BNP Paribas Securities Services’ Ross Bowman talks about the latest trends in the securities lending market and the growing needs of beneficial owners.
Changes to the use of, demand for and regulation of collateral have been a big driver of change in the securities lending market. When comparing what current collateral is being held in tri-party versus what was being held a year ago, you can see that equity collateral has fallen from 49% to 41%, although the use of government bonds as collateral has increased from 39% to 48% over the same period.
This shift in what banks are looking to give up as collateral is paradoxical to some extent, says Ross Bowman, business development, securities finance, Market & Financing Services, BNP Paribas Securities Services. “The lending of high quality liquid assets (HQLA) has been a big trend in the last year, and the acceptance of equity collateral has played a major part in this revenue stream for lenders. However, as banks have become more efficient at managing their balance sheets, the amount of equities readily available to give up as collateral has fallen,” he says.
“Furthermore, cautionary sentiment among investors across the Eurozone has meant that a demand divergence in European government bonds has emerged, with some banks looking to borrow only the higher tier government bond HQLA, such as German and French bonds, while giving the lower tier or peripheral Eurozone government bonds as collateral, such as Spain and Italy.
“We have also seen a change in the way borrowers are looking to provide collateral under securities lending transactions, most notably banks are looking to provide collateral as a pledge rather than an outright transfer of title. Under a pledge, securities collateral and margin stay within the borrower’s ownership and as a result, the transaction attracts a much lower risk weighting, significantly reducing the cost of executing securities lending transactions for borrowers.”
Although, pledge structures have been commonplace in the derivatives market for many years, they are a relatively new development in securities lending and one that will begin to gather momentum into 2017, says Bowman.
“Given the capital costs associated with providing collateral under title transfer, the demand to use pledge has naturally increased. However, although the benefits to the borrower are clear, the benefits to the underlying beneficial owner require further evaluation.
“For one, pledge collateral structures could impact the provision of indemnification offered by an Agent lender as title and access to collateral in the event of a borrower default need to be fully established prior to the implementation of any pledge arrangement. However, if capital costs are reduced for the borrower, lenders will look to benefit from an increase in lending activity and higher fees as borrowers will have room to pass on some of their cost savings to the underlying beneficial owner,” says Bowman.
The International Securities Lending Association (ISLA) has started to run workshop discussion groups for all participants in the lending chain in order to evaluate the possibility of using pledge arrangements. “The collective aim of which is to establish a legal framework through the potential use of standard pledge contracts to the satisfaction of all participants while reducing costs and managing risk” says Bowman.
Regulation has been a key area of focus for securities lending participants, just as it has for every other market segment. The requirements under Securities Financing Transactions Regulation and MiFID II have put more pressure on Agent lenders in terms of managing compliance and developing internal systems and processes. “These challenges will be overcome,” says Bowman. “There are solutions already under discussion in the market, which will incur additional time and resource, the cost of which will be absorbed by the market as a cost of doing business.”
He adds that “securities lending markets have always been sensitive to macro financial and political events”. In addition to the events seen so far this year, (most notably the US presidential election and the UK and Italian referendums), there are general elections due in Germany, France and Italy next year, together with increased asset purchases by central banks that could well generate further market volatility and securities lending opportunity.
“Securities lending service providers have been historically slow in reacting to change, but,” says Bowman, “the pace of change has now quickened, with a focus on greater product automation, data transparency and the adaptation of infrastructure change through the use of CCPs.
“Clients are increasingly looking for dynamic reporting and data analytics tools. Many of our clients now prefer to extract their lending data for use within their own reporting tools rather than be provided with a static report on a predetermined basis. In a similar context, lenders have also embraced the availability and access to securities lending trading desks, thus benefiting from the ability to communicate with the traders in real-time.”
In 2012, BNP Paribas Securities Services opened its US agency lending office and has grown its programme to over 40 US- domiciled clients. Bowman is optimistic about the prospects for its US team, not least because of the challenges that the large US custodians are facing in their home markets.
“US securities lending agents continue to be challenged with managing single counterparty limits imposed by the Federal Reserve and as a consequence, US lenders have seen balances fall,” he says.
“Our programme has been a net beneficiary of this effect. Our client segment has increased significantly in the US and although in the beginning we were cautiously optimistic of our success, we were confident that a great opportunity exists for us in the region.”
Bowman is optimistic about the prospects for new products, services and business models. “Some of the traditional revenue streams are certainly waning, but we are seeing other streams replace them.”
Increased M&A activity and the strong performance of so-called ‘specials’ such as US auto manufacturer Tesla, oil and gas firm Vale, and UK retailer Sports Direct, this year have created strong revenues for lenders. Buoyant equity markets and increased HQLA demand are both welcome developments for lenders and beneficial owners, says Bowman.
He expects to see more interest from beneficial owners and asset managers in the CCP model, which could in turn impact the traditional lending model. “We see clients looking for greater integration between securities lending and related services. As providers, we should be addressing clients’ needs across the board – from repo to securities lending to collateral management – so there will be strong opportunities for those that can offer a full suite of services.”
Clients also want, above all, efficiently run programmes with minimal impact on their day-to-day businesses, says Bowman. Shortened settlement cycles in Europe under Target2 Securities (T2S) coupled with increased market volatility in 2017, will ensure this remains a constant focus for service providers.
“When equity markets are buoyant, you typically see a greater level of portfolio rebalancing. What clients do not want is to see is a lending programme disrupting their businesses activities. So the focus for Agent lenders will be to ensure that disruption is minimised in every way possible when market volatility increases.”
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