Eric Deudon, global head of market and financing services at BNP Paribas Securities Services, shares his views on some of the changing dynamics in securities lending.
What are the current trends that you see in the securities lending market?
Activity is particularly strong in Asia Pacific (APAC) bolstered by strong demand in some very dynamic markets such as Hong Kong. We see growth in demand for lending and borrowing in APAC, which is why we are further expanding our securities lending business in the region.
There continues to be robust borrower demand for eligible collateral securities and high-quality liquid assets (HQLA), especially for US Treasuries and European fixed income. This is being driven overwhelmingly by regulations such as Basel III’s Supplemental Leverage Ratio (SLR); Liquidity Coverage Ratio (LCR); and Net Stable Funding Ratio (NSFR). As a result, the ability to lend out these assets on a term structure will remain highly sought after, even though spreads have recently been under pressure. Furthermore demand for HQLA is also being fuelled by regulation (i.e. Dodd-Frank), which mandates that financial institutions post good-quality collateral as margin on their OTC trades at either CCPs (central counterparty clearing houses) or bilateral counterparties.
Securities lending revenue linked to equities was lower than expected in 2019. The marginal slowdown in demand is primarily a result of the drop-off in mergers and acquisitions over the past two years, which saw global deal-making decline by 11% to USD 2.8 trillion1. Meanwhile, ETFs as assets have driven strong interest overall, fully supported by ETF asset managers, keen to ensure a high level of liquidity to facilitate the work of market-makers and drive more flows into their programmes.
How is regulation shaping the securities lending market?
Regulation is a massive focus for market participants. The demand for HQLA will increase as the Basel III and IOSCO fifth and sixth waves of initial margin regulation come into force over the next two years.
Inside the EU, the Securities Financing Transaction Regulation (SFTR) is due to go live in April 2020 and will subject lenders and borrowers to extensive reporting and transparency requirements. In summary, the regulation is partly modelled on the EMIR (European Market Infrastructure Regulation) framework insofar as it insists that institutions engaging in securities lending and borrowing (plus repurchases or ‘repos’ and sell and buy-backs) practices must disclose the details of their transactions to an ESMA (European Securities and Markets Authority) approved trade repository. BNP Paribas is already providing support to clients as they prepare for the SFTR.
Elsewhere, the Central Securities Depository Regulation (CSDR) is poised to introduce widespread efficiencies in the securities lending market by imposing mandatory buy-ins (where the lender recalls shares) and financial penalties for late settlements. Furthermore, operational efficiencies within lending programmes will become an increasingly important factor when pricing loans. Institutions that develop Straight Through Processing (STP) loan and recall processes will be net beneficiaries of the positive pricing premium versus those organisations that are less efficient.
Despite the benefits of new rules such as SFTR and CSDR, they do of course generate costs for clients, and this is prompting institutions to outsource more of their operational activities and regulatory reporting requirements to their custodian providers.
What level of incremental revenue can institutional investors expect from engaging in a securities lending programme?
The current historic low/negative interest rate environment along with other challenging market headwinds has made it harder for beneficial owners to ignore the added value that securities lending can deliver. Revenue generation from securities lending is ultimately determined by the nature of the underlying assets which an institution holds, but also the tenors (the amount of time remaining on the loan) and the collateral that will be acceptable. In terms of securities lending revenues, a stable portfolio can generate a wide range of returns, keeping in mind that the main revenue drivers will be specials, ETFs or HQLA on term. Furthermore, potential additional revenues can be accrued through the reinvestment of cash collateral, which will complement the intrinsic value obtained from the securities lending programme.
However, regulators are challenging asset managers regarding the proceeds that they generate from securities lending. Regulators want to ensure that the revenues are split fairly between the asset management arm and the fund itself.
What are the main concerns of asset managers when engaging in securities lending?
A proper governance framework is essential when entering into a securities lending programme, which means asset managers need to have full oversight and transparency of the activities being undertaken. From authorised borrowers and collateral, to ad-hoc or specific parameters, the onus on asset managers is to ensure they have strong and robust internal controls over their programmes, which comply with the relevant regulatory frameworks.
How are you enhancing your securities lending proposition?
We offer principal and agency lending, a proposition that is not available at many of our competitors, but which gives clients maximum flexibility. We have made various enhancements to our securities lending product offering. For example, the bank is expanding its agency/principal services in Hong Kong, and is increasingly looking to leverage its in-house triparty capabilities to deliver a broader product suite to clients.
For agency lending, a combination of organisational changes and enhancements to our platform’s operating model has enabled us to better service our existing clients while preparing the business to grow substantially. Our global lending platform now enables assets in any major market across the globe to be placed on loan 24 hours a day, five days a week. This model results in better execution for client assets due to the local expertise of lending desks around the world to distribute assets in their local markets.
In terms of principal lending, we operate a single trading engine across our Corporate and Institutional Bank (CIB). Clients benefit from the combined capabilities of our Securities Services trading desks (i.e. equities and fixed income) as well as our Global Markets trading desks. By leveraging these channels together, BNP Paribas provides optimal pricing and utilisation to its clients, who are serviced by BNP Paribas Securities Services and benefit from its operational and reporting capabilities.
Do you have a message for new lenders contemplating entering the securities lending market in 2020?
In my experience you first need to assess whether a principal or agency model is the right solution. The two offerings are readily available but the risks are ultimately very different. For instance, a large asset manager might prefer to go for the agency model as it provides better risk diversification although other firms may opt for the operational simplicity that comes with the principal model.
Secondly, firms must identify their optimal risk-return framework (i.e. type of collateral an entity can accept, nature of the tenors). Collateral ‘flexibility’ in particular is a critical factor for beneficial owners to consider when setting up a new lending programme. Participants must also seek assurances that their service providers have excellent operational controls in place along with robust post-trade reporting.
1 – Financial Times (September 30, 2019) Global deal making grinds to slowest pace in 2 years
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