Modernising the securities lending infrastructure
19 June 2020
OCC has set out a vision to establish a permissioned distributed ledger network for cleared securities lending transactions
Image: Matt Wolfe/OCC
The role of the Options Clearing Corporation (OCC), the world’s largest equity derivatives clearing organisation, in the securities lending market is to serve as the central counterparty (CCP) for lenders and borrowers.
As a CCP, we provide a guarantee of performance and mitigate the risk of loss due to a failure by the original lender or borrower.
We identified some common industry challenges by listening to market participants and we are working on developing solutions and tools to help them lower their costs stemming from manual processes, lack of automation, and disparate systems. That is why we are working with Axoni, a technology firm that specialises in multi-party workflows and infrastructure, to develop and implement a distributed ledger technology (DLT) solution to replace our existing securities lending infrastructure. This new technology solution will benefit our clearing member firms and securities lending market participants by increasing efficiency and reducing reconciliation and associated costs. This new platform will also lay the foundation for a future fit CCP securities lending model.
Our vision of the initial roll-out is to establish a permissioned distributed ledger network for cleared stock loan transactions, governed by OCC. With the potential for peer nodes at clearing member firms that will enable participants to have a real time, accurate copy of contract and activity information, thereby reducing the need for manual reconciliation. The solution will be deployed using AxCore, Axoni’s distributed ledger protocol, and is slated to be hosted in the cloud.
OCC, Axoni and our clearing member firms already have identified several opportunities to further streamline processing within the securities lending marketplace once the baseline platform has been established.
Our securities lending programme was created in 1993 to clear and guarantee transactions between our clearing member firms, with OCC serving as the CCP to lenders and borrowers. Since 2017, securities lending clearing volumes have increased by a compound annual growth rate of 16 percent, and open interest has grown by 22 percent. As of 30 April, OCC balances were approximately $72 billion, which is about 13 percent of the total equities on loan across the Americas.
The 2010 Dodd Frank Act and the establishment of minimum risk-based capital requirements have been key drivers of increased CCP usage. More recent regulatory changes may also generate additional interest in the CCP securities lending model. As the uncleared margin rules for non-cleared derivatives continue to be applied to more and more counterparties, it is possible more firms might look for alternative ways to achieve the same financial outcome of gaining exposure to a security or hedging the risk of financing. Securities lending through a CCP may provide opportunities to do that in an equivalent way on potentially a lower cost basis.
To help us get to this point, we have been executing a three-stage strategic plan that reinforces our foundation as a resilient CCP, allowing us to begin work on new products and enhanced services to help our clearing member firms gain capital savings, and innovate for the future.
For our securities lending programme, our new DLT platform will support an enhanced model that will more closely align with market practices and better reflect OCC’s role as a CCP. Some of the programme enhancements that OCC is working on include a new trade interface to receive and confirm details of transactions prior to them settling and/or updating contracts.
By confirming counterparty agreement before the fact, we can help reduce the challenges associated with reconciliation and agreement after the fact. This new trade interface will also allow OCC to have more complete contract details to reduce residual counterparty credit risk on interest and cash distributions. Not only will this reduce risk, but the settlement of these cash flows will be far more efficient through single net payments to-and-from OCC as opposed to myriad counterparty-specific payments needed today.
Once this new platform and technology are in place, we will begin taking steps toward introducing services such as support for baskets of loans for term financing, as well as non-cash loans, as part of growing our base.
In terms of future opportunities, we are looking at how we can expand our membership eligibility to support entities that have not been able to self-clear in the past (e.g. banks, corporations, and others). We are also looking at buy-side specific solutions, where CCP securities lending creates potential for higher utilisation, lower costs, and improved pricing.
Most buy-side firms’ securities lending activities are facilitated by agent lenders that are subject to capital requirements, as are most borrowers. Clearing transactions through a CCP like OCC means that the regulatory capital requirements are typically about 95 percent less than uncleared bilateral transaction. Not only could that reduce the costs of agent lenders, it also could create potential for borrowers to be able to borrow greater amounts of securities or offer better pricing for the securities they are already borrowing. All of these should boost the profitability of lending programmes.
At the core of this work is our Renaissance Initiative, a multi-year effort to modernise our risk management, clearing and data systems. The point of Renaissance is to make sure we are delivering on what the industry needs. We are working closely with our clearing member firms to understand what they need in the short term and also thinking about what we can do now to ensure we are addressing needs that may be unidentified, perhaps five to ten years down the road.
There are other ways that OCC is working with the industry on solutions that will benefit all of us. One example is our work with the FIX Trading Community on a set of enhancements to the FIX messaging standard for securities lending. Adoption of standards has helped improve other areas of the financial markets, (e.g. equities and derivatives), and we are working to bring those benefits to the securities lending market. This will enable more accurate communication, more rapid adoption of new trading platforms, and innovation from third-party service providers.
OCC believes that by collaborating with the industry on process changes, standards, and new technology that we can help the industry reduce their costs, improve efficiency, reduce risk, and support greater profitability.
