes may be adapted accordingly. Revised fee splits, limitations on the scope of indemnities, and restrictions on lending activity are all potential adaptations open to agent lenders to manage these costs.
Given the relevance, these considerations have to individual programme performance, staying current to the circumstances of their indemnification policy should be on every beneficial owner’s agenda this year.
One of the main themes in 2018 for beneficial owners to optimise their programme revenue was for more emphasis to be placed on improvement in meeting borrower demand. Those lenders whose programmes were closer to a broad ‘ideal’ would inevitably outperform those lenders at the other end of the spectrum. It is the undeniable understanding that portfolio composition (quality and quantity) is the primary driver in determining the revenue opportunity available to an individual lender. However, increasingly, decisions concerning route to market, acceptable collateral, and ability to enter term trades are affecting programme performance to an ever-greater degree.
With regulatory expenditure growing across the industry, cost-management becomes an even more important feature of the business in 2019, thus driving this focus on optimising the supply/demand dynamic for beneficial owners. The differential in borrower demand for lendable supply deemed of higher quality will increase. This will provide an opportunity to enhance performance for those lenders that can develop their programmes accordingly, yet hindering those lenders whose programmes are deemed less attractive due to portfolio composition, collateral requirements, or otherwise.
For beneficial owners, the name of the game remains constant—structuring their securities lending programmes within a robust governance framework, ensuring their service providers are delivering on their goals and objectives, and that the risk/reward equation is appropriately managed.
New entrants/new supply
Last year saw several new beneficial owners coming to market, either lending for the first time or re-entering after a hiatus. Many absences even stretched back to the financial crisis in 2008. The reasons behind this are relatively consistent; an increasingly competitive fund management sector that recognises the boost to funding performance that securities lending revenue can provide, and for other asset owners, a greater appreciation of the revenue opportunity that may be left on the table by sitting on the sidelines.
This scenario is expected to continue through 2019, supported by a combination of factors. These include the continued downward pressure on fund management fees and consequential impact on profitability. Additionally, further growth in the passive and exchange-traded funds sector—funds for whom securities lending is often an integral strategic component—and more subjectively, the level of comfort investors have around securities lending—seemingly rising every year—we are removed from 2008; helped by the increase in regulation, education, and transparency in the industry.
With new lenders, there is new lendable supply, which could have a potentially dilutive effect on the performance of individual lenders in the more liquid asset classes and markets. While it is true that the market evolves and identifies new opportunities from lending in new markets to enhanced operational efficiencies through automation, beneficial owners should be cognisant of any potential impact on their individual programme. This may be more the case for those lenders that participate in a pooled programme structure, for whom programme performance is oftentimes relative to other lenders in the pool, and therefore more obviously influenced by the dilutive effect of increased lendable supply within the pool. Going back to previous comments on revenue optimisation, we see further benefits for beneficial owners in considering how programmes may be enhanced to push to the front of the pack. For new entrants, this is another factor to take into the decision-making process when deciding how to best access the market.
Regulation
No article that looks at how the coming year is shaping up is complete without the mention of regulation. Though for our purposes in this article, we will limit our discussion to observations of how beneficial owners are dealing with regulatory change, the potential impact to lending programmes that beneficial owners should be mindful of, and the questions to be asked of service providers in 2019.
Securities Financing Transactions Regulation (SFTR) is the four-letter acronym that will be getting the most airtime from market participants in 2019, with the current expectation that the requirement to report will be live during 2020. While beneficial owners domiciled outside of the EU may not have a reporting requirement per se, their borrowing counterparties and agent lenders will likely be impacted to varying degrees, which for many organisations will require significant human and financial resources. Those beneficial owners not directly impacted by SFTR requirements should still be aware of how their service providers and counterparties may be impacted to avoid any consequential negative impact on their individual programme provision and performance.
Another piece of European regulation, the Central Securities Depositories Regulation (CSDR) will be receiving attention from securities lending market participants this year and next, for the impact that delayed settlement of securities lending transactions in the EU may have on the costs associated with this piece of regulation. The focus for lenders will be on settlement efficiency for new loans, recalled loans, and most importantly for beneficial owners, ensuring timely settlement of sales trades of securities that were on loan at the point of trade and necessitate a market recall.
While market participants lending in emerging and Asian markets are well versed in the risks associated with failed settlement in these markets and associated costs, operational efficiency will come under increasing scrutiny through this coming year, thanks to CSDR.
Although no longer a topic that is considered new, the cost of regulatory capital on the business remains as relevant today as it ever was, even as the impact on securities lending programmes continues to develop. As we noted at the outset, beneficial owners that best meet the evolving borrower demand dynamic will stand to profit most from enhanced programme performance. These shifts in demand are in part a product of the regulatory costs faced by borrowers. So, to comprehensively examine this topic, we need to look at the key regulatory costs facing agent lenders and most importantly indemnification costs, which is potentially the biggest impact on beneficial owners.
Again, while the topic is one that has been a talking point among agent lenders and beneficial owners for some time, the discussion does not stand still. As other regulatory costs come to the forefront, existing costs like indemnification provisions must get reviewed in a new context, and programmes may be adapted accordingly. Revised fee splits, limitations on the scope of indemnities, and restrictions on lending activity are all potential adaptations open to agent lenders to manage these costs.
Given the relevance, these considerations have to individual programme performance, staying current to the circumstances of their indemnification policy should be on every beneficial owner’s agenda this year.
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100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
