The choice is yours
16 June 2015
There are three strategies at play in securities finance right now. Tom Dibble of SunGard’s Apex Securities Finance finds out which one will stay the course
Image: Shutterstock
The securities finance industry is currently digesting the heavy meal that has been Basel III, Capital Requirements Directive (CRD) IV , the Dodd-Frank Act and related regional regulatory initiatives affecting the global market. These are not light appetisers at all. Rather, financial intermediaries are facing tough questions about how they will move forward in their business models. We see three options on the buffet table for market participants in their business decision-making: the ‘get out now’ strategy, the ‘wait and see’ strategy, or the ‘double down’ strategy.
Get out now
Leaving any marketplace is a difficult decision, taken only after substantial soul searching. Leaving securities lending or repo is even more difficult given the fundamental impacts that these businesses have on financial intermediary business lines. Leaving securities lending may mean a loss of inventory for prime brokerage clients, or exiting a matched book programme. Exiting repo could affect government bond trading at a basic level. Taken as standalone businesses, securities finance may look unattractive. Their roles are well known, but this is the decision that some firms have come to or are actively considering.
The rationale for exiting the market is driven by regulation that has made spreads, factored after internal liquidity or collateral costs, untenable. The liquidity coverage ratio, coupled with a lack of counterparty interest in accepting equities as collateral, may create inflow and outflow ratios that do not add up to firm-wide requirements. In the meanwhile, capital costs are a reality and returns on securities lending transactions are unproven and may not hold up in the new frontier of securities finance.
In repo, the leverage ratio has already pushed government bond repos to unusual spreads at quarter end. As financial intermediaries need to report their figures and require a best possible leverage ratio, repo is a logical target. Is it any wonder that a financial intermediary may choose to exit the market?
Wait and see
The ‘wait and see’ crowd may have the right idea: do nothing for now and see how the market develops. Although costs are increasing, these firms know that they can pass on costs to clients when needed and can seek cost-effective alternatives where possible, often looking at cost efficiencies in technology and business processing outsourcing. These firms are typically balancing multiple product lines, including synthetic prime brokerage and futures.
In response, SunGard has launched Apex Securities Finance 2015 to enable firms to undertake their securities finance activities, efficiently and within the changing regulatory environment.
Double down
The ‘double down’ group is the most dynamic in securities finance these days. They recognise that while securities lending or repo might be difficult, the economic need for similar transactions stays the same.
The ‘double down’ group is the most exciting to watch, and with good reason. These firms are typically first to join new central counterparties (CCPs) and other market initiatives, because they have less to lose than their competitors in trying new routes to market. They are also looking at cost rationalising with the goal of preserving and growing their market while competitors pull back. These firms are also looking at various combinations of outsourcing and reorganisations to keep their franchises healthy.
One option considered lately is merging securities lending and repo into one business unit. SunGard recently investigated this idea, and found that approximately 50 percent of our customers were already running repo and stock borrow/loan/securities lending under one organisational unit. Another 20 percent were actively considering merging business lines, while 30 percent are planning to keep their lending, repo and derivatives businesses separate.
Making your choice
There is no question that now is a difficult time to be in securities finance. As with any transition, it can be expected that there will be a shakeout, then market participants will find routes and operational processes that lead to greater profitability. We see two main options that could assist financial intermediaries in managing the transition:
Industry utilities: financial intermediaries have substantial fixed costs and transaction processing does not need to be one of them. A move towards outsourcing securities finance operations can reduce total cost of ownership while keeping intact the software and services that clients need.
Product consolidation: SunGard recognises that our customers’ businesses are changing, and we are merging, consolidating and adapting our solutions to suit the shifting business and operational requirements of customers in securities finance.
Securities finance has a long life ahead of it—of that we are certain. Financial intermediaries must adapt to new pressures in order to sustain their businesses. While some firms will choose to exit the market, others will wait to see what comes next or are investing in their securities finance franchises for greater growth. The next several years will see continued change in the securities finance marketplace. How financial intermediaries act now will determine their future standings in this evolving space.
Get out now
Leaving any marketplace is a difficult decision, taken only after substantial soul searching. Leaving securities lending or repo is even more difficult given the fundamental impacts that these businesses have on financial intermediary business lines. Leaving securities lending may mean a loss of inventory for prime brokerage clients, or exiting a matched book programme. Exiting repo could affect government bond trading at a basic level. Taken as standalone businesses, securities finance may look unattractive. Their roles are well known, but this is the decision that some firms have come to or are actively considering.
The rationale for exiting the market is driven by regulation that has made spreads, factored after internal liquidity or collateral costs, untenable. The liquidity coverage ratio, coupled with a lack of counterparty interest in accepting equities as collateral, may create inflow and outflow ratios that do not add up to firm-wide requirements. In the meanwhile, capital costs are a reality and returns on securities lending transactions are unproven and may not hold up in the new frontier of securities finance.
In repo, the leverage ratio has already pushed government bond repos to unusual spreads at quarter end. As financial intermediaries need to report their figures and require a best possible leverage ratio, repo is a logical target. Is it any wonder that a financial intermediary may choose to exit the market?
Wait and see
The ‘wait and see’ crowd may have the right idea: do nothing for now and see how the market develops. Although costs are increasing, these firms know that they can pass on costs to clients when needed and can seek cost-effective alternatives where possible, often looking at cost efficiencies in technology and business processing outsourcing. These firms are typically balancing multiple product lines, including synthetic prime brokerage and futures.
In response, SunGard has launched Apex Securities Finance 2015 to enable firms to undertake their securities finance activities, efficiently and within the changing regulatory environment.
Double down
The ‘double down’ group is the most dynamic in securities finance these days. They recognise that while securities lending or repo might be difficult, the economic need for similar transactions stays the same.
The ‘double down’ group is the most exciting to watch, and with good reason. These firms are typically first to join new central counterparties (CCPs) and other market initiatives, because they have less to lose than their competitors in trying new routes to market. They are also looking at cost rationalising with the goal of preserving and growing their market while competitors pull back. These firms are also looking at various combinations of outsourcing and reorganisations to keep their franchises healthy.
One option considered lately is merging securities lending and repo into one business unit. SunGard recently investigated this idea, and found that approximately 50 percent of our customers were already running repo and stock borrow/loan/securities lending under one organisational unit. Another 20 percent were actively considering merging business lines, while 30 percent are planning to keep their lending, repo and derivatives businesses separate.
Making your choice
There is no question that now is a difficult time to be in securities finance. As with any transition, it can be expected that there will be a shakeout, then market participants will find routes and operational processes that lead to greater profitability. We see two main options that could assist financial intermediaries in managing the transition:
Industry utilities: financial intermediaries have substantial fixed costs and transaction processing does not need to be one of them. A move towards outsourcing securities finance operations can reduce total cost of ownership while keeping intact the software and services that clients need.
Product consolidation: SunGard recognises that our customers’ businesses are changing, and we are merging, consolidating and adapting our solutions to suit the shifting business and operational requirements of customers in securities finance.
Securities finance has a long life ahead of it—of that we are certain. Financial intermediaries must adapt to new pressures in order to sustain their businesses. While some firms will choose to exit the market, others will wait to see what comes next or are investing in their securities finance franchises for greater growth. The next several years will see continued change in the securities finance marketplace. How financial intermediaries act now will determine their future standings in this evolving space.
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