New participants are entering the securities lending market in search of extra revenues at a low risk. Funds Europe
talks to Dan Copin
and Donia Rouigueb
about the role that asset servicers can play in helping these new clients find their way.
The securities lending market is experiencing much greater interest from potential lenders, be they asset managers, beneficial owners, pension funds, corporates or institutional investors.
One of the main reasons for this renewed appetite is the negative interest rate environment, says Dan Copin, head of equity finance at Caceis.
In addition, the securities lending market has undergone a reform in the last few years, making it more transparent and regulated since the pre-crisis days. “For these new participants, securities lending is a new way to generate returns with low risk. That doesn’t mean that every asset owner is looking to do it, and there are still some challenges with on-boarding but there is definitely much greater interest.”
For asset servicing firms such as Caceis, their job is to explain the benefits of securities lending to these potential clients and to help them navigate the various rules, regulations, strategies and market dynamics. This enhanced relationship management approach helps to maintain client confidence.
Clients are also more inquisitive about how securities lending programmes work, says Donia Rouigueb, group product manager, securities lending, Caceis. In previous years, many of the asset managers that participated in securities lending were essentially looking for a quick and easy way to make extra money from their portfolios. Few questions were asked and few details were given.
But the financial crisis marked a change in the industry, says Rouigueb. “Before the crisis, there was no real framework and some bad practice.”
Securities lending became linked only to short-selling and all of a sudden, asset managers and their investors became far more concerned about how their assets were being used by lenders, leading to many withdrawing from the market.
For the lending agents and asset servicers with securities lending programmes, a lot of work has gone into meeting the buy-side concerns, creating more bespoke programmes with greater transparency into the process and more reporting on the performance.
Of course, some firms and their risk managers will still prefer not to engage in securities lending, but when the extra basis points accrued from a lending programme is the difference between the performance of one asset manager and their competitors in this low-rate environment, then risk managers will need to explain to their senior management why such a decision was taken.
THE FULL GAMUT
The new entrants in the securities lending market run the full gamut of buy-side firms – beneficial owners, corporates, asset managers and institutional investors. Some of them have been active in the repo market but are new to the world of securities lending, while others were uncomfortable about engaging in securities lending, or, in the case of some corporates, were simply unaware of the benefits on offer.
All of which face the same issue – the need to find extra performance in a low-rate environment. The difference, though, lies in the respective regulatory requirements that they face, says Rouigueb. “As an asset servicer, we have to know all of this. For example, a Ucits fund will have to comply with European Securities Market Authority (ESMA) rules regarding securities lending transactions. Meanwhile, institutional investors will be governed by Solvency II and its rules on capital levels in case of possible borrower defaults.
The chance of falling foul of these rules is a big concern from buy-side participants in securities lending programmes, says Copin. Consequently they want more regular and granular reporting from their lending agents, rather than being satisfied with simply receiving the proceeds at the end of every month.
Meeting this requirement is a challenge for the asset servicers and agent lenders and it requires significant investment in technology and staff, says Copin. “Today, transactions are done on an OTC basis, which makes it much harder to get hold of the relevant data.”
Lending agents also face their own rules, namely increased risk-weighted, asset-calculated capital costs for providing indemnification.
In addition to ensuring that they are compliant with various rules and regulations, clients also want simplicity above all else, says Copin. “In our experience, the more time we have to discuss possible transactions and trading ideas with the end investors, the greater their appetite for securities lending because they understand the advantages. Once we reach this stage, we can create bespoke solutions that provide them with high added value.”
For the asset servicers such as Caceis, their role is one of a matchmaker – to find the most suitable trade and counterparty for borrowers and lenders and then explain the virtues and mechanics of the arrangement to the asset owners.
“Clients want to know the impact on their systems, what regulations are involved and how the trade will work,” says Rouigueb. “Only a few of them can absorb the heavy investment necessary to run a securities lending desk of their own and most will look to a custodian or lending agent to help with all of this, from settlement to compliance to reporting to indemnity to collateral management. They want added revenue but without having to do too much work and without getting overwhelmed.”
A FINE BALANCE
Financial institutions are seeking trades of a longer duration as they need to lock up liquidity for longer periods in order to comply with capital adequacy rules. They are willing to pay a premium for that type of trade. On the other hand, lenders need to be sure that they can commit themselves for those maturities. However, a fine balance is needed to meet the needs of both parties, says Copin.
It is a fine balance that has to be achieved in order to meet the needs of borrowers and lenders and also to make the effort worthwhile for all concerned. Managers want to be more involved than in previous years. They want to participate and understand the process, with everything being more transparent. In essence, they want low-risk transactions and they want to remain compliant, which is why they rely on the expertise of an agent lender.
“At Caceis, one of our biggest strengths is the diversity of our client base and the fact that we know the specificities of them all,” says Copin. “Client service is in our DNA. When you go to other global providers, they may have a set template to which clients have to adapt. In contrast, we do our best to adapt to our clients.”
The flexibility is a real benefit for clients, says Copin. “Every time we meet with a client, we try to come up with at least one trading idea that is perfectly suited to the client’s expectations.”
©2016 funds europe