Securities lending reg reforms could hike European buy-side trading costs by €40 billion, report finds

Credit Benchmark found cost of capital for banks could rise fivefold when undertaking securities financing activity with pension and mutual funds.

Trading costs for the European buy-side could be set to hike up by up to €40 billion due to new securities lending regulation, a report by Credit Benchmark has found.

Incoming Basel regulation due to come into play in 2025 is expected to see high quality credits that have no external rating jump in risk weight to 100%. The rise will result in a dramatic increase in capital requirements.

Following concerns raised from industry participants around the impending changes to risk weights, the European Commission has proposed that there should be a transitional arrangement for unrated corporates and funds whereby internal ratings based (IRB) institutions would apply a preferential risk weight of 65% to their corporate and fund exposures that do not have an external rating, provided those exposures have a probability of default of less or equal to 50 basis points.

However, according to Credit Benchmark’s report even with this transitional arrangement, the new rules will have a “dramatic” impact on the buy-side that will see spreads widened and liquidity lessened.

The firm predicts that the changes will see lending out of securities for general collateral (GC) cease due to a reduction in the annualised €1.2 billion income that European savers currently receive. They could also spark a decline in securities financing activity that Credit Benchmark predicts will dry up market liquidity.

The result could be a range of widening spreads that could see trading costs for the buy-side rise anywhere from €20 to €40 billion per year.

“As costs increase there is likely to be some depressing impact on volume, although it is not clear what the sensitivity of this is likely to be,” said Thomas Aubrey, risk advisor at Credit Benchmark, and author of the report.