Aug 07, 2012
Shorting to move to CCP model – Celent
The bulk of securities lending in
the future will be transacted via central counterparties (CCPs), one research firm has
forecast.
Market volatility, regulatory concerns
and the G-20 worldwide push towards the central clearing and exchange trading
of OTC derivatives are the key impetus behind a possible change in the way
market participants short sell, according to a new report from Celent titled 'Top trends in securities lending: The road to recovery and evolution'.
“Now that Dodd-Frank, the European market infrastructure regulation, and
MiFID II are pushing OTC derivatives to be cleared centrally, the Financial
Stability Board is exploring how to reduce systemic risk in securities
lending, otherwise known to regulators as ‘shadow banking’,” the report read. "The first question that comes to mind is: Can securities lending follow in the
same footsteps as OTC derivatives and use a CCP model to increase liquidity and
address counterparty risk factors?”
Celent said since its
introduction in 2009, the CCP model for securities lending had contributed to risk reduction and
liquidity increases in other capital market avenues that are correlated to
securities lending.
“The problem, however, arises
when larger counterparts are brought toe-to-toe with smaller, less capitalised
firms, which could result in larger market exposure,” the report read. “This
takes away the advantage from the larger and more creditworthy counterpart and
puts the ball in the smaller, less capitalised counterpart’s court.”
Celent has predicted the CCP
venue to be a viable option for securities lending with the caveat that similar
to other capital markets practices which have CCPs and exchanges, an OTC market
would likely also exist.
“In the event a CCP model is
mandated and the market moves to full implementation, custodians will still
play a major role in the securities lending space; it would be highly unlikely
for beneficial owners to go directly into the marketplace,” the report read. “Not
to mention that an exchange model would require significant operational and
technological investments for all parties involved; borrower, lender, intermediaries,
and CCP.”
European short selling
restrictions throughout 2011 and 2012 stemming from market volatility have
curbed securities lending practices and drawn them to the attention of
regulators around the globe. In the US, the Dodd-Frank Act’s Orderly
Liquidation Authority puts credit limits on counterparties. Capital rules and
short sale disclosure studies could have a major impact on securities lending
market participants. Additionally, Celent said the so-called Volcker Rule ban
on prop trading by deposit-taking institutions calls into question the ability
of agent lenders to manage certain unregistered cash collateral reinvestment
pools.
In Europe, Basel III potentially
impacts the value of indemnification that a bank provides its securities
lending clients, and encourages banks to consider credit CCPs. Additionally,
greater transparency could discourage short sellers who prefer to remain
anonymous, therefore resulting in fewer securities loans. Celent said European
regulators’ abilities to intervene to eliminate or reduce short selling in
times of stress legitimise the elimination of short selling during market
crises may result in decreased borrower demand as short sellers worry about
uniformity in market rules.
Bruce Love
+44 (0)20 7397 3818
bruce.love@thetrade.ltd.uk