Finding the silver lining
25 October 2022
Entering the fourth quarter, industry leaders reflect on the current state of the securities lending industry as it continues to battle economic and geopolitical pressures. From how to retain top talent to the possibilities of buy versus build, participants provide words of wisdom for the industry. Carmella Haswell reports
Image: Securities Finance Times
Securities lending is a good hedge to volatility and declining markets. But despite the pressures of rampant inflation, volatility and a potential recession, the securities lending industry is assured that these challenges present opportunity.
In tackling the “doom and gloom” landscape as geopolitical struggles persist, market participants set their priorities straight. Aperture Investors’ COO James O’Connor says the firm is focused on the asset liability matching environment which the industry is dealing with.
Over the past 10 to 15 years, O’Connor has seen the growth of the private credit space — a signpost he is watching out for. Given the velocity of the rate rises, the market has not seen this translate into the mark-to-market of that asset class.
He reveals: “What you are seeing in the UK right now is clearly another signpost. When you see investment grade credit being sold off more than high yield, that does not make sense. Why does one sell the higher grade credit instead of lower grade credit? Because when you need a lot of cash quickly, you sell what can generate the most amount of cash. Keep watching and stay alert for the signposts. Stay close to your risk management team right now. This is where companies basically go bankrupt, it is in the securities finance industry. Liquidity is the killer, not performance.”
The industry can expect to face periodic bouts of illiquidity. Some firms have been preparing their clients for the possibility, trying to help them immunise their portfolios to weather the air pockets by being able to survive a couple of days without liquidity in the market.
According to the Structural Changes to Cash Reinvestment panel at the Risk Management Association’s 37th Securities Finance & Collateral Management Conference, it appears that, from a broader treasury perspective, the market is fragile and liquidity is thin. Panellists raised the concern that the treasury market could be one shock away from experiencing pronounced air pockets.
Putting a positive spin on the current market environment, head of agency lending at Fidelity Investments Justin Aldridge says while crises and volatility are bad, this also presents opportunity. Fidelity is monitoring the situation and feels well positioned with its credit and risk expertise and the actions that it is taking. Aldridge believes that the risk-to-reward ratio remains the same, even with the volatility that is being seen in the markets.
Fidelity’s plan of action is to stay the course and to continue to do what it is doing to seize opportunities that fit its business profile, wherever the firm sees them. According to Aldridge, the current market has shown that securities lending — from an income perspective for an asset managers’ fund shareholders — is a good hedge to volatility and declining markets.
He adds: “If you look at the historical lending earnings of funds over the past 10 years — or going back a little further to 2008 or 2007 — earnings were up, and again, earnings are up this year with the volatility that we are seeing in the markets.”
Remaining focused
Participation in securities lending markets is on the rise, according to panellists in the Industry Leaders session at the RMA conference. EquiLend confirmed that trend, with the firm reporting a 12 per cent increase in revenue for the global securities lending market in Q3 2022, compared to Q3 2021. The market generated US$2.63 billion in revenue during Q3, with the year-to-date revenue for 2022 reaching US$7.45 billion, an 8 per cent increase from 2021.
John Templeton, global head of sales and relationship management for securities finance at BNY Mellon, says he is seeing more interest from clients continuing to join securities lending and very little feedback from clients who are looking not to participate. There are a multitude of avenues available to participate in the market and to be able to complement clients’ other investment objectives. Templeton continues: “The opportunity to be able to earn the returns that are correct for your organisation, both from a risk perspective and from a return perspective, is the key.”
Although the numbers are up for the industry, securities lending is proving increasingly difficult for asset managers as a result of upcoming regulation. Some asset managers are apprehensive to financially support adherence to new and cumbersome regulations that affect their participation in securities lending.
To keep up with the highs and lows of the market, the panellists pinpointed areas of focus for their firms. Fidelity’s Aldridge says operational stability is paramount. The US-based financial services company is focused on the returns to its investors, making sure that the company is monitoring things in a “risk-constrained” environment. Fidelity is also focused on achieving automation of its operations and ensuring there is no unnecessary friction for lending clients.
BNY Mellon’s Templeton suggested that as an industry, market participants need to reduce the amount of capital wasted, so that participants can use it on the trades that make most sense for their firms. “When we talk about the constraints of capital, I think there are two forms that come in,” Templeton explains. “Number one is the capital that we want to use as a component of the trade. But there is also capital that comes up because of inefficiencies in the way that we do the daily mark-to-market process.
Every firm has a customised focus, but the panellists collectively agreed on the significance of retaining talent. A PwC survey — presented at the RMA’s Women in Securities Finance panel — identifies a labour market shrinkage. It found that 1.9 million workers left the workforce post-Covid due to child care and Covid-related issues. PwC has encouraged firms to offer flexible working to help support a better work-life balance for employees, particularly women, who represent the large majority of caregivers.
As firms continue to navigate through the new working environment after the impact of the Covid-19 pandemic, companies have yet to find the happy medium with regards to flexible working. Aperture Investors’ O’Connor indicates that everybody has a different perspective on what defines productivity, with most people believing that productivity means getting your job done.
