US securities finance panel
01 October 2024
Leading participants in US securities lending markets discuss the major themes shaping the past year after an eventful 12 months, client engagement, and significant regulatory initiatives which are set to shape the landscape for the industry
Image: stock.adobe.com/coffeemill
John Fox, US Head of Market and Financing
Services, Íø±¬³Ô¹Ï Services, BNP Paribas
Lori Paris, Senior Vice President, Head of Client Management NA, Íø±¬³Ô¹Ï Finance, Northern Trust
Jarrod Polseno, Managing Director and Head
of Agency Lending Trading, State Street
Simon Tomlinson, Global Head of Agency
Lending Trading, BNY
Which trends stand out in terms of lending activity and strategy in the US securities lending market over the past 12 months?
Jarrod Polseno: 2024 has been an interesting year for the US securities lending market. Three major themes that standout as we look back on the year would be the move to T+1 settlement for the US, Canada, and Mexico; the overall lack of specialty (intrinsic value lending) in the US equity space; and the overarching theme of if or when we would see changes in monetary policy from the Federal Reserve and central banks around the world.
Simon Tomlinson: The trends in the US securities lending market have changed significantly this year compared with 2023. While there were several notable special issues last year, including AMC and JNJ, there has been a considerable decline in such issues over the past 12 months, with only a few names contributing substantial value.
The market is now saturated with equities, driven by long-bias activities and index arbitrage, resulting in greater internalisation and reduced borrower demand for equities compared to 2023. Conversely, increased inventory pools have made it necessary to finance more equities, resulting in substantial growth in both our upgrade and equity repo trading books.
There has also been a continued upward balance trend in the US corporate bond sector, bolstered by record-breaking new issues in investment-grade bonds, a surge in financing and refinancing activities in the high-yield sector, and an influx of new participants, which has driven increased demand.
US government securities have continued to grow following a robust performance in 2023. This sector is benefiting from the increase in upgrade and equity repo activities I mentioned before, as well as higher funding requirements amid the prevailing uncertainty surrounding interest rate policies.
What notable securities or asset classes have been particularly vibrant in terms of securities lending activity? What have been the primary drivers of this?
Lori Paris: Level 1 high-quality liquid asset (HQLA) securities, such as US Treasuries (UST), have been particularly well sought after in the securities lending market — several factors have contributed to this strong demand. Regulations such as the liquidity coverage ratio (LCR), net stable funding ratio (NSFR), and global systemically important bank (G-SIB) scores, led to borrower demand to source Level 1 HQLA securities and pledge back lower grade collateral, known as collateral upgrade trades.
Polseno: While it would be hard to argue that there has been a robust lending market for the majority of the year, certainly there were advantageous opportunities. In the first quarter, there were lending opportunities for shares of Manchester United (MANU), as well as the exchange offer as Cummings (CMI) split off their remaining holding of ATMUS Filtration. The second quarter brought the annual reconstitution of the Russell indices, historically an event which causes volatility in lending markets — the 2024 edition was fresh off the back of the move to the new T+1 settlement cycle and created a sense of uncertainty. Finally, in Q3 the market witnessed the long anticipated merging of SiriusXM with multiple Liberty Media Corporation tracking asset classes. The ETF sector is an asset class that has seen, and continues to see, interest and growth. Within the ETF world demand for trackers such as S&P and sector-specific names that follow real estate, utilities and banks, seem to garner a lot of interest.
Earlier in the year, with interest rates at historical highs, the broader market-tracking ETFs such as SPY saw a lot of borrower interest. As the interest rate decline cycle starts, the borrowing community has shifted focus to defensive names that track banks and utilities. In the government fixed income markets, US Treasury Bills have undoubtedly been the main attraction over the past year.
There have been fewer specials in current issues due to an inactive Fed and Federal Open Market Committee (FOMC) since July 2023, and larger issue sizes. T-Bills have especially picked up over recent months as speculation on Fed rate cuts has increased, and has forced more cash to be ‘parked’ in the front-end of the curve, creating sporadic illiquidity in various T-Bills and UST issues maturing less than six months, widening some spreads to 10 to 25 (or more) basis points.
Tomlinson: For BNY, US corporates and US Treasuries have been the most vibrant asset classes.
US corporations have continued to gain momentum. Given the previous challenges in the credit space as a result of higher interest rates and the constrained financing environment, there is now an influx of new market participants, at both banks and hedge funds. This additional demand has led to significantly higher balances over the past 12 months. The statistics are astonishing. According to LCD News, high-yield deal formation is up 42 per cent quarter-on-quarter, and year-to-date volumes have already surpassed the total for 2023, with US$220 billion compared to US$176 billion last year.
