Funds Europe – Will asset owners internalise their securities lending programmes in the face of lower spreads and loan revenue? Are you noticing a shift from ‘outsourced’ to ‘in-house’ securities lending activity?
Rouigueb – As a custodian bank with a sizeable agency-lending and principal-lending programme, we see little sign that asset owner clients are wanting to take their securities lending activity in-house.
Many of the largest securities lending providers are aggressive with their profit splits and, for the most part, it makes little sense for our clients to internalise this activity, even if they have the necessary scale. There is a high entry cost and this requires a lot of IT resources. When offered an aggressive profit split to manage the front-to-back processing, the SFTR [Securities Financing Transactions Regulation] reporting, and often with indemnification – the cost/reward is pretty clear. If a third-party provider will provide this service for minimal cost on the street, why would a lender do this internally?
Dyson – The way that this regulatory agenda has been rolled out is working in favour of those who have scale. You need to be a big player to absorb the costs of reporting, compliance, oversight and credit. Whether the regulators like it or not, this is likely to drive consolidation, with activity being concentrated in the hands of the larger securities lending providers that have the size to absorb these costs on behalf of their customers.
Regulated funds are under a lot of pressure and it is here that the Commission is placing a lot of its regulatory focus, particularly around the activities of Ucits funds. It will be a poor day for Europe if this regulatory agenda causes Ucits to be marginalised from securities lending activity. One consequence is that this will open the door for lenders that are less constrained, big sovereign wealth funds for example, to enter the market more aggressively.
Bouthors – We see some of these issues close up. For a Ucits fund, there is a high level of regulation and Ucits are limited in the risk they can take on. These lenders have been impacted particularly severely this year in terms of their ability to generate revenue.
Rouigueb – These circumstances are forcing clients to reassess how they approach their lending business. It requires significant flow volume, mostly through general collateral (GC) lending, to generate an attractive income. We have been talking to a number of clients who consider only lending their ‘specials’ stocks on demand. But, particularly for the regulated funds, there is a lot of monitoring and reporting required to support their lending activity and some are questioning whether they are generating enough revenue from this activity to make this worthwhile at the current time.
Meaden – This is one year when few beneficial owners would want to be bringing lending activities in-house and accessing the market directly. Some of the large universal bank and trust bank lenders are reporting that their aggregate loan revenues are down more than 25% over the year. We’ve seen examples of insurance companies opening their own lending desks for a time, but these are now closed.
Dyson – The message I am getting is that the big providers are pricing this service at marginal cost because they own the infrastructure. The large banks are interested in throughput, in putting flow through their machines, and that is leading to aggressive pricing. However, we need to question whether a 10% split is sustainable when this is also covering the capital cost associated with indemnification.
More broadly, this dialogue illustrates why, for asset owners, it is important to have a well-designed securities lending strategy in place, one that their securities lending provider can understand and implement. This will include situations where it may be impractical or unprofitable to lend, whether for operational or economic reasons.
Beyond this, there is a need for standardisation and clarity – regulators must step forward to provide clearly defined terms and a consistent legal framework for securities lending. Donia has highlighted the importance of technology to increase automation, but automation is not possible unless policymakers harmonise market rules and promote the standardisation of trade events and actions required for these automated systems to be effective.