O’Connor concludes: “We are building ourselves as an organisation that can be a little bit transient. We plan to introduce more business and social gatherings that bring our teams together. Our bet is that once people make regular connections, relationships will develop and we will see the collaborative things that we missed with the remote work environment.”
Buy versus build
The financial services industry has evolved substantially over the past 20 years, with technology innovation sharpening competition, performance and industry processes. There is not a one-size-fits all approach when it comes to buy versus build, but the end goal is the same, to keep ahead of the curve.
Aperture Investors’ O’Connor explains that unless you are a technology company, it is important to evaluate everything from a buy or build perspective. He continues: “The build versus buy is an ROI calculation, and we are just not the experts. Furthermore, unless we can generate a decent equity return on the capital, it does not make sense to build something, I am going to buy.”
The wide availability of technology to aid transparency and operational efficiency, to help with collateral management, is encouraging. O’Connor says it is a positive step to see people from the industry move into solving problems for the industry, because those are the best people to create the tools.
Fidelity’s Aldridge indicates that there are a lot of specialisations in the vendor space and when it comes to the core blocking and tackling there are only a handful of providers. However, competition is key to keeping the market active, people spending and products evolving.
He continues: “Our philosophy is if there is scale and efficiency in the offering, then we will buy it for the core blocking and tackling, and then as it relates to the secret sauce to customisation, we build it. If someone has something better than what we can build, then we will certainly buy it.”
Goldman Sachs has historically been a build institution, but now the firm is leaning into buy, according to Nehal Udeshi, co-head of cross-asset financing at Goldman Sachs.
“Thinking about buying does make sense in a lot of different places. The oversight is absolutely necessary, the reputational risk is a big piece of many of these discussions and how we think about the impact of those can take as much time as building out some of the solutions,” explains Udeshi. “But having the ability to use a third-party solution and make slight tweaks and to get those done very quickly without having to go through a long list of other internal resource priorities that are going to fall above it or below it, that has made a huge difference.”
As panellists summarised their final thoughts for the industry, the underlying theme was collaboration. As an industry, despite being clients and competitors of one another, they noted that it is imperative to work together to tackle the constraints ahead.
Fidelity’s Aldridge reflected on the regulatory challenges the industry has come to blows with — including the Central Securities Depositories Regulation (CSDR) and Securities Finance Transaction Regulation (SFTR) — and how daunting they were, with the move to T+1 settlement also presenting a major transition project. However, Aldridge is confident that the industry, between the service providers and vendors, will be able to overcome these challenges.
“Having been involved with the industry for as long as I have, I think the industry does a great job of collaborating,” says Aperture Investors’ O’Connor. “I think that everybody recognises the importance of the securities finance industry, and there are trade-offs between having operational efficiency, or operational alpha, which I think is something that people should really think about for next year.”
In tackling the “doom and gloom” landscape as geopolitical struggles persist, market participants set their priorities straight. Aperture Investors’ COO James O’Connor says the firm is focused on the asset liability matching environment which the industry is dealing with.
Over the past 10 to 15 years, O’Connor has seen the growth of the private credit space — a signpost he is watching out for. Given the velocity of the rate rises, the market has not seen this translate into the mark-to-market of that asset class.
He reveals: “What you are seeing in the UK right now is clearly another signpost. When you see investment grade credit being sold off more than high yield, that does not make sense. Why does one sell the higher grade credit instead of lower grade credit? Because when you need a lot of cash quickly, you sell what can generate the most amount of cash. Keep watching and stay alert for the signposts. Stay close to your risk management team right now. This is where companies basically go bankrupt, it is in the securities finance industry. Liquidity is the killer, not performance.”
The industry can expect to face periodic bouts of illiquidity. Some firms have been preparing their clients for the possibility, trying to help them immunise their portfolios to weather the air pockets by being able to survive a couple of days without liquidity in the market.
According to the Structural Changes to Cash Reinvestment panel at the Risk Management Association’s 37th Securities Finance & Collateral Management Conference, it appears that, from a broader treasury perspective, the market is fragile and liquidity is thin. Panellists raised the concern that the treasury market could be one shock away from experiencing pronounced air pockets.
Putting a positive spin on the current market environment, head of agency lending at Fidelity Investments Justin Aldridge says while crises and volatility are bad, this also presents opportunity. Fidelity is monitoring the situation and feels well positioned with its credit and risk expertise and the actions that it is taking. Aldridge believes that the risk-to-reward ratio remains the same, even with the volatility that is being seen in the markets.
Fidelity’s plan of action is to stay the course and to continue to do what it is doing to seize opportunities that fit its business profile, wherever the firm sees them. According to Aldridge, the current market has shown that securities lending — from an income perspective for an asset managers’ fund shareholders — is a good hedge to volatility and declining markets.
He adds: “If you look at the historical lending earnings of funds over the past 10 years — or going back a little further to 2008 or 2007 — earnings were up, and again, earnings are up this year with the volatility that we are seeing in the markets.”
