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Sec finance: working towards a digital future

securities lending, digitalisationAndrew Dyson, CEO of the International Securities Lending Association, participated in our recent securities finance roundtable. He shares his view on digitalisation in sec lending markets and a wider range of issues, including ESG screening and the impact of Covid-19.

How have financial markets responded to the Covid shock?

Andrew Dyson: This has been a different type of financial shock to that witnessed in 2007-8. We have not seen major corporate insolvencies, as we did during the global financial crisis when counterparty defaults were a feature of the early days of the crisis. This may be testament to the steps taken by financial authorities since 2008 requiring banks to strengthen their capital positions and to quantify and manage their credit risk exposures more effectively.

However, many banks are now reluctant to take risk. Given the constraints on their balance sheets and restrictions on proprietary trading activity, dealer firms are now limited in their capacity to intermediate the markets. In the early days of the recent crisis, banks absorbed sales of government bonds from market participants searching for liquidity – but they had neither the risk appetite nor the balance sheet capacity to meet further demand as liquidity concerns heightened.

With investment banks no longer able or willing to provide this intervention, systemic risk has moved from the banking sector to the markets. Particularly in the US, the central bank is no longer just lender of last resort, but also increasingly market maker of last resort. We are dealing with a different type of crisis as a result.

What are the priorities for driving digital transformation in sec lending?

Andrew Dyson: Implementation of the Securities Financing Transaction Regulation (SFTR) has been a major commitment across the market. But with the standardisation that SFTR has demanded, it is a relatively short – although by no means insignificant – step to start truly digitalising our markets. With movement towards a common domain model (CDM)­ providing greater consistency in how firms represent events and processes across a securities loan transaction lifecycle ­ this provides the foundations for a cleaner, straight-through (STP) process across trading and corporate actions processing.

Ultimately, when we can digitalise master agreements, taking advantage of standardised terms held in firms’ trading systems, this will enable greater automation of collateral allocation, offering potential to enforce counterparty schedules electronically without someone needing to contact the legal department to manually check the terms and conditions.

How important are ESG principles in guiding sec lending and collateralisation strategy ?

Andrew Dyson: ESG is front and centre of the regulatory and policy agenda in Europe. In the UK, this will be prominent as the UK government hosts the COP26 UN Climate Change Summit  in Glasgow– and it may potentially be used by UK policymakers to reinforce the appeal of the UK market after Brexit.

There is still work to do in extending flexibility around collateral use that is ESG compliant. We are liaising with tri-party agents to ensure more product and wider choice for the collateral taker. Applying ESG filters to collateral eligibility cannot simply mean having a long list of exclusions.

More broadly, the ESG agenda has reinforced the need for asset owners to engage more fully with their lending programmes and to have a better understanding of this activity. This centres on having a well-designed governance structure which can then be applied onto your lending programme.

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