US Treasuries have largely remained steady in a general collateral (GC) market this year, albeit in an orderly and range-bound manner. The secured overnight financing rate (SOFR) has gradually moved higher in the second half of this year, due in part to increased issuance, quantitative tightening, reduced reverse repurchase agreement (RRP) usage, and increased sponsorship volumes.
While balances have grown as a result of demand for more term upgrades, the specials market has remained muted. Apart from the occasional short coupon or T-bill, the current 20-year bond has been the highlight in this market over the past 12 months. This has primarily been driven by a relative-value short base, coupled with relatively small issuance and limited system open market account (SOMA) availability, leading to short demand trading through fail levels.
Have there been any notable trends or changes on the supply side in terms of lendable assets?
John Fox: The majority of market participants and prospects are now very aware that a substantive income stream on the right type of assets can be attained with controlled low risk elements. Our industry’s lendable assets have just eclipsed US$40 trillion in assets, according to DataLend. This is a testament to the education securities finance market practitioners have successfully engaged in over the last 15 years. We will need to continue this to ensure that future changes, especially those regulatory in nature, are interpreted clearly and communicated by our industry to ensure a widespread understanding of the impact of those changes.
Polseno: The theme on the supply side this year has been one of continued growth, both due to asset appreciation as well as new assets entering the market. We are seeing even more client interest in lending, whether it is to help offset fees, better compete with other investment manager returns that participate in lending, or simply to earn incremental alpha on their fully-paid assets. The evolution of our risk management centric lending programme resonates with clients and brings comfort that lending returns can be generated with minimal value at risk exposures.
Tomlinson: There has been a clear expansion of lendable inventory. Notably, S&P Global reported a headline figure of US$40 trillion in lendable assets this year, which is a remarkable increase compared to the early post-global financial crisis (GFC) landscape. This reflects not only an influx of new market participants, but also a significant mark-to-market adjustment as equity markets have rallied post-pandemic.
We have seen interest from a wide array of clients, from those entirely new to the securities lending business to existing clients seeking to broaden their offerings. This widespread client engagement underscores a collective intent to participate in the securities lending market, leveraging opportunities to achieve ancillary returns that align with risk management strategies.
Paris: Lendable assets have grown at a faster clip than revenue, standing at US$38 trillion across international and domestic equities, corporate and government bonds, exchange traded products (ETPs) and other products, with around US$2.7 trillion on loan, according to DataLend.
The increase in lendable assets is attributed to three factors: first, increased client interest in securities lending to generate alpha to increase fund performance or to offset costs. Second, government bonds made available for lending in increasing amounts, with new supply coming into the market — government bond lending is about 36 per cent of on-loan balances and contributes to overall secondary market liquidity and the role of lending in sourcing HQLA. Third, US equity markets have increased year-over-year, resulting in increased lendable asset values (for the 10 years ending in August 2024, the S&P 500 has outpaced the historical average, returning an annual average of 12.9 per cent with dividends reinvested).
What new pressures are facing firms’ securities lending activities in the US in anticipation of Basel III Endgame? How will industry participants and banks cope with the three-year transition period, starting from 1 July 2025?
Tomlinson: Market participants are well-versed in navigating the implementation of global regulations, and we do not anticipate any significant challenges as a result of the Basel Endgame. All regulatory changes present both opportunities and constraints for individual market participants, and it is expected that the market will naturally adjust to these modifications. It is crucial to understand that, while regulations apply uniformly to firms, their impact varies depending on each firm’s unique business mix, balance sheet structure, growth strategy, and the systems employed to measure resource consumption. Consequently, these impacts will be nuanced rather than binary.
The nuanced nature of these impacts is particularly evident in the context of overall capital costs, leading to elevated funding pressures and a reduction in some balance sheet capacities. Over the years, there has been a considerable discussion about central clearing, and our position is unchanged: an increasing focus on risk-weighted assets (RWA) by primary dealers, coupled with additional supply, has heightened this need.
Polseno: In short, capital usage is always a consideration, this past year we saw a continuation of borrowers being more discerning with regards to the beneficial owners with which they face off from a regulatory capital classification standpoint. With capital constraints at the forefront of borrowers’ minds, borrowers look for more efficient, low risk weighted lenders which tend to be government associated entities. From a supply side standpoint, this creates an unlevel playing field for some types of clients to match market demand. This is spurring further innovation in terms of capital efficient structures that will allow a wider lender base to receive similar low risk weighted treatment.
