Has the boat steadied in US securities lending?
28 April 2020
As head of agency lending at BMO Global Asset Management, Christopher Kunkle shares his outlook and wisdom on the current US market upheaval and how the pandemic is affecting securities lending
Image: ifong/Shutterstock.com
The coronavirus pandemic has massively affected global stock markets, but how is it hitting securities lending businesses?
For the past couple of years, US equities and other financial activities in the US have been fairly robust and even overseas markets have been stable. Now, COVID-19 is hurting infrastructure and people’s ability to work. It’s damaging confidence in small-and-medium-sized-entities, and even large firms have had a massive impact on business in the US and globally.
From a securities lending perspective, the question is how this affects the ability to lend securities for agent lenders and their clients. At the same time, is the ability to borrow securities being undermined? A capital utilisation impact on a borrower will affect their needs and demands for financing and short coverage and other activities.
For the European stock markets specifically, this is happening right through the middle of the yield enhancement season and dividend season in Europe, which is approximately January through to May.
I think, for the most part, agent lenders’ clients and borrowers are getting through this with a lot of communication. Borrower demand is down a bit as they are having to be careful from a capital perspective. This will affect lenders differently depending on what’s in their portfolio. Some may be down significantly while others may be only slightly affected. I can’t speak for every business in the country or in the world but the effects of the pandemic are across the board. It is affecting securities lending from the borrowing and the supply side.
For BMO, the areas we look at most importantly right now is liquidity in our reinvestments, which are holding up in addition to counterparty credit risk. I’m assuming some people have had tighter issues than others, but that’s just an assumption.
For the most part, there hasn’t been any mass default issues around borrowers. While some borrowers may be in rougher shape than others, most are getting through for their financing and demand needs.
I can’t speak for Europe, but in the US things are pretty stable in the borrowing network. Demand for general collateral has been even further down since the middle of March.
At the beginning of the year there were plans for a busy regulatory schedule including potential changes to SEC Rule 15c3-3. What has the pandemic done to these plans?
In Europe, prior to the pandemic, there were a variety of regulatory efforts that the market was working diligently to meet, but many of those have been delayed.
In the US, we are proactively working towards equities as collateral in securities finance transaction. Equities as collateral is something that the Securities and Exchange Commission (SEC) has been reviewing working with the Risk Management Association (RMA) and SIFMA. However, the SEC has gone into a “high-priority item” methodology within the COVID-19 pandemic so 15c3-3 will probably not be reviewed during this timeframe.
A temporary repo facility was put in place by the Fed recently, do you think this will be effective?
I think it will keep knee-jerk reactions from occurring. The various facilities that are now in place help create liquidity and if an agent or short-term fund feels it’s in a jam you have a place to get a fair price. Short term investment and funds are already benefiting from the facilities.
The US banks just got through Q1, how was that? Liquidity problems?
For the most part, from a securities lending point of view, we are getting through it fine, a couple of organisations that have affiliated money market funds unrelated to securities lending may have needed some support. Most banking operations get affected when rates go lower. It makes it harder for banks to earn revenue, trading revenue, transaction revenue, but the banks are fairly healthy and the Fed are putting in these facilities to help out where needed.
The US Fed has injected a lot of cash into the market to steady the boat, did that help?
It is steadying the boat, but the boat is still going to jibe left and jibe right periodically. The Fed’s support helps the mentality of the general public and the traders, which avoids a knee-jerk reaction when they’re nervous of something caused by coronavirus.
You had a period of time a few weeks ago, when people were uncomfortable with money markets. A couple of places have had to put restrictors on money markets, that’s a knee jerk reaction, that’s fear, that’s what this pandemic is doing. The Federal stimulus creates facilities to mitigate these hysterical periods by keeping liquidity up at a fair price.
Comparing the coronavirus pandemic’s effect on the market to the financial crisis in 2008, are we seeing a similar trend? What kind of recovery can we expect?
A lot of firms are in a much stronger place than they were in 2008. On the surface this is a health crisis, whereas 2008 was a credit/liquidity crisis.
There was one major default during that crisis and a few near misses. A lot of regulatory work has gone on since then to avoid a repeat of that situation and you’re seeing the benefits of that work now as banks are being tested.
If the election goes ahead at the end of the year, how will it affect the markets?
I think the US has a Republican president who is seen as very business friendly, then you have a Democratic contender who’s moderate, and not overly progressive. I think both of them are safe candidates for future business and stability.
