A worthy cause
03 September 2013
David Lewis, senior vice president of Astec Analytics, SunGard’s capital markets business, discusses value generation in a complex market
Image: Shutterstock
It has been many years since securities lending was treated as a back-office settlement coverage process. Now much more in the mainstream, the business is firmly in the front office as a risk-taking and revenue-generating activity, and more recently has become a central part of some firms’ liquidity and collateral functions. This brings benefits and drawbacks, of course, including much greater scrutiny and much greater attention from regulators around the globe.
Now seemingly under attack from all angles, the industry has to defend itself on many fronts. For example, short selling rules are arguably part of the cause behind dampened demand levels, whilst new regulations are increasing costs and adding friction to the market, potentially deterring the supply from remaining involved. The latest risk of assault has come in the form of the Financial Stability Board’s papers on oversight and regulation of shadow banking, released on 29 August.
Looking at these latest draft regulations has brought few surprises but has reignited some concerns over just what the effect on market liquidity will be. With the objective of reducing systemic risk, the fear of ‘runs’ and spiralling asset valuations if (when?) a market shock hits, the regulations seek to set minimum haircuts and limit the re-use of collateral, otherwise known as re-hypothecation; a term surely headed to join shadow banking and short selling on the financial markets naughty step.
With all these headwinds, is there sufficient interest and engagement from the beneficial owners to ensure the business remains alive? Whilst it is fair to say that you cannot force demand to borrow securities, without the willingness of enough funds to lend there will be insufficient supply and the market will wither.
August saw Finadium publish its 2013 annual survey of asset managers’ views on securities lending and collateral management. Notably, the tone of responses was more than positive with regard to asset managers’ views of the securities lending market and its importance to their businesses. Revenues may be below the peaks of five years ago, but valuable levels of income continue to be generated and, thus far, additional costs of doing business seem to have been absorbed as the industry continues to find a way forward.
Commonly, the costs of managing lending programmes is met through the fee split, but these have also come under scrutiny both through regulation (albeit indirectly through the ESMA view of how much of the lending revenues generated should be returned to the beneficial owner) and through a small number of legal actions alleging unfair splits. Such actions have largely failed it has to be said, but their existence would suggest that there is some level of dissatisfaction regarding how much revenue the market participants retain for providing their services.
What is clear in some quarters is that split may well need to change; just perhaps not yet. But as the costs of running a securities lending business rise, particularly for the agent lender, then these costs will need to be met from somewhere. Pricing in an indemnity is one such cost that may well have to be recognised in a fee split arrangement—one price with indemnity, a cheaper split without. According to Finadium, only 9 percent of respondents have already had such a conversation with their agents, although it was not disclosed as to whether any fee change resulted. This may be a direct result of the remaining uncertainty of some regulatory costs, but also an indication of the level of competition in the market keeping splits static and forcing agents to quietly absorb the costs.
Another important trend in the market is for increasingly engaged beneficial owners taking ever more active roles in the management of their programmes, including counterparty approval, more closely defined collateral schedules and dynamic restrictions on the securities they are prepared to lend. Ever greater transparency, through enhanced reporting from their agents, alongside third-party data from providers such as SunGard’s Astec Analytics, has allowed beneficial owners to make more informed decisions about their programs. One large asset manager that used the Astec Analytics reporting and benchmarking services identified that 85 percent of their income comes from only 100 lines of assets—all equities. More than 90 percent comes from less than 300 lines and, armed with this information, they can finely tune their programme for maximum revenues for the least exposures.
This new found dynamism from the asset owners has forced the market to change; now there are smaller pools of homogenous lendable assets. These have been replaced by more specific and individual programmes with their own actively managed collateral requirements, permissions and limits. This has driven behavioural and systems changes at both the lenders and borrowers managing the business.
