Andrew Dyson, of ISLA, explains why 2020 will be an inflection point for securities lending and how this is an opportunity for profound industry change.
As we think about how securities lending markets have changed during 2019 and what we might expect to see in 2020, I think that it is increasingly clear that we are at something of an inflection point. 2020 will see the arrival of two important pieces of regulation that are set to redefine much of our industry.
The Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) are seen by many as the concluding acts in a story that has been with us almost constantly since the financial crisis. Whilst the importance of these regulatory regimes cannot be underestimated, they also act as a ‘call to action’ and create an atmosphere for change. It is vitally important therefore that our industry embraces these opportunities to fundamentally change the way we operate.
In thinking about our markets more broadly, it is probably worth just pausing to reflect on the role that securities lending plays in supporting wider market liquidity and effective price transparency. In its simplest form, securities lending is no more than the buying and selling of liquidity that allows market makers and investment managers to offer effective and deep two-way markets and express directional sentiment respectively. These are all attributes that are now generally accepted as prerequisites of fully fledged capital markets and it is these important fundamentals that will set the direction of future travel.
Set against this backdrop, we are also seeing changing fundamentals asking different questions of our markets. The implementation of Uncleared Margin Rules (UMR), particularly for buy-side clients in waves four and five of this regime, is forcing institutions, perhaps for the first time, to think about collateral. Securities lending markets have always been a very efficient mechanism of moving collateral around the system and many institutions are looking at the role securities lending can play in delivering their broader collateral and liquidity requirements.
A common language
If UMR acts as a catalyst to think about securities lending against a broader regulatory backdrop, then SFTR and CSDR are forcing the market to look at the way in which it organises itself especially in the post-trade world. Here, we see significant opportunities to create efficiencies by the adoption of common standards around data, trading and lifecycle events in the form of a Common Domain Model (CDM).
Using the work the industry is doing to comply with the mandatory reporting obligation under Article 4 of SFTR, much of the work to standardise how we both interoperate and report activity in our markets has already been done. We believe that it is a relatively small incremental step to take this work and develop a common set of standards within a CDM framework.
CDMs will allow market participants to build new as well as link existing legacy systems via a common language that will create a common view across markets and products. These efficiencies will naturally lead to lower costs for processing transactions as the resources associated with managing fails and reconciliation breaks will fall away. From a regulatory perspective, a single view of a market will facilitate digital regulatory reporting where traditional rules-based reporting regimes will be replaced by smart interrogation of data.
As we look further out into 2020, we have already seen the new European Commission (EC) highlight the green agenda as a priority for the next five years. The Green Deal is the first policy proposal from the new EC, signalling the high priority given to sustainability, and additionally the sustainable finance agenda. This raises a number of important questions for all of us to think about in the context of the developing ESG agenda, as well as other important initiatives such as the Shareholders Rights Directive (SRD) here in Europe.
More recently, we have seen press commentary and speculation about the compatibility of securities lending and ESG funds. Some of these questions have centred around familiar topics such as short selling and corporate governance in the form of voting. It is therefore important that work across the industry to ensure that institutional investors continue to both lend securities but also discharge their responsibilities in the context of ESG.
Inevitably the answer to these questions is perhaps not straightforward and is multi-layered. As we look at ESG, it is important that investors develop policies around their own preferences in areas such as voting, governance and even short selling. To do this in isolation will over time mean we will see a proliferation of bespoke frameworks that will present challenges for agent lenders and borrowers of securities alike. Therefore, working on a cross-industry basis, I feel that it is incumbent on industry associations to lead the way on developing principles that support securities lending in the context of ESG that can be embraced across the industry. Taking this lead will demonstrate to regulators and policymakers that we as an industry are serious about trying to reach consensus as the ESG debate increasingly influences everything that we do.
Market liquidity
The final area that I wanted to touch upon takes me back to my earlier comments about liquidity. The EC has been developing the concept of a more autonomous capital market across Europe through its Capital Markets Union initiative. Although this is not a Brexit-specific issue, there are implications for the other liquidity and trading hubs across Europe as the UK leaves the EU. We have for some time argued for the greater involvement of European funds in the provision of market liquidity. As Europe strives to be less reliant on external liquidity and be more competitive with other trading blocs such as North America, investors will demand to see greater trading liquidity and efficient price discovery. To support these crucial parts of the investment lifecycle, it is important that market liquidity comes through the provision of robust and well-controlled securities lending markets.
So, as we head into 2020, we still have much to do to deliver the final elements of SFTR and CSDR. Whilst this very process presents important opportunities for securities lending to play an integral part in the future development of the wider capital markets across Europe, we see the post-crisis regulatory agenda days finally disappear over the horizon.
Andrew Dyson is the chief executive of the International Securities Lending Association
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