Regulation has pushed up securities lending costs and made beneficial owners more aware of risk. Firms such as BNY Mellon have responded with flexibility.
It’s no secreT that in the wake of the financial crisis, all parties involved in securities lending have become highly risk-aware. What they’ve also done is made a sophisticated analysis of each aspect of the securities lending process.
Consider the spotlight that is now on indemnification. According to Stephen Kiely, Head of New Business Development, Securities Finance, at BNY Mellon, “it’s important that clients look behind it to see what exactly is indemnified”.
“It’s a bit like a musical chairs,” he adds. “You want to make sure there’s a chair with your name on it.”
Of course, one challenge is that regulation such as Basel III has vastly increased the cost of providing indemnification – by up to ten times, says Kiely. As a result, some clients are deciding to forego indemnification, in order to benefit from lower fees. Central banks, sovereign wealth funds and government pension schemes, based on past behaviour, probably wouldn’t do this, but independent pension funds, insurance companies and hedge funds are increasingly doing so. Providers such as BNY Mellon are responding with flexibility, for instance allowing, within a single securities lending programme, for some parts to be indemnified and some parts not.
“By and large, people will still err on the side of caution,” he says. “However, there are new players in the markets who are willing to accept increased risk if there is an increase in reward.”
This adjustment to risk tolerance need not necessarily worry regulators, though. In a sense it reflects a positive trend – that in post-crisis world, both borrowers and agent lenders are looking closely at the securities lending process and deciding which aspects they need and which they don’t. Kiely says the industry as a whole is more focused on certain aspects of securities lending than before the crisis.
One example of increased sophistication is the trend for beneficial owners to dip in and out of the market with one-off trades, instead of establishing a complete discretionary lending programme. Some of Kiely’s clients prefer to come in and out of the market by lending specific stocks, trying to benefit from demand associated with corporate events such as mergers and acquisitions. But why are owners doing this instead of giving their agent lenders the authority to lend their whole portfolio, as they would in a traditional discretionary lending arrangement?
“It may be that 10% of your trades are earning 90% of your revenue,” says Kiely. “Owners see that with fewer loans, they have less risk.”
Another trend that is affecting the business is an increasingly sophisticated approach to collateral. People are now more willing to put equity loans against equity collateral, for instance, or they are employing the “upgrade” trade, by lending bonds and taking equities as collateral.
“We will get to a stage where clients who are willing to take a basket of equities will be comfortable to take an ETF [exchange-traded fund] instead,” says Kiely. “To my mind, the ETF is even more liquid. It can be more easily priced. That’s not something we’re seeing now but in the next year or two it will come.”
In sum, although the increased regulatory requirements have pushed up costs and increased complexity for agent lenders such as BNY Mellon, the overall effects of the post-crisis environment has been positive, says Kiely. All parties in the chain are keenly aware of their risks and responsibilities, and have responded by becoming more transparent and flexible. This, he says, can only be a good thing.
The views expressed herein are those of the authors only and do not reflect the views of BNY Mellon or any of its subsidiaries or affiliates.
The material contained in this interview is intended for the purposes of general information only. This does not constitute business or legal advice, and it should not be used or relied upon as such.
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