Regulatory pressures are encouraging more securities lending activity to take place through central counterparties (CCP). However more work is needed to win over beneficial owners, according to panellists at the IMN European Securities Lending Conference.
As regulations such as Basel III and Dodd Frank continue to sink in, market participants are warming to securities lending CCPs as a means of alleviating capital and balance sheet constraints.
While activity between CCPs and the broker-dealer/agent lending community has increased, participation is yet to pick up amongst beneficial owners.
“From the beneficial owners’ perspective, I think some things still need to be answered fully by the CCPs,” says Keith Haberlin, global head of Securities Lending, Brown Brothers Harriman.
“It is another one of those tools in the toolkit, where if they want to continue to generate revenues from low margin trades, such as General Collateral trades, and they want to continue to have an indemnification they have to keep open minded to the CCP model. I think what is more important than pricing right now is to have some of these questions answered fully because there is still quite a lot of work to do, from an operational perspective, to get the CCPs to work.
“The point of a CCP is that it should not fail, so you should not need to indemnify a beneficial owner if you are lending to a CCP. That is a discussion that will have to happen over time.”
Regulatory demands are constantly shifting the risk/reward models for both agent lenders and beneficial owners. As focus continues to centre on return on assets (ROA) and capital, participation from both sides could be dependent on pricing.
“From a beneficial owner perspective, you are looking to get the reward for the right risk profile; from an agent lender perspective you are looking to get the right reward from the return on capital. The pricing needs to be more dynamic, depending on the product or the indemnity or the haircut,” says Alex Lawton, head of Securities Finance, EMEA, State Street.
The issue of pricing, as well as the ability to net trades through a CCP, was also emphasized by one prime broker.
“I do not know how much the CCP is going to charge me because we have to put money into the default fund. The lenders and the beneficial owners do not have to do that. Then there is also the question of how are they going to calculate what is going into a default fund. Am I paying for mutualising the risk? If I am in position where I am netting but the other broker-dealers are not, this risk is not being mutualised, and all of this is still to be confirmed,” he says.
However, according to Paul Wilson, global head of Agent Lending, Product and Portfolio Advisory at J.P. Morgan, agent lenders will ultimately decide how transactions for beneficial owners will take place.
“The agents have run out of capacity to provide indemnification, and they are trying to offload the risk to the CCP,” says Wilson.
“You’ve got to look at where lending fits with the majority of the beneficial owners. It is not something they do every single day; there are many other things they are trying to deal with, and I don’t think they have the breadth of capacity to understand all of these things, which I think is what they pay their agents for.
“They haven’t got round to the 1000-page clearing agreements yet, so the agents are paid to do much of that for them, and it is the agent who decides how they transact.”