The customer’s always right
IMN’s Beneficial Owners’ International Securities Finance & Collateral Management Conference in Florida saw many lenders shut down agents’ calls for the terms of their strategies to be revised

IMN’s Beneficial Owners’ International Securities Finance & Collateral Management Conference in Florida provided lenders a platform to reassert their needs and stress the importance of certain aspects the status quo that some agents would like to change.

Above all else, for many beneficial owners, indemnification was the line in the sand that cannot be crossed.

Some agent lenders argue that indemnification is the appendix of the securities lending transaction. A benign feature that has outlived its usefulness but stubbornly remains, threatening acute pain at any moment.

However, despite agent lenders’ protest of the unreasonable balance sheet allocations associated with it in contrast to the level of protection it provides, beneficial owners, and their underlying investors, remain unwilling to allow the service to go under the knife.

In the words of one beneficial owner speaking on a panel in Florida, any cuts to indemnification would force some to shut down their securities lending programmes.

The panellist explained that, although beneficial owners must bear the cost of indemnifying trades, the guarantee of redemption frees up budgets that would otherwise be absorbed by maintaining staff able to assess the counterparty risk associated with a trade.

In a separate panel, beneficial owners that do not have indemnification were advised that their collateral liquidation procedures must be efficient and be able to act quickly during a crisis scenario to avoid taking on losses.

Although the cost of retaining indemnification was acknowledged, multiple panellists countered with the opinion that, ultimately, beneficial owners lack the technology infrastructure and expertise to manage the counterparty risk exposures involved in removing that safety net.

Another beneficial owner observed that indemnification also serves to keep agent lenders honest by making sure they have ‘skin in the game’.

Agent lenders responsible for making their clients whole may be more motivated to act more efficiently in the case of a trade fail than they may otherwise, explained the speaker.

As usual, regulation is also at the heart of the problem. Specifically, concerns have been raised that the US Dodd-Frank Act’s Collins Amendment and Basel III’s capital ratios could potentially affect an agent lender’s ability to offer the service.

Speaking too soon?

The US financial services industry has been rocked in recent weeks with newly installed President Donald Trump embarking on a reform programme that threatens to loosen the moorings that hold the country’s regulatory framework in place.

Trump’s executive orders giving the US Treasury powers to review and amend large swathes of post-financial crisis regulation has created a period of uncertainty in the future direction of markets at a time when fresh regulatory deadlines are fast approaching.

During a panel reviewing the landscape as it stood at the time—and a day before Trump would sign the executive order regarding the Treasury—speakers defiantly stated that the securities lending industry shouldn’t expect an axe to be taken to banking regulation any time soon.

“I don’t think we will see repeal of regulations,” according to a legal expert panellist.

The panellist added the caveat that frameworks such as the new stay protocols are largely based on authority handed down from Dodd-Frank, meaning any amendments that may come will have significant knock-on effects.

An established market authority on the panel added: “Dodd-Frank isn’t going away anytime soon, despite what you read in the paper.”

A panellist with connections to policymakers also reaffirmed that the move to shorten the settlement cycle from T+3 to T+2 is receiving a lot of momentum from the industry and is expected to come into force in September.

The final draft of the rule is currently being formulated and is expected in March. For beneficial owners, the key change is that the recall window for on-loan securities will become a day shorter.

The question of whether the review of Rule 15c3-3, which may be amended to allow equities to be accepted as collateral in the US, is likely to move forward this year was posed to the panel.

The response was that it is very unclear, although talks are ongoing.

Row back for repo

The emergence of central banks reverse repo programmes is an admission that balance sheet regulations have gone too far, according to the keynote speaker the conference.

Keynote speaker Manmohan Singh, a senior economist at the International Monetary Fund, suggested that central bank quantitative easing policies are causing the traditional “plumbing” of financial markets to “rust” due to an over-reliance on government programmes. “There’s two balance sheets in play,” Singh explained.

Non-banks that are accepting newly printed money for their bonds are contributing to the emerging liquidity issues because these securities “end up siloed at the US Federal Reserve”, instead of being reused within the market.

Singh also highlighted the risks posed by the expanding divergence between the secured and unsecured funding rates. The rift that currently exists between these, although still within acceptable parameters, is an unhealthy feature of the current market environment.

The rift must be closely monitored in the future, especially if the much anticipated rate hike occurs in March as some panellists predicted. If the two rates continue to drift apart, the monetary policy transmission will be impaired, Singh concluded.
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