Don’t cry for me, I’m already ahead

ISLA's 25th Securities Finance and Collateral Management Conference in Vienna saw many of the issues that had brought industry participants to loggerheads at previous events finally begin to move forward, for the benefit of everyone.

The International Securities Lending Association’s (ISLA) 25th Securities Finance and Collateral Management Conference in Vienna saw many of the issues that had brought industry participants to loggerheads at previous events finally begin to move forward, for the benefit of everyone.

Age-old issues such as the role of central counterparties (CCPs), the burdens of regulatory compliance and data reporting, and inefficiencies across the entire transaction chain were all addressed, along with the relative newcomers such as blockchain—with actual progress being made in some of these areas.

As an industry association, ISLA is going through a transitional period, a theme that featured prominently during the conference. Primarily, the conference served as platform for a passing of the torch for Kevin McNulty, ISLA’s CEO of seven years, who stepped down and handed his responsibilities over to then COO Andrew Dyson. McNulty received a round of applause from all in attendance after he was thanked for everything he had achieved during his tenure by Dyson during his opening speech.

The changing of the guard means that ISLA is currently shopping for a new COO who, at time of writing, is yet to be confirmed by the association. Two of ISLA’s board of directors have also chosen to step down this year.

Market, ‘excellent’

A survey of conference delegates revealed that a largely optimistic mood had captured the industry, twinned with a mildly contradictory undercurrent of realism.

The survey, on the first day of the event, showed that the majority of delegates, mostly representing principal lenders, borrowers and agent lenders, were bullish about their future business prospects, with aspirations to grow in revenue and staffing terms over the next three years.

At the same time, however, the audience predicted the the overall securities revenue pool to decrease over the same time period.

The poll showed that 53 percent predicted growth in their business, but 43 percent believed this would come in spite of the overall industry revenue pool shrinking.

Delegates heard that changes to fee splits and pricing may become an improved revenue source for some agent lenders, but panellists warned that citing regulatory costs and other market forces as a reason to revisit these topics with beneficial owners might be unhelpful for the industry as a whole.

Eat my shorts

On the second day, a panel of senior market participants were united in their belief that CCPs offer legitimate compression and netting advantages at a time when both features are becoming
more valuable.

This is a big leap forward for the advocates of central clearing, who have been battling to win the hearts and minds of the securities lending industry for some years.

But it was pointed out that these benefits all fall at the feet of agent lenders and are unlikely to convince beneficial owners of the need to centrally clear their loans in the face of lingering concerns around collateral visibility that exist with CCP use. One panellist, from a large agent lender, described his business as “standing ready to work with CCPs”, but acknowledged that without the essential beneficial owner demographic on-board there was still work to be done.

At the same time, in the wider industry, the CCP cause has also been helped along in the past 12 months by several regulators, along with major industry players, reinforcing their approval of central clearing.

The ISLA conference highlighted a distinct geographic divide in the acceptance of CCPs in the securities lending market.

During a panel discussion at the 6th Annual Canadian Securities Lending Association Conference on Securities Lending earlier in June, one custodian panellist, discussing the US market, described how increasing numbers of participants are “joining the CCP bandwagon every year”.

However, at the IMN Beneficial Owners’ International Securities Lending Conference in the US in February, scepticism around CCPs was highlighted. A forward-looking poll showed that 63.9 percent of respondents expected less than 5 percent of their business to use central clearing by 2017.

ISLA’s European delegates in Vienna voted in stark contrast to this when asked a similar question.

More than half, 56 percent, of the audience said they could see between 1 and 25 percent of their trades using a CCP in the next three years, while 23 percent of respondents said 26 to 50 percent of their trades could go through a CCP.

Commenting on the shift of industry mentality, Jonathan Lombardo, senior vice president in Deutsche Börse’s global funding and financing division, and Deutsche Börse representative at the ISLA conference, said: “The significant change in market sentiment from Lisbon last year can be defined in three components. Firstly, organisations have interpreted regulatory rules around leverage and capital and have clearly seen benefits from dealing with a CCP.”

“Secondly, Eurex Clearing’s Lending CCP offering has continued to grow with additional clearable markets such as the UK as well as additions to acceptable jurisdictions for our specific lender licene such as the Middle East.”

“Finally, Eurex Clearing have invested heavily in the infrastructure of lifecycle risk management, asset servicing and enhanced collateral models which have been well received by our present participants as well as pushing the ‘on the fence’ organisations over towards participation.”

Blockchain: the cause of, and solution to, all of the industry’s problems

Those attending ISLA’s conference, could be forgiven for thinking that the blockchain roundtable was the only one on the agenda, not just one of three options that ran simultaneously.

The packed-out secondary conference room left attendees (and journalists) perching on tables at the back of the room, even after extra seating was brought in.

The session was chaired by itBit Company Trust’s head of Europe, the Middle East and Africa, Jason Nabi.

itBit had stolen the spotlight earlier in the day by announcing that it was collaborating with Euroclear to look into creating a settlement services for the London gold market, based on distributed ledger technology.

Nabi fell short of explaining what blockchain actually was, but instead opted to focus what it could potentially do, such as significantly reduce balance sheet use and bring settlement risk to near zero. It could also re-engineer back-office processes and reduce the settlement cycle to T+0.

Concerns were raised in the session, however, that a reduction in settlement risk would be offset by an increase in liquidity risk, as rapid settlement is dependant on sufficient cash being available at all times to complete the trade.

Delegates heard that blockchain may create opportunities for banks to provide credit and margin solutions to users that would otherwise struggle to meet cash requirements.

Counterparty risk could also be mitigated through a hybrid CCP-blockchain system, but the industry will have to wait at least 18 months before anything tangible will appear.

Nabi described talks between CCPs and distributed ledger technology providers around creating such a hybrid system as being in very early stages.

Cash markets were highlighted as a simpler market structure that will probably see a functioning blockchain solution much sooner than the securities finance industry.

Blockchain has certainly captured the imagination of the securities lending industry in 2016. Last year was described by one delegate as the “year of hype” for blockchain, inferring that 2016 is the year of reality.

That might be optimistic, considering that a large number of the people who spoke of the roundtable afterwards were still unsure about what this mystical distributed ledger actually was, and how it could assist in securities lending transactions.

However, the technology will no doubt feature again, and prominently, at every industry event for the rest of the year, and beyond.

No, money down!

The theme of market shake-ups also spilled over into discussions on the growing trend of beneficial owners looking to cut out the middleman and engage in peer-to-peer lending with non-banks.

One buy-side panellist explained: “Securities lending at its core is a very simple transaction.”

“I’m here with a very high demand to borrow securities, and the other side wants to lend them, but there are a lot of people in the way who are often using clunky infrastructures that make the process very inefficient.”

In an audience poll, it was revealed that 47 percent of voters were beneficial owners that are “seriously considering lending to non-banks”.

Delegates heard that greater transparency and communication between counterparties is the future of the industry, and that this will likely result in the growth of peer-to-peer lending.

The counterpoint was raised that, historically, end users have not had the resources to properly manage the various exposures and counterparty vetting processes involved in securities lending without leaning heavily on agent lenders, and that this hasn’t changed significantly yet.

However, the unstoppable rise of financial technology, as well as the growth of central counterparties could mean that change is finally on the horizon.

Annoyed grunt (D’oh!)

Finally, after three days of debate and toasting the milestone of 25 years of successful conferences, delegates were looking to carry the market stability and optimism forward into the second half of the year … and then Brexit happened.

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