How can UK beneficial owners position themselves for success in 2018?
When you look at the interest rate environment and the equity markets, we’re still some way away from having a normal world. Going forward we would hope that an increase in volatility and/or corporate activity will contribute to creating securities lending opportunities in the equity space thus creating higher associated revenues for this asset class. We do hope that new supply will continue to come to the securities lending market. We’ve also seen more beneficial owners questioning their current arrangements: “Are we getting the best deal? Are we performing in the right way? Are we being told the right thing?” These conversations will be ongoing.
That said the financial markets may still have to normalise for new supply to come in en masse. As an agent it is our responsibility to present new strategies and ideas to beneficial owners. This includes unique structures (borrow vs pledge), new counterparties and bespoke solutions (collateral transformation) to increase revenue. Specifically, asset owners are seeking idea generation from their agents with greater interaction and involvement in the educational process. A prime example is equities as collateral and the perceived notion of higher risk associated with accepting this collateral type. We cannot lose sight of the ongoing critical role that transparency plays within a lending programme. These elements will remain front and centre of the relationship that agent lenders must build and provide to clients.
Where are investors asking for more transparency in their securities lending programmes?
Securities lending, like many other financial products, is a risk-reward activity. Prior to 2008, reward was arguably the main focus. Some lenders incurred substantial losses within their lending programmes during the credit crisis, while others went unscathed. This helped the industry to ensure an increased focus on transparency and communication, in order for the sponsor to understand the risks associated with both lending and reinvestment. For agents, it is imperative to understand each client’s risk-reward appetite and to tailor a programme to achieve their desired results. As an example, Central banks may be motivated to engage in securities lending to inject liquidity into the market, while other types of investors, having a longer term, hold-to-maturity type strategy, may be seeking to maximise the yield earned on their assets. At BNP Paribas Securities Services, we are focused on ensuring that our clients receive all of the appropriate information in order to make an informed decision to achieve their goals. We are further committed to ensuring that we provide active engagement on their portfolio’s performance in meeting those targets.
How are beneficial owners approaching SFTR?
We, as an industry, have always encouraged transparency and SFTR certainly formalises this. There have been significant delays in its implementation, and this is a testament to the significant impact and effort required to implement such a macro reporting change. Once done though, we are confident that it will yield the desired results of improving transparency within our traditionally opaque over-the-counter (OTC) market. Regulators have taken an active interest in ensuring that the improvement to transparency occurs and SFTR is one example which shows their commitment and engagement in making that happen. The data is going to help the regulators and industry at the very least to understand the material nature of SFTs and how important our business is for the optimal functioning of capital markets globally. Greater transparency through increased levels of reporting to regulatory entities certainly has a cost and thus far the industry has elected to absorb these costs. As both SFTR and SEC Modernisation mature, the market will need to evaluate how to share these costs with beneficial owners.
Do you expect some of the smaller lenders to step out because of SFTR reporting?
We would recommend beneficial owners to look at their lending programmes, and question if the cost of operating a lending programme justifies the reward that they gain from lending. Asset owners will have to take a serious look at their business models and question whether it makes sense.
Ultimately, is this a market that truly embraces technology or puts the brakes on innovation?
As an industry we have been reasonably slow in embracing technology. Banking institutions are keen to highlight their investment across technology and innovation with Blockchain being a key focus. Securities finance is of course included in technology spend, but we must do more as an industry to get key concepts right and, ultimately, take to market quicker. That said the industry is engaged in dedicating resources to operate more efficiently. This engagement has led to substantial initiatives across the entire transaction from pre-trade to execution through post-trade reporting. Substantial amounts of resources at both the agent level and even beneficial owner level continue to be allocated to refine the lending process. Machine learning, artificial intelligence, and Blockchain are several examples. It is imperative your agent is involved in this process and there is a direct correlation between technological developments and increased efficiency and thus higher revenues.
How can lenders continue to attract sufficient borrower demand to maintain a securities lending programme at scale?
Ensuring that our clients are keenly aware of the drivers of demand is essential. We are committed to unlocking the mystique and enhancing transparency between our counterparts and lenders. The data providers have done an excellent job of providing detailed information that we utilise to provide our clients with appropriate commentary on their portfolio performance and associated risks. We find that our clients are committed to understanding drivers and have been actively engaged in that respect. Through a transparent dialogue, we undertake as our responsibility, to provide any revenue enhancement opportunities to our lenders, and help them optimise their returns within their risk parameters.
What is your outlook for securities lending going forward?
Demand drivers have changed over the past decade. Regulation has been one of the key contributors to this change, due to the changes within Basel III, for example. We are seeing enhanced opportunities within the HQLA lending space as a result, and several of our clients have been able to enjoy substantial returns in that respect. With the significant bull market trend that we have seen over the past few years, equity lending revenues have been reduced from historical levels, as fewer high value securities have existed. Despite this, client portfolios have seen significant returns in part due to the increased fail coverage demand as a result of the settlement timeline changes to T+2 from T+3 which are still ongoing in some markets. Increased corporate activity has also led to significant opportunities to capture incremental returns within the equity space. Furthermore, many beneficial owners continue to have a misunderstanding around general collateral. There is continuous demand for general collateral with the right structure and decreased levels of risk, particularly in a non-cash transaction. The stable revenue stream general collateral lending provides is something not to be ignored.
We feel that it is our role as agent, to educate our lenders about the risks inherent and present within the business, as well as equipping them with the tools available to manage those risks. Revenue enhancement opportunities are best derived through managing within the context of each individual client’s risk criteria.
Securities Financing Transactions Regulation (SFTR) - regulation memo
Collateral opportunities - a shift of the risk pendulum