In May, the US, Canada and Mexico moved to T+1. How has the move impacted the US securities lending market? How will this achievement guide other regions looking to implement the shorter settlement cycle?
Fox: The T+1 transition in the US, Canada, and Mexico went extremely smoothly due to a tremendous amount of preparation in the 18 months leading up to implementation. Risk reduction, reduced counterparty and settlement risk, and further automation were great outcomes that may motivate other markets to move on a more accelerated basis to a shorter settlement cycle. Given that the US equity market is the largest in the world, it was obvious that each institution had to adopt a global implementation approach. Many will find this as a good case study with many applicable elements for future market adaptations.
Tomlinson: The impact of the transition to T+1 on the securities lending market has been minimal, primarily due to the high level of automation in the market prior to implementation and existing market practices, including T+0 settlement capabilities for US securities. These factors had already resulted in most securities lending transactions settling on T+1 or earlier before the change was enacted.
For other markets considering a similar transition, it is imperative to have the same level of automation, same-day settlement capabilities, and market liquidity depth before implementing such a major change. Failure to have these capabilities in place may result in increased transaction problems, which could deter market participation and ultimately harm liquidity.
Paris: The transition to the shortened settlement cycle of T+1 went smoothly. One measure of this is the amount of failed trades across the industry. At Northern Trust, fails of securities lending transactions have not changed materially since the advent of T+1.
One area where we saw benefit from T+1 was the engagement with borrowers to improve automated communication in the lead up to the transition. Northern Trust worked with borrowers across the industry to ensure we had robust and timely recall notifications. This included using vendors to automate the notification, tracking and settlement process. This was viewed as a positive step forward to ensure our clients and their securities lending programmes were not impacted by this significant industry change.
In Canada, Northern Trust worked with borrowers to automate our loan recall process as part of our overall efforts to prepare for T+1. The Canadian market is going to add a communications hub for securities lending loan recalls and Northern Trust will participate in this automation when it is ready.
Using the US and Canada as a model, other markets in Europe and Asia will see the success as a path forward to moving their markets to T+1.
Polseno: The implementation of a shorter settlement cycle has forced the entire market to focus on efficiency and the reduction of manual workflows. A shorter settlement cycle has led to firms adopting and implementing automated processes. This focus on a shorter settlement cycle has also started the conversation across the Street on the readiness for T+0.
Most firms have taken this opportunity to take a long, hard look at their T+0 capabilities and are using the existing technological budget to make sure T+0 readiness is also part of the equation. Other regions have seen no major disruption due to this move and have taken note of the headwinds that were faced during the preparation phase. Given that global asset managers now have to deal with multiple settlement time frames across their books, a push for more uniform settlement schedules globally will be to their benefit as well.
What implications will the proposed US Treasury clearing mandate have for your securities lending business (or the clients you support)? What adaptations will you need to make ahead of this enactment on cash and repo transactions?
Polseno: We have a long history of centrally cleared repo and see this impending mandate as an opportunity for our clients to potentially source even more liquidity than they previously have been able to. The largest initial impact will be for our reinvestment funds, where we will amend contracts and build our access to centrally cleared repo over the coming year. Overall, given the adoption of sponsored repo, our current use and comfort with the structure, we do not see the move to centrally cleared UST repo as a significant disruption but rather the end state of an evolution that is already occurring for our clients.
Tomlinson: The US Treasury clearing mandate will have significant implications for our securities lending business given our unique position as both an agent lender and a sponsoring member of the Fixed Income Clearing Corporation (FICC). Our clients across the franchise will certainly be impacted as well.
Currently, only 15 to 20 per cent of the repo market is cleared, but the goal is to clear most of the market, which is a daunting challenge. The new rules could bring an estimated US$2-3 trillion in daily activity into scope, a substantial increase that the market will need to digest. There is a significant amount of work involved for both dealers and clients to arrange sponsored or agent clearing relationships. The process typically takes 6-12 months, given the length and complexity of the required documentation.
There are additional benefits and complexities that arise from the rule. This includes reduced reserve requirements on the broker-dealer side, and potential indemnification relief for UST investments via cash collateral reinvestment programmes. On the other hand, trading efficiency could be impacted when it comes to block trading and allocations involving certain clients who are exempted from the rules.
