The financial markets have been in a process of constant change for the past several years. What is your take on the current situation?
Philippe Seyll: For more than a decade, banks have been moving away from borrowing through unsecured channels towards collateralised lending mechanisms. Throughout this period, firms have been focused on how they can mobilise and allocate collateral efficiently and minimise fragmentation of collateral across geographical locations and product silos.
As is so often the case in financial services, regulation has been a primary driver for reform in this area. The move towards secured funding and financing mechanisms requires that firms can access eligible collateral quickly and at affordable cost. The overarching message is that good-quality collateral is a precious resource that needs to be managed carefully.
Policymakers have spent a lot of effort focusing on finding new means to restructure the post-crisis financial market and at the same time to make it safer. The result of these efforts is a host of new regulations, some of which are designed to force market participants to comply with higher security standards. As a result, the framework of rules and regulations means that our expectations of future developments can influence our decision-making and play a role in how our world will evolve.
Quantitative easing continues to put pressure on the securities financing industry. For example, the European Central Bank’s decision to stick to its bond buying programme despite strong EU-wide economic growth has dampened hopes in the market that interest rates will rise any time soon. This loose monetary policy can be felt in the real economy and has effects that reach into the post-trade business as well. Quantitative easing has major implications for the securities finance industry, in particular when it comes to capital requirements and risk management.
With quantitative easing set to continue in 2017, we see an increasing shortage of high-quality collateral in the market. Even if the repo market continues to be under pressure, the scarcity of good collateral is expected to positively influence the securities lending business. As a market infrastructure provider, it is our role to fuel the markets with high-quality securities. We can accommodate the return back to the market of these high-quality securities held by our clients, in particular central banks, through our range of securities lending services.
Market infrastructure providers have become much more significant. How much has this affected Deutsche Börse Group’s overall focus?
Seyll: Aligning our activities around securities financing, secured funding and collateral management within the new global funding and financing (GFF) organisational structure allows us to better address the new regulatory requirements and serve more efficiently the emerging needs of our clients in regards to trading, risk and liquidity management. The key themes and central role of GFF are collateral mobility, capital, liquidity and efficient balance sheet management combined with the important role of technology. Market infrastructure providers help to create a market that is fit for purpose, and build on the fact that we all have a responsibility and a mission to build a market that is efficient, systemically responsible and sustainable.
Market participants have reacted to the comprehensive changes that have influenced the market over the past 10 years. Now, the securities finance market is the best-placed mechanism for the movement of collateral that is an integral part of the implemented regulatory directives. This key role of infrastructure and technical developments enable the mobilisation of collateral and the standardisation of trading and settlement in order to ensure that the key components of the securities finance market are able to sustain liquid and capital-efficient solutions.
Eurex Clearing was the first CCP in Europe to offer central clearing to the bilateral securities lending market. How does the Lending CCP assist the marketplace?
Erik Müller: The Lending CCP enhances the security and efficiency of a market that traditionally has been defined by OTC transactions; it is important to involve a central counterparty, particularly for lending transactions, to hedge against changes in the credit risk profile. This also allows positions to be netted—so-called multilateral netting, which reduces capital employed and therefore the costs associated with a transaction.
The business customs of the securities lending market influenced the design of the Lending CCP, which also features the well-known strengths of the CCP clearing service offered by Deutsche Börse Group. This approach pursues the evolution of the markets, and their customs, and takes the interests of market participants into account. There are advantages not only for the individual clearing participants—the markets will become more transparent and secure in general. This represents a truly sustainable offer from Deutsche Börse Group for the financial sector.
Part of the group’s key initiatives is to focus on establishing and enhancing the securities lending services. One focus is agency lending, where lending transactions are carried out via banks and settled via a transparent pool of securities. Another form is principal lending, where the CCP borrows lenders’ assets, passing them on to the ultimate borrower. High-value collateral is pledged to hedge and thus manage the risk. Both types of securities lending via the Lending CCP bring customers the best trading, clearing, settlement and collateral management services across the group and prove the added value of GFF’s cross-divisional cooperation between Clearstream and Eurex Clearing.
The Lending CCP has been designed as a full service model in order to increase the degree of automation, thus reducing manual intervention in the securities lending process chain. Participants benefit from electronic reporting and trade reconciliation capabilities, such as links to the existing specialist providers for electronic trading markets.
The full range of the operational activities required for the securities lending market is wholly integrated: automated services such as re-rates, mark-to-market, corporate actions, as well as lending fee and rebate calculation and settlement, give the opportunity for users to benefit from an increase in operational efficiency. The Lending CCP offers a flexible solution via existing market infrastructure for the management of non-cash loan collateral being held at triparty collateral agents.
What can your clients expect in terms of further development of these services and initiatives?
Seyll: Additional upgrades will be implemented in the course of 2017 and beyond. Our Lending CCP service enhancements include the introduction of exposure netting for triparty collateral agents and multiple loan allocation for agent lenders. The specific lender licence will be made available in further jurisdictions and its holders will benefit from enhanced principal collateral management services. In addition, securities lending services for equities will be rolled out in the UK and Target2-Securities markets in Europe.
One of the key objectives lies in the inclusion of key agent lenders for equity financing and prime brokers to the Lending CCP. Furthermore, the introduction of new triparty collateral locations such as BNY Mellon will further extend our offering. Further extension of Clearstream’s ASLplus service through an agency and/or a principal lending model via the Lending CCP creates further efficiency gains and synergies across Deutsche Börse Group.
For users of the specific lender licence, it will also allow extensions to non-EU participants in Asia, the Middle East and North America. To leverage our new markets and offer our global customers further services and opportunities, we are also continuing our strategic partnerships with leading borrowers and agent lenders. In addition, we aim to further facilitate simplified access to our services, and therefore develop additional partnerships to facilitate the capture of trade flows and assist market participants in their ability to select from a multiple range of collateral locations.
What was the overall feedback from market participants on the Lending CCP? Is change paving the way for progress?
Müller: Significant progress has been made while the constructive feedback and ongoing engagement that we have with key market participants are essential components for the continued progress of the Lending CCP. Buy-side participants have been keen to explain that two key issues are critical for their involvement: revenue and demand.
Asset managers need to see a greater demand for CCP usage, but also need the reward and incentive for doing so. Even though capital and operational benefits are expected, the major determining factor is the opportunity cost and how much more revenue can be generated for clients by choosing the Lending CCP over existing bilateral trading relationships.
Borrowers have indicated that more beneficial pricing is available by using the Lending CCP currently. However, in order to maintain cost-effective pricing, the CCP needs to introduce further enhanced solutions for banks to be able to take advantage of netting capabilities, increased margin utilisation across cleared products, and a greater capability to allow for efficient re-use of collateral.
The requirement to implement netting across securities lending and repo transactions would result in more effective management of regulatory capital requirements, while the introduction of cross-margining capabilities on centrally cleared product ranges and asset classes would make a significant positive impact on the pricing, efficiency and attractiveness of the Lending CCP.
Over the coming years, CCPs will continue to progress and become even more important. All the advantages of central clearing lead to greater safety and integrity in the financial markets. As both are objectives that market participants have in common, we expect further demand for these services. Once all phases of the European Market Infrastructure Regulation are fully implemented, there will be increased regulatory-driven demand.
However, today, many market participants already clear their trades voluntarily to benefit from our offering. In addition, new legislation is coming, which will further enhance and strengthen the group’s role in the securities finance markets.