Va va boom: increasing securities lending revs
04 February 2014
The hunt for revenue is perilous and fraught with danger, or is it?
Image: Shutterstock
Profit, as its clairvoyant cousin of similar spelling is wont to do, is impossible to predict. Of course, the age of data has made profit and loss projections more than just educated guesses, but what happens a day from now could be vastly different to what was predicted. While the assumption joke cannot be repeated here, its humourous point is still valid—assume at your peril.
Custodian banks and agent lenders regularly publish their financial results. State Street’s Q4 2013 earnings came out on 24 January, revealing a securities finance revenue increase for the bank.
The bank, a global financial services provider with $27.43 trillion in assets under custody and administration, and $2.35 trillion in assets under management, reported that it earned securities finance revenue of $76 million in Q4 2013, an increase of 2.7 percent from Q3 2013 and Q4 2012, respectively.
Chria Holzarth, senior managing director in securities finance at State Street Global Markets, comments: “We saw securities finance revenue increase approximately 3 percent from both the third quarter of 2013 and the fourth quarter of 2012 (securities finance revenue was not up for the full year 2013, just up sequentially in the fourth quarter) and average securities on loan were relatively unchanged sequentially at $315 billion.”
“Securities lending continues to be a source of returns for our clients, and while it is often cyclical, it still plays an important role in portfolios.”
At approximately the same time as State Street, Northern Trust brought out its Q4 2013 results. Banks, and financial institutions in general, tend to vary in how they report their earnings, so a measure of explanation is required to understand the context in which Northern Trust has reported a securities lending revenue increase.
Investment, trust and other servicing fees at Northern Trust reached $673.8 million in Q4 2013, an 8 percent increase on the previous year. The $51.2 million increase over Q4 2012’s $622.6 million “primarily reflects new business and the favourable impact of equity markets, partially offset by higher waived fees in money market mutual funds”.
Assets under custody and assets under management are the primary drivers of Northern Trust’s investment, trust and other servicing fees. The bank’s corporate and institutional services (C&IS) and wealth management businesses had combined assets of $5.6 trillion under custody and $884.5 trillion under management in Q4 2013.
C&IS trust, investment and other servicing fees increased $26.8 million, or 8 percent, to $371.1 million in Q4 2013 from the prior year quarter’s $344.3 million.
So, securities lending revenue at Northern Trust increased 7 percent, “primarily reflecting higher volumes in the current quarter”. But revenue was down 4 percent in Q4 2013 Q3 2013, due to lower volumes.
Commenting on the results, Andy Clayton, senior vice president and head of global securities lending at Northern Trust, says: “[Our] securities lending revenue increase was attributed to a combination of several new client wins, expansion of acceptable collateral types, the addition of new distribution channels and improved efficiencies. Throughout 2013, we remained focused on developing programme enhancements for the benefit of our clients.”
Ed Oliver, senior vice president and head of product development at securities lending agent eSecLending, which was bought by a private equity firm in August 2013, discussed securities lending revenue at the 18th Global Securities Finance Summit in Luxembourg.
In an interview following the event, he described revenues in securities lending as “consistent for some time”.
He says: “During the Global Securities Finance Summit, our panel showed some graphs from Markit that demonstrated on-loan balances have been flat for five years and equity utilisation is at a seven-year low. In that context, one could conclude that any securities lending agent achieving a revenue increase year over year is doing a good job.”
“The data from SunGard also showed that the majority of revenues now come from a small number of super-specials (above 500 bps) and so it is also important that you have a diverse lending base where you have a good chance of exposure to those assets.”
The sentiment of the audience at the Global Securities Finance Summit “was very disparate”, according to Oliver. “There remains a lot of regulatory uncertainty in our business at the moment.”
“However, there are some positive signs with reports of hedge fund managers raising capital to start to take more short positions. Allocations to long/short strategies are at the highest levels in the last four years.”
“We also have seen some good M&A activity in the early weeks of 2014. However, our panel discussion suggested the best opportunity for growing revenues was from emerging markets and we agree with that.”
Holzarth adds that despite the ambiguity of regulatory reform, the market has shown signs of stabilisation.