The evidence and data indicates that the supply side of our market remains healthy, at least for now, with more beneficial owners placing greater importance on the revenues that are available as well as increasingly integrating their lending programmes into more sophisticated liquidity and collateral management functions. With the gradual reduction of yield enhancement revenues expected to continue, the industry has had to realign itself with the new trading environment, fit in with new regulatory regimes and seek out new revenue sources.
Now seemingly under attack from all angles, the industry has to defend itself on many fronts. For example, short selling rules are arguably part of the cause behind dampened demand levels, whilst new regulations are increasing costs and adding friction to the market, potentially deterring the supply from remaining involved. The latest risk of assault has come in the form of the Financial Stability Board’s papers on oversight and regulation of shadow banking, released on 29 August.
Looking at these latest draft regulations has brought few surprises but has reignited some concerns over just what the effect on market liquidity will be. With the objective of reducing systemic risk, the fear of ‘runs’ and spiralling asset valuations if (when?) a market shock hits, the regulations seek to set minimum haircuts and limit the re-use of collateral, otherwise known as re-hypothecation; a term surely headed to join shadow banking and short selling on the financial markets naughty step.
With all these headwinds, is there sufficient interest and engagement from the beneficial owners to ensure the business remains alive? Whilst it is fair to say that you cannot force demand to borrow securities, without the willingness of enough funds to lend there will be insufficient supply and the market will wither.
August saw Finadium publish its 2013 annual survey of asset managers’ views on securities lending and collateral management. Notably, the tone of responses was more than positive with regard to asset managers’ views of the securities lending market and its importance to their businesses. Revenues may be below the peaks of five years ago, but valuable levels of income continue to be generated and, thus far, additional costs of doing business seem to have been absorbed as the industry continues to find a way forward.
Commonly, the costs of managing lending programmes is met through the fee split, but these have also come under scrutiny both through regulation (albeit indirectly through the ESMA view of how much of the lending revenues generated should be returned to the beneficial owner) and through a small number of legal actions alleging unfair splits. Such actions have largely failed it has to be said, but their existence would suggest that there is some level of dissatisfaction regarding how much revenue the market participants retain for providing their services.
What is clear in some quarters is that split may well need to change; just perhaps not yet. But as the costs of running a securities lending business rise, particularly for the agent lender, then these costs will need to be met from somewhere. Pricing in an indemnity is one such cost that may well have to be recognised in a fee split arrangement—one price with indemnity, a cheaper split without. According to Finadium, only 9 percent of respondents have already had such a conversation with their agents, although it was not disclosed as to whether any fee change resulted. This may be a direct result of the remaining uncertainty of some regulatory costs, but also an indication of the level of competition in the market keeping splits static and forcing agents to quietly absorb the costs.
Another important trend in the market is for increasingly engaged beneficial owners taking ever more active roles in the management of their programmes, including counterparty approval, more closely defined collateral schedules and dynamic restrictions on the securities they are prepared to lend. Ever greater transparency, through enhanced reporting from their agents, alongside third-party data from providers such as SunGard’s Astec Analytics, has allowed beneficial owners to make more informed decisions about their programs. One large asset manager that used the Astec Analytics reporting and benchmarking services identified that 85 percent of their income comes from only 100 lines of assets—all equities. More than 90 percent comes from less than 300 lines and, armed with this information, they can finely tune their programme for maximum revenues for the least exposures.
This new found dynamism from the asset owners has forced the market to change; now there are smaller pools of homogenous lendable assets. These have been replaced by more specific and individual programmes with their own actively managed collateral requirements, permissions and limits. This has driven behavioural and systems changes at both the lenders and borrowers managing the business.
The evidence and data indicates that the supply side of our market remains healthy, at least for now, with more beneficial owners placing greater importance on the revenues that are available as well as increasingly integrating their lending programmes into more sophisticated liquidity and collateral management functions. With the gradual reduction of yield enhancement revenues expected to continue, the industry has had to realign itself with the new trading environment, fit in with new regulatory regimes and seek out new revenue sources.
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