We are very grateful for the feedback and guidance of the industry on these changes and we are looking forward to continuing this relationship and implementing changes to benefit us all.
As a CCP, we provide a guarantee of performance and mitigate the risk of loss due to a failure by the original lender or borrower.
We identified some common industry challenges by listening to market participants and we are working on developing solutions and tools to help them lower their costs stemming from manual processes, lack of automation, and disparate systems. That is why we are working with Axoni, a technology firm that specialises in multi-party workflows and infrastructure, to develop and implement a distributed ledger technology (DLT) solution to replace our existing securities lending infrastructure. This new technology solution will benefit our clearing member firms and securities lending market participants by increasing efficiency and reducing reconciliation and associated costs. This new platform will also lay the foundation for a future fit CCP securities lending model.
Our vision of the initial roll-out is to establish a permissioned distributed ledger network for cleared stock loan transactions, governed by OCC. With the potential for peer nodes at clearing member firms that will enable participants to have a real time, accurate copy of contract and activity information, thereby reducing the need for manual reconciliation. The solution will be deployed using AxCore, Axoni’s distributed ledger protocol, and is slated to be hosted in the cloud.
OCC, Axoni and our clearing member firms already have identified several opportunities to further streamline processing within the securities lending marketplace once the baseline platform has been established.
Our securities lending programme was created in 1993 to clear and guarantee transactions between our clearing member firms, with OCC serving as the CCP to lenders and borrowers. Since 2017, securities lending clearing volumes have increased by a compound annual growth rate of 16 percent, and open interest has grown by 22 percent. As of 30 April, OCC balances were approximately $72 billion, which is about 13 percent of the total equities on loan across the Americas.
The 2010 Dodd Frank Act and the establishment of minimum risk-based capital requirements have been key drivers of increased CCP usage. More recent regulatory changes may also generate additional interest in the CCP securities lending model. As the uncleared margin rules for non-cleared derivatives continue to be applied to more and more counterparties, it is possible more firms might look for alternative ways to achieve the same financial outcome of gaining exposure to a security or hedging the risk of financing. Securities lending through a CCP may provide opportunities to do that in an equivalent way on potentially a lower cost basis.
To help us get to this point, we have been executing a three-stage strategic plan that reinforces our foundation as a resilient CCP, allowing us to begin work on new products and enhanced services to help our clearing member firms gain capital savings, and innovate for the future.
For our securities lending programme, our new DLT platform will support an enhanced model that will more closely align with market practices and better reflect OCC’s role as a CCP. Some of the programme enhancements that OCC is working on include a new trade interface to receive and confirm details of transactions prior to them settling and/or updating contracts.
By confirming counterparty agreement before the fact, we can help reduce the challenges associated with reconciliation and agreement after the fact. This new trade interface will also allow OCC to have more complete contract details to reduce residual counterparty credit risk on interest and cash distributions. Not only will this reduce risk, but the settlement of these cash flows will be far more efficient through single net payments to-and-from OCC as opposed to myriad counterparty-specific payments needed today.
Once this new platform and technology are in place, we will begin taking steps toward introducing services such as support for baskets of loans for term financing, as well as non-cash loans, as part of growing our base.
In terms of future opportunities, we are looking at how we can expand our membership eligibility to support entities that have not been able to self-clear in the past (e.g. banks, corporations, and others). We are also looking at buy-side specific solutions, where CCP securities lending creates potential for higher utilisation, lower costs, and improved pricing.
Most buy-side firms’ securities lending activities are facilitated by agent lenders that are subject to capital requirements, as are most borrowers. Clearing transactions through a CCP like OCC means that the regulatory capital requirements are typically about 95 percent less than uncleared bilateral transaction. Not only could that reduce the costs of agent lenders, it also could create potential for borrowers to be able to borrow greater amounts of securities or offer better pricing for the securities they are already borrowing. All of these should boost the profitability of lending programmes.
At the core of this work is our Renaissance Initiative, a multi-year effort to modernise our risk management, clearing and data systems. The point of Renaissance is to make sure we are delivering on what the industry needs. We are working closely with our clearing member firms to understand what they need in the short term and also thinking about what we can do now to ensure we are addressing needs that may be unidentified, perhaps five to ten years down the road.
There are other ways that OCC is working with the industry on solutions that will benefit all of us. One example is our work with the FIX Trading Community on a set of enhancements to the FIX messaging standard for securities lending. Adoption of standards has helped improve other areas of the financial markets, (e.g. equities and derivatives), and we are working to bring those benefits to the securities lending market. This will enable more accurate communication, more rapid adoption of new trading platforms, and innovation from third-party service providers.
OCC believes that by collaborating with the industry on process changes, standards, and new technology that we can help the industry reduce their costs, improve efficiency, reduce risk, and support greater profitability.
We are very grateful for the feedback and guidance of the industry on these changes and we are looking forward to continuing this relationship and implementing changes to benefit us all.
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