Securities finance is at a turning point. The Basel Committee on Banking Supervision’s liquidity coverage ratio (LCR) and net stable funding ratio (NSFR), the Dodd-Frank Act, European Market Infrastructure Regulation (EMIR), and uncleared margining are all examples of the complex regulations that have increased capital requirements, balance sheet consumption and the overall demand for collateral assets.
At the same time, an increase in the consumption of high-quality liquid assets (HQLAs) is significantly affecting the supply. Securities finance and treasury desks must act as business enablers to adapt to market conditions. To facilitate the access and the management of collateral assets across the enterprise, new operating models are being established. Financial institutions are realising the benefits associated with new business models and services, including lending programmes, collateral transformation and optimisation services. The rise of synthetic financing is also at the forefront of client service discussions. New market infrastructure solutions and the increasing focus on the central clearing of repos is being closely monitored. Regulation directly targeting the securities finance industry, namely the Securities Financing Transaction Regulation (SFTR), is also on the way.
This article explores how technology can help financial institutions adapt to changes in the securities finance industry. Moreover, it will illustrate how the correct technology can support value creation within a firm.
What are the drivers for securities finance and their impact on technology requirements?
Pressure on collateral supply
The possibility of liquidity or collateral scarcity is an undeniable challenge for actors in the capital markets. The Basel III LCR is a driving force behind this development. The LCR requires banks to hold a stock of unencumbered HQLAs to cover the net outflows for the next 30 days. Clearing obligations and uncleared margining rules, with the mandatory exchange of both initial and variation margins, are also key factors.
There have been a variety of market responses to the increasing demand for high-quality assets. Data reports surrounding securities lending confirm the correlation between a decline in the role of cash collateral and increased usage of non-cash collateral. This development highlights how new regulatory regimes are forcing borrowers to turn to alternative forms of collateral to access and borrow HQLAs. Reports also expose a strong move towards the term repo market and the rise of evergreen or extendible structures to ensure easy access to pools of available HQLAs.
The new regulatory regime is having an indirect impact on the repo market. Under the LCR and NSFR rules, banks are not permitted to offset market-to-market exposures. As a result, they are reluctant to accept high-quality government bonds as collateral for derivatives. In light of this, typical bank clients, such as pension funds whose holdings are mostly concentrated in high-yield assets rather than cash, might need to turn to the repo market to release the required cash. This puts more pressure on the repo market.
In addition to these immediate concerns surrounding liquidity, the possibility of further monetary policy evolution over the coming years has created concerns among key market players.
To facilitate quick access to security assets and optimise their usage, leaders in the industry, including lenders and borrowers from both the sell and buy sides, have started turning to centralised, bank-wide asset monitoring, which creates a single view of all asset classes and geographic markets, aggregating the pool of available securities with an equity and fixed income mix.
The rise of synthetic financing
Synthetic financing is seen as a valuable complement of client services. For example, total return swaps (TRS) or portfolio swaps are enabling buy-side institutions, such as pension funds, to access emerging markets and a wider range of assets, without the regulatory and operational constraints of physical financing. Synthetic financing has also been gaining momentum because of the lower capital costs involved. Similar to derivatives, synthetic financing falls under the umbrella of the upcoming standardised approach for measuring counterparty credit risk regulations. It offers more netting opportunities than repo and securities lending.
Developing this new type of business model requires the correct technology. In addition to supporting the operations of over-the-counter derivatives, the technology must also support repo and securities lending.
In particular, it requires advanced analytics measurement and dynamic hedging capabilities for a wide range of risk factors. Credit risk capabilities, to measure capital costs involved, are also becoming a key element.
The need for cross-asset efficient operations
As well as focusing on operational efficiency in the face of liquidity scarcity, institutions need to be prepared for increasing volumes following the introduction of the uncleared margining rules. Firms turning to synthetic financing need to process a large variety of products, such as TRS, portfolio swaps, contract for difference and dividend swaps. By investing in an enterprise-wide operations factory, financial institutions can support the business, control costs and reduce operational risk. The upcoming SFTR is increasing the need for data centralisation. Starting in 2018, this regulation will require firms to report a granular level of information on assets positions to an approved EU trade repository.
An enterprise solution that allows for the centralisation of transaction reporting across regulatory regimes can leverage similar reporting solutions for derivatives and ease the compliance process.
Accurate internal cost allocation
Costs related to capital, collateral and funding charges need to be reflected accurately in the performance measurement of the various business lines. Securities finance and collateral desks will play a central role in this internal process.
Taking this into consideration, firms need the right technology to integrate transfer pricing and capital cost consistently across business lines.
What are the possible technology strategies for securities finance players?
Many banks are relying on a disaggregated, multi-system infrastructure to support each business function. Individual legacy systems for the back office, collateral management, securities finance, liquidity and derivatives trading, with a regulatory reporting layer, are not uncommon.
Banks need to modernise these systems and rethink their business processes. The typical target model is a centralised inventory of assets, across activities and entities, with efficient integration with trade lifecycle management, corporate action automated execution, collateral transformation and liquidity optimisation engines.
This may require the complete overhaul of obsolete infrastructures and the implementation of new integration channels. Banks can regroup traditional trading silos in an effort to manage resources and risks effectively and centrally. Where synergies are identified, business areas can then be regrouped to improve efficiency.
Alternatively, banks can invest in a single technology platform. Enterprise platforms are gaining traction among the leaders in the capital markets. There is a growing realisation that the flexibility and the best-of-breed associated with a multi-system approach is outweighed by high integration and maintenance costs.
The enterprise platform bridges the gap between multiple silos, decreases the total cost of ownership and increases efficiencies at every step of the value chain.
With a single platform, operational processes are rationalised around a single data source. This ensures that unnecessary reconciliations between front office, back office and risk functions are avoided.
Financial institutions preparing for external capital markets challenges and internal technology challenges want to build long-lasting partnerships with technology vendors they can trust.
These partnerships will result in an effective technology strategy and the definition of an achievable roadmap for the future.
On top of providing a wide range of functionality for securities finance, collateral trading and treasury desks, technology vendors will increasingly be expected to leverage cross-asset, end-to-end processing, regulatory compliance and liquidity management capabilities in a single enterprise platform.