Driving the industry
Collateral trends, risk management and central counterparties were debated at the 24th Annual Beneficial Owners’ International Securities Finance & Collateral Management conference
This year’s IMN conference discussion began with scrutinising the role of agent lenders. Panellists put traditioanal agent/owner relationship under microscope and offered advice to beneficial owners on how to manage a securities lending programme without risking asset safety and accessibility.
The most important factor for beneficial owners to consider before lending is who the borrower is. This can be done by looking into the borrower’s credit rating, obtaining information about their balance sheet or conducting its own analysis.
Indemnity is also critical to consider before starting the securities lending programme, according to Sudha Datta, president of SL&C Consulting, who noted that agent lenders sometimes didn’t specify what was covered in the indemnity policy. Another important element to deal with is whether cash or non-cash will be accepted as collateral. Setting the duration of lending is another issue not to neglect, according to Datta. He also recommended that beneficial owners should make sure they have a strong legal and service level agreement with the lending agent in which all the conditions are clearly set.
Beneficial owners in attendance had the chance to receive a running list on how to keep their assets safe, or at least manage the risk that lending them out exposes them too. To be able to insulate yourself from counterparty risk, it is necessary to consider all the possible aspects that can go wrong in a securities lending programme, according to a panellist. Speakers unanimously agreed on the significance of conducting risk and return analysis.
When it comes to engaging in emerging markets especially, agent lenders and their beneficial owners must be be very clear on their required risk profile.
Emerging markets can be very lucrative, but without knowing all the relevant regulations, investors could easily face penalties. If industry participants fail to comply with the expectations of the local regulators in these markets, it can result in some mandatory buy-ins and fines. This is not something European investors will be used to, although the Central Securities Depository Regulation is on its way.
Another panellist suggested that it is a safe path to “hold back a certain percentage of the assets”. This means a certain amount of yield will be sacrificed to preserve the portfolio’s safety. During this panel, the major fallout that a default could cause was discussed with speculative costs running into the billions of dollars. The best preparations for this scenario are the constant monitoring of the counterparties and understanding all the exposures you have got through your counterparty, according to a panellist.
However, before anyone would turn their back on the emeging markets, in on other panel discussion, it was outlined that “there was plenty of business out there”, referring to South East Asia, China, and Japan, where funds continue to grow.
Audience members heard that the trend for beneficial owners globally moving towards accepting non-cash collateral is continuing unabated, according to DataLend. The data provider’s representative, Nancy Allen, outlined that mixed collateral constituted the greatest part among collateral types accepted. Beneficial owners accepted 41 percent mixed collateral last year, while some 35 percent only accepted non-cash. Cash only collateral made the smallest part of the collateral breakdown last year, with 24 percent.
DataLend highlighted the global revenue earned by beneficial owners stood at roughly $9.22 billion globally for 2017. North American revenue was more than $ 4.85 billion last year.
DataLend’s annual beneficial owners survey, conducted in December 2017, showed that their purpose for engaging securities lending was shifting in line with rising revenues, from merely covering costs to actively seeking alpha. Of those surveyed, 66 percent cited alpha generating as their primary reason for lending assets, while only 35 percent were looking to simply cover costs.
The average lendable in 2017 was valued at $16.6 trillion, according to DataLend. US-based beneficial owners account for 51 percent of global lendable balance. Collective investments vehicles constitute 42.1 percent of all US-based lendable balance. Pension funds come second as the largest group with 26.3 percent lendable. Government/sovereign entities make 16.2 percent, while insurance companies embody 8.3 percent lendable balance.
The million-dollar question
Recent years have seen traditional beneficial owner risk profiles challenged by the buy-side’s growing issues with offering too much cash collateral and suggestions that opening up collateral profiles would invite more revenue from choosy borrowers. The vast majority of IMN panellists agreed on that taking non-cash as collateral is increasingly significant. While some 15 years ago, cash collateral dominated the market, nowadays non-cash is coming up. One panellist suggested that taking equities as a non-cash is a real opportunity.
There were strong opinions on the collateral issue voiced on both on the beneficial owner and agent lender side. One speaker representing a major US pension fund stated he was consistently only taking cash as a collateral. Since the financial crisis, he prefers to follow a conservative strategy. “Just because we can go out a little further, we don’t necessarily do that,” he explained.
However, a panellist representing an agent lender side was convinced that “if you don’t start taking non-cash, you will lose business soon”. There was also panellist from another agent lender side who tried to find the middle ground through the heated debate. “We have to find the balance between cash versus non-cash,” he suggested. However, the optimal solution to managing the risk/reward balance remains unclear.
CCPs on the rise
The ever-raging debate around the use of central counterparties (CCPs) continued for another IMN gathering. The majority of speakers were convinced that CCPs “would come and increase”. It was widely argued that in the near future, central clearing will not only impact the lending agent side, but also the borrower side. However, there are still challenges around the use of CCPs, warned one panellist. First and foremost, the necessity of educating investors on what are the obligation and responsibilities by joining the CCP. A special panel was dedicated to CCPs, where leading North American investment banks, a clearing house and the regulatory body attempted to debunk insecurities around the CCPs. All the attendees received a brief tutorial about what CCPs are and how they have evolved in the past couple of years. In short, there are two CCP participants in the US market. One clears repo, and one clears securities lending transactions.
According to a panellist representing an investment bank, clearing is not new. It has been around for a long time. The panellist said: “The trend is that both the activity and the number of members are growing at the central clearing space. It can also be seen as a product extension at clearing houses.”
The same panellist also noted that there is also a shifting trend among the client base where the discussion and education turned to execution. But more panellists outlined that a CCP is not ideal and not a “silver bullet to solve all problems” but it can be used as “a tool from the tool kit”. In the toughening regulatory environment, CCP may be the tool that is better suited to the
The attendees also learnt the scale of the activity of a leading North-American clearing house. The clearing house matched 70.5 trillion government securities transactions for their members, dated from December 2017.
The clearing house representative outlined that buy-side participation in clearing is not new, either. The clearing house expects that the changing regulatory landscape that brings more activity into clearing. In an attempt to get prepared, the central counterparty lifted the restrictions that money and mutual funds had to register with investment companies.
As it stands now, pension funds, for example, can be cash or collateral providers for the clearing house in the future. The move provides a greater pool of beneficial owners.