“Client engagement has been strong and reflective of a flight to quality to providers who have distinguished themselves over the long-term by delivering strong risk-adjusted returns and whose service commitment underscores a core competency within their respective organisation.”
Clayton is equally positive: “Although the regulatory environment and its impact on borrower demand will remain a factor in the coming year, our continued expansion of acceptable collateral and distribution channels, coupled with the implementation of technology enhancements, well position Northern Trust to maximise revenue opportunities in 2014.”
Regulation—again
The ever-present specter of regulation will affect revenue, agree Oliver, Holzarth and Clayton, with Basel III, shadow banking, the Financial Transaction Tax (FTT) and the work of national regulators likely to result in significant changes to securities lending.
Holzarth says: “Of particular note are the large exposure limits/single counterparty limits, which may require the reduction in transactions between certain participants, and the standardised approach to risk-weighted assets (RWA) under Basel III, which all US banks will have to apply (they would then determine which measure, the advanced or standardised would be applied based on which is the most conservative at an institution level).”
“The potential increase in RWA and the associated capital that would be required may make certain indemnified transactions less appealing to agent lenders.”
“The industry will likely adapt to these regulatory pressures by developing and enhancing alternative routes to markets, such as central counterparties and principal lending,” he adds.
Clayton says: “Northern Trust, along with other industry participants, is actively monitoring the cumulative impact of global regulatory developments. The level of uncertainty that surrounds the regulatory environment is negatively impacting borrower demand. Depending upon the final outcome of regulations such as Basel III and the Financial Transaction Tax, securities lending demand may be affected. We continue to engage with federal agencies on these regulations either directly or through industry groups.”
The EU 11’s FTT has the biggest potential to affect revenue, according to Oliver.
“There is no certainty on how it will affect the business but if it is implemented as proposed we all know that the impact will be substantial. Other regulations may also begin to affect the business this year as, for example, borrowers start to position themselves under Basel III requirements.”
“Agent lenders need to be responsive to the new demand landscape in order to maintain revenues and potentially increase revenues where opportunities exist to do so. It is important that agent lenders start communicating the impact of these regulatory drivers on their securities lending business to their client base as things will change. As an example, general collateral transactions, which make up to 80 percent of securities lending volumes, are likely to shrink substantially, but fortunately they only provide 20 percent of the revenues.”
Custodian banks and agent lenders regularly publish their financial results. State Street’s Q4 2013 earnings came out on 24 January, revealing a securities finance revenue increase for the bank.
The bank, a global financial services provider with $27.43 trillion in assets under custody and administration, and $2.35 trillion in assets under management, reported that it earned securities finance revenue of $76 million in Q4 2013, an increase of 2.7 percent from Q3 2013 and Q4 2012, respectively.
Chria Holzarth, senior managing director in securities finance at State Street Global Markets, comments: “We saw securities finance revenue increase approximately 3 percent from both the third quarter of 2013 and the fourth quarter of 2012 (securities finance revenue was not up for the full year 2013, just up sequentially in the fourth quarter) and average securities on loan were relatively unchanged sequentially at $315 billion.”
“Securities lending continues to be a source of returns for our clients, and while it is often cyclical, it still plays an important role in portfolios.”
At approximately the same time as State Street, Northern Trust brought out its Q4 2013 results. Banks, and financial institutions in general, tend to vary in how they report their earnings, so a measure of explanation is required to understand the context in which Northern Trust has reported a securities lending revenue increase.
Investment, trust and other servicing fees at Northern Trust reached $673.8 million in Q4 2013, an 8 percent increase on the previous year. The $51.2 million increase over Q4 2012’s $622.6 million “primarily reflects new business and the favourable impact of equity markets, partially offset by higher waived fees in money market mutual funds”.
Assets under custody and assets under management are the primary drivers of Northern Trust’s investment, trust and other servicing fees. The bank’s corporate and institutional services (C&IS) and wealth management businesses had combined assets of $5.6 trillion under custody and $884.5 trillion under management in Q4 2013.
C&IS trust, investment and other servicing fees increased $26.8 million, or 8 percent, to $371.1 million in Q4 2013 from the prior year quarter’s $344.3 million.