Remaining focused
Participation in securities lending markets is on the rise, according to panellists in the Industry Leaders session at the RMA conference. EquiLend confirmed that trend, with the firm reporting a 12 per cent increase in revenue for the global securities lending market in Q3 2022, compared to Q3 2021. The market generated US$2.63 billion in revenue during Q3, with the year-to-date revenue for 2022 reaching US$7.45 billion, an 8 per cent increase from 2021.
John Templeton, global head of sales and relationship management for securities finance at BNY Mellon, says he is seeing more interest from clients continuing to join securities lending and very little feedback from clients who are looking not to participate. There are a multitude of avenues available to participate in the market and to be able to complement clients’ other investment objectives. Templeton continues: “The opportunity to be able to earn the returns that are correct for your organisation, both from a risk perspective and from a return perspective, is the key.”
Although the numbers are up for the industry, securities lending is proving increasingly difficult for asset managers as a result of upcoming regulation. Some asset managers are apprehensive to financially support adherence to new and cumbersome regulations that affect their participation in securities lending.
To keep up with the highs and lows of the market, the panellists pinpointed areas of focus for their firms. Fidelity’s Aldridge says operational stability is paramount. The US-based financial services company is focused on the returns to its investors, making sure that the company is monitoring things in a “risk-constrained” environment. Fidelity is also focused on achieving automation of its operations and ensuring there is no unnecessary friction for lending clients.
BNY Mellon’s Templeton suggested that as an industry, market participants need to reduce the amount of capital wasted, so that participants can use it on the trades that make most sense for their firms. “When we talk about the constraints of capital, I think there are two forms that come in,” Templeton explains. “Number one is the capital that we want to use as a component of the trade. But there is also capital that comes up because of inefficiencies in the way that we do the daily mark-to-market process.
Every firm has a customised focus, but the panellists collectively agreed on the significance of retaining talent. A PwC survey — presented at the RMA’s Women in Securities Finance panel — identifies a labour market shrinkage. It found that 1.9 million workers left the workforce post-Covid due to child care and Covid-related issues. PwC has encouraged firms to offer flexible working to help support a better work-life balance for employees, particularly women, who represent the large majority of caregivers.
As firms continue to navigate through the new working environment after the impact of the Covid-19 pandemic, companies have yet to find the happy medium with regards to flexible working. Aperture Investors’ O’Connor indicates that everybody has a different perspective on what defines productivity, with most people believing that productivity means getting your job done.
O’Connor concludes: “We are building ourselves as an organisation that can be a little bit transient. We plan to introduce more business and social gatherings that bring our teams together. Our bet is that once people make regular connections, relationships will develop and we will see the collaborative things that we missed with the remote work environment.”
Buy versus build
The financial services industry has evolved substantially over the past 20 years, with technology innovation sharpening competition, performance and industry processes. There is not a one-size-fits all approach when it comes to buy versus build, but the end goal is the same, to keep ahead of the curve.
Aperture Investors’ O’Connor explains that unless you are a technology company, it is important to evaluate everything from a buy or build perspective. He continues: “The build versus buy is an ROI calculation, and we are just not the experts. Furthermore, unless we can generate a decent equity return on the capital, it does not make sense to build something, I am going to buy.”
The wide availability of technology to aid transparency and operational efficiency, to help with collateral management, is encouraging. O’Connor says it is a positive step to see people from the industry move into solving problems for the industry, because those are the best people to create the tools.
Fidelity’s Aldridge indicates that there are a lot of specialisations in the vendor space and when it comes to the core blocking and tackling there are only a handful of providers. However, competition is key to keeping the market active, people spending and products evolving.
He continues: “Our philosophy is if there is scale and efficiency in the offering, then we will buy it for the core blocking and tackling, and then as it relates to the secret sauce to customisation, we build it. If someone has something better than what we can build, then we will certainly buy it.”
Goldman Sachs has historically been a build institution, but now the firm is leaning into buy, according to Nehal Udeshi, co-head of cross-asset financing at Goldman Sachs.
“Thinking about buying does make sense in a lot of different places. The oversight is absolutely necessary, the reputational risk is a big piece of many of these discussions and how we think about the impact of those can take as much time as building out some of the solutions,” explains Udeshi. “But having the ability to use a third-party solution and make slight tweaks and to get those done very quickly without having to go through a long list of other internal resource priorities that are going to fall above it or below it, that has made a huge difference.”
As panellists summarised their final thoughts for the industry, the underlying theme was collaboration. As an industry, despite being clients and competitors of one another, they noted that it is imperative to work together to tackle the constraints ahead.
Fidelity’s Aldridge reflected on the regulatory challenges the industry has come to blows with — including the Central Securities Depositories Regulation (CSDR) and Securities Finance Transaction Regulation (SFTR) — and how daunting they were, with the move to T+1 settlement also presenting a major transition project. However, Aldridge is confident that the industry, between the service providers and vendors, will be able to overcome these challenges.
“Having been involved with the industry for as long as I have, I think the industry does a great job of collaborating,” says Aperture Investors’ O’Connor. “I think that everybody recognises the importance of the securities finance industry, and there are trade-offs between having operational efficiency, or operational alpha, which I think is something that people should really think about for next year.”
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