Joe Biden is not ultra-progressive and will probably not scare Wall Street as he’s more middle of the road. I believe that either candidate will continue institutional business in a somewhat stable manner.
For the past couple of years, US equities and other financial activities in the US have been fairly robust and even overseas markets have been stable. Now, COVID-19 is hurting infrastructure and people’s ability to work. It’s damaging confidence in small-and-medium-sized-entities, and even large firms have had a massive impact on business in the US and globally.
From a securities lending perspective, the question is how this affects the ability to lend securities for agent lenders and their clients. At the same time, is the ability to borrow securities being undermined? A capital utilisation impact on a borrower will affect their needs and demands for financing and short coverage and other activities.
For the European stock markets specifically, this is happening right through the middle of the yield enhancement season and dividend season in Europe, which is approximately January through to May.
I think, for the most part, agent lenders’ clients and borrowers are getting through this with a lot of communication. Borrower demand is down a bit as they are having to be careful from a capital perspective. This will affect lenders differently depending on what’s in their portfolio. Some may be down significantly while others may be only slightly affected. I can’t speak for every business in the country or in the world but the effects of the pandemic are across the board. It is affecting securities lending from the borrowing and the supply side.
For BMO, the areas we look at most importantly right now is liquidity in our reinvestments, which are holding up in addition to counterparty credit risk. I’m assuming some people have had tighter issues than others, but that’s just an assumption.
For the most part, there hasn’t been any mass default issues around borrowers. While some borrowers may be in rougher shape than others, most are getting through for their financing and demand needs.
I can’t speak for Europe, but in the US things are pretty stable in the borrowing network. Demand for general collateral has been even further down since the middle of March.
At the beginning of the year there were plans for a busy regulatory schedule including potential changes to SEC Rule 15c3-3. What has the pandemic done to these plans?
In Europe, prior to the pandemic, there were a variety of regulatory efforts that the market was working diligently to meet, but many of those have been delayed.
In the US, we are proactively working towards equities as collateral in securities finance transaction. Equities as collateral is something that the Securities and Exchange Commission (SEC) has been reviewing working with the Risk Management Association (RMA) and SIFMA. However, the SEC has gone into a “high-priority item” methodology within the COVID-19 pandemic so 15c3-3 will probably not be reviewed during this timeframe.
A temporary repo facility was put in place by the Fed recently, do you think this will be effective?
I think it will keep knee-jerk reactions from occurring. The various facilities that are now in place help create liquidity and if an agent or short-term fund feels it’s in a jam you have a place to get a fair price. Short term investment and funds are already benefiting from the facilities.
The US banks just got through Q1, how was that? Liquidity problems?
For the most part, from a securities lending point of view, we are getting through it fine, a couple of organisations that have affiliated money market funds unrelated to securities lending may have needed some support. Most banking operations get affected when rates go lower. It makes it harder for banks to earn revenue, trading revenue, transaction revenue, but the banks are fairly healthy and the Fed are putting in these facilities to help out where needed.
The US Fed has injected a lot of cash into the market to steady the boat, did that help?
It is steadying the boat, but the boat is still going to jibe left and jibe right periodically. The Fed’s support helps the mentality of the general public and the traders, which avoids a knee-jerk reaction when they’re nervous of something caused by coronavirus.
You had a period of time a few weeks ago, when people were uncomfortable with money markets. A couple of places have had to put restrictors on money markets, that’s a knee jerk reaction, that’s fear, that’s what this pandemic is doing. The Federal stimulus creates facilities to mitigate these hysterical periods by keeping liquidity up at a fair price.
Comparing the coronavirus pandemic’s effect on the market to the financial crisis in 2008, are we seeing a similar trend? What kind of recovery can we expect?
A lot of firms are in a much stronger place than they were in 2008. On the surface this is a health crisis, whereas 2008 was a credit/liquidity crisis.
There was one major default during that crisis and a few near misses. A lot of regulatory work has gone on since then to avoid a repeat of that situation and you’re seeing the benefits of that work now as banks are being tested.
If the election goes ahead at the end of the year, how will it affect the markets?
I think the US has a Republican president who is seen as very business friendly, then you have a Democratic contender who’s moderate, and not overly progressive. I think both of them are safe candidates for future business and stability.
Joe Biden is not ultra-progressive and will probably not scare Wall Street as he’s more middle of the road. I believe that either candidate will continue institutional business in a somewhat stable manner.
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