So, securities lending revenue at Northern Trust increased 7 percent, “primarily reflecting higher volumes in the current quarter”. But revenue was down 4 percent in Q4 2013 Q3 2013, due to lower volumes.
Commenting on the results, Andy Clayton, senior vice president and head of global securities lending at Northern Trust, says: “[Our] securities lending revenue increase was attributed to a combination of several new client wins, expansion of acceptable collateral types, the addition of new distribution channels and improved efficiencies. Throughout 2013, we remained focused on developing programme enhancements for the benefit of our clients.”
Ed Oliver, senior vice president and head of product development at securities lending agent eSecLending, which was bought by a private equity firm in August 2013, discussed securities lending revenue at the 18th Global Securities Finance Summit in Luxembourg.
In an interview following the event, he described revenues in securities lending as “consistent for some time”.
He says: “During the Global Securities Finance Summit, our panel showed some graphs from Markit that demonstrated on-loan balances have been flat for five years and equity utilisation is at a seven-year low. In that context, one could conclude that any securities lending agent achieving a revenue increase year over year is doing a good job.”
“The data from SunGard also showed that the majority of revenues now come from a small number of super-specials (above 500 bps) and so it is also important that you have a diverse lending base where you have a good chance of exposure to those assets.”
The sentiment of the audience at the Global Securities Finance Summit “was very disparate”, according to Oliver. “There remains a lot of regulatory uncertainty in our business at the moment.”
“However, there are some positive signs with reports of hedge fund managers raising capital to start to take more short positions. Allocations to long/short strategies are at the highest levels in the last four years.”
“We also have seen some good M&A activity in the early weeks of 2014. However, our panel discussion suggested the best opportunity for growing revenues was from emerging markets and we agree with that.”
Holzarth adds that despite the ambiguity of regulatory reform, the market has shown signs of stabilisation.
“Client engagement has been strong and reflective of a flight to quality to providers who have distinguished themselves over the long-term by delivering strong risk-adjusted returns and whose service commitment underscores a core competency within their respective organisation.”
Clayton is equally positive: “Although the regulatory environment and its impact on borrower demand will remain a factor in the coming year, our continued expansion of acceptable collateral and distribution channels, coupled with the implementation of technology enhancements, well position Northern Trust to maximise revenue opportunities in 2014.”
Regulation—again
The ever-present specter of regulation will affect revenue, agree Oliver, Holzarth and Clayton, with Basel III, shadow banking, the Financial Transaction Tax (FTT) and the work of national regulators likely to result in significant changes to securities lending.
Holzarth says: “Of particular note are the large exposure limits/single counterparty limits, which may require the reduction in transactions between certain participants, and the standardised approach to risk-weighted assets (RWA) under Basel III, which all US banks will have to apply (they would then determine which measure, the advanced or standardised would be applied based on which is the most conservative at an institution level).”
“The potential increase in RWA and the associated capital that would be required may make certain indemnified transactions less appealing to agent lenders.”
“The industry will likely adapt to these regulatory pressures by developing and enhancing alternative routes to markets, such as central counterparties and principal lending,” he adds.
Clayton says: “Northern Trust, along with other industry participants, is actively monitoring the cumulative impact of global regulatory developments. The level of uncertainty that surrounds the regulatory environment is negatively impacting borrower demand. Depending upon the final outcome of regulations such as Basel III and the Financial Transaction Tax, securities lending demand may be affected. We continue to engage with federal agencies on these regulations either directly or through industry groups.”
The EU 11’s FTT has the biggest potential to affect revenue, according to Oliver.
“There is no certainty on how it will affect the business but if it is implemented as proposed we all know that the impact will be substantial. Other regulations may also begin to affect the business this year as, for example, borrowers start to position themselves under Basel III requirements.”
“Agent lenders need to be responsive to the new demand landscape in order to maintain revenues and potentially increase revenues where opportunities exist to do so. It is important that agent lenders start communicating the impact of these regulatory drivers on their securities lending business to their client base as things will change. As an example, general collateral transactions, which make up to 80 percent of securities lending volumes, are likely to shrink substantially, but fortunately they only provide 20 percent of the revenues.”
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