As easy as the CCP
Matt Wolfe, vice president of new products and business development at OCC, explains how the central clearer is enhancing its stock loan programme to better serve the market
As the only US clearinghouse that provides central counterparty (CCP) services for stock loans, OCC’s programmes promote market stability and integrity through a framework that delivers prompt and accurate clearance and settlement and robust risk management services. As the marketplace continually evolves and regulatory change creates a tailwind for cleared solutions, OCC remains committed to its role as the foundation for secure markets, and to enhance its offerings to its current stock loan clearing programme.
Stock loan is an essential and substantial component of the global financial market, with the largest part of this market conducted through uncleared, bilateral transactions lacking the recognised benefits of clearing services with CCP substitution. Since OCC’s introduction of CCP services for the stock loan market, the volume of stock loans cleared by OCC has increased steadily. From 1 January through 31 May of 2017, OCC processed just under one million new stock loan transactions, a 19 percent increase over the same period in 2016, and had a daily average of $78 billion dollars in equity securities on loan.
OCC currently operates two distinct stock loan programmes: stock loan/hedge and market loan. Stock loans in the hedge programme are bilaterally negotiated between clearing members, usually through the facilities of a service provider, prior to being transmitted for settlement. If the borrower and lender are OCC clearing members that have elected to clear the stock loan, OCC is substituted as the CCP after initial settlement. Daily mark-to-market payments are settled through OCC, and OCC guarantees the return of lent stock (including any non-cash dividends and distributions) to the lender and the return of the collateral to the borrower. Payments in lieu of cash dividends are generally effected through the Depository Trust Company (DTC) but are subject to a limited guaranty by OCC. However, stock loan rebates remain bilateral rights and obligations between the lender and borrower.
In the market loan programme, lending and borrowing clearing members submit orders to an electronic trading platform known as a loan market. The loan market transmits resulting matched loans to OCC, and OCC sends settlement instructions to DTC where the lent stock is transferred to the borrower against the payment of cash collateral to the lender. These matched transactions are maintained on an anonymous basis. Alternatively, a lending and borrowing clearing member may negotiate the terms of a loan bilaterally and submit the transaction to a loan market for affirmation. The loan market transmits the transaction to OCC, and OCC sends settlement instructions to DTC. In either case, OCC guarantees not only the return of the lent stock (including any non-cash dividends and distributions) and the cash collateral, but also guarantees payments in lieu of cash dividends and rebates, which are paid through OCC’s cash settlement system.
According to OCC’s rules and by-laws, at present, participation in OCC’s stock loan programmes is limited to clearing members, and only brokers or dealers registered as such in the US or Canada are eligible to be OCC clearing members for the purposes of participating in OCC’s stock loan programme. However, most transactions in the US stock loan market, involve other types of entities acting as agent lenders to loan securities on behalf of their beneficial owner clients.
Clearing members and agent lenders are strong proponents of OCC enhancing its stock loan programmes in order to realise the benefits of clearing, including those outlined below.
Broker-dealers may realise additional capacity to lend and borrow through the following regulatory capital efficiencies offered by central clearing:
• Balance sheet savings through increased supplementary leverage ratio netting opportunities
• Mitigation of counterparty exposures as measured by single counterparty credit limits and comprehensive capital analysis and review
• Reduction in risk weighted assets due to CCP risk weight of 2 percent rather than 20 percent for banks and 100 percent for broker-dealers
• Expanded pool of counterparties
Agent lenders (referred to as lending agents) may be able to preserve and expand loan balances due to the following advantages of central clearing:
• Increased utilisation and mitigation of counterparty credit limits
• Improved pricing due to reductions in cost for the borrowing
• Improved counterparty credit quality due to CCP risk weighting of 2 percent and reduced regulatory capital requirements and indemnification expenses as a result
Beneficial owners (lending principals) may benefit from the following advantages of central clearing:
• Increased reinvestment revenue due to improved pricing for cleared loans and expanded utilisation
• Upgrades to counterparty credit quality due to CCP credit rating and additional guarantees
To achieve these goals and to provide greater capital efficiencies for its clearing members, OCC is implementing a number of enhancements to its stock loan programmes in order to reduce systemic risk, enhance transparency and allow more efficient use of capital, which lends to our mission of promoting stability and market integrity through efficient and effective risk management, clearing and settlement services.