Market participants will need access to a variety of options to help them comply with the new rule. This could mean execution using existing clearing models like the FICC’s sponsored member programme, or new clearing pathways like the ‘done away’ model, which allows clients to leverage diversified counterparty relationships without having to contract with each one.
BNY has unique capabilities that we use to ensure our clients retain access to liquidity and continue to invest in accordance with their risk guidelines. Our expertise is informed by our role as a provider of custody, clearing, collateral management, liquidity, margin, and financing services for US Treasuries. By taking a holistic view of our clients’ challenges and our capabilities, BNY is able to offer solutions that are precisely aligned with our clients’ objectives.
What new technologies or processes will you be adopting or expanding on in the coming year?
Tomlinson: The securities finance landscape is undergoing continuous transformation, propelled by technological advancements and regulatory changes. Looking ahead, several new technologies and processes are poised to further redefine the industry in the year ahead.
Artificial inteligence (AI) and machine learning (ML) are expected to play crucial roles in enhancing decision-making processes and operational efficiencies in securities finance. Key focus areas include risk management, using AI-driven analytics for predictive modelling and risk assessment, and developing more sophisticated automation for trading strategies and portfolio optimisation.
Asset tokenisation, which involves creating digital representations of real assets to facilitate transfers and trading, is expected to gain significant traction. Our ongoing collaboration with HQLAx demonstrates our commitment to innovations in this space.
Central counterparties (CCPs) will play an increasingly important role in the securities finance ecosystem by mitigating counterparty risk and enhancing market stability. Cboe Clear will be launched in Europe sometime in the next 12 months, with the US strategy currently being refined. Additionally, we continue to explore opportunities with the National Íø±¬³Ô¹Ï Clearing Corporation (NSCC) regarding their offerings.
Lastly, the importance of resilience was underscored by the challenges faced by a key market vendor. Alternative options are needed to address this situation, either through direct connectivity or one of the new offerings that enable business continuity.
Polseno: We are focused on our ongoing re-platforming internally and how the investments we are making in key technologies will create a more seamless lending and borrowing experience by more fully integrating automations into our daily business. We are doing so with specific attention paid to interoperability of systems, especially as we move towards more of a multi-venue approach to lending. A key component of this is our proprietary bilateral lending platform, Venturi ALP, which allows borrowers to directly source lendable supply from State Street against a full suite of collateral offerings. Additionally, we are always looking at the breadth and depth of our data offerings, and are working with our research partners to leverage the enormity of our internal data sets to create predictive modelling for lending rates.
Where do you identify the strongest opportunities for the growth of your US securities lending activities in the 12 months ahead?
Paris: The strongest opportunities for growth lie with clients with collateral flexibility. First, clients who accept equity collateral may take advantage of equity versus equity trades or government debt versus equity trades. Borrowers continue to optimise their balance sheet by obtaining HQLA. Second, clients who are open to collateral pledge or pledge-back models, where the collateral remains in the borrower’s name throughout the lifecycle of the loan, may see additional volume from borrowers who are looking to significantly reduce their regulatory capital burden.
Polseno: The two items that are top of mind for growth in the coming year are ones we have touched upon in this conversation. Such as creating structures and solutions to reduce the capital impact of our clients on borrowers, making our assets as commercial as possible. And, using our technology stack from our trading and post-trade management system to connect with counterparties over a growing network of electronic trading platforms.
Tomlinson: With the evolving macro and regulatory environment including shifts in global rates and the geopolitical landscape, working with our clients to ensure they are well positioned for whatever lies ahead will be key.
Given increasing supply and decreased central bank intervention, prioritising efficiency and optimisation will be crucial. We believe that the most promising opportunities will come from partnering closely with clients to offer integrated solutions — rather than individual products — tailored to clients’ specific needs. Clients want comprehensive solutions across financing, liquidity, and collateral. We are well-equipped to innovate and adapt by providing alternative funding options and using cutting-edge technology.
Services, Íø±¬³Ô¹Ï Services, BNP Paribas
Lori Paris, Senior Vice President, Head of Client Management NA, Íø±¬³Ô¹Ï Finance, Northern Trust
Jarrod Polseno, Managing Director and Head
of Agency Lending Trading, State Street
Simon Tomlinson, Global Head of Agency
Lending Trading, BNY
Which trends stand out in terms of lending activity and strategy in the US securities lending market over the past 12 months?
Jarrod Polseno: 2024 has been an interesting year for the US securities lending market. Three major themes that standout as we look back on the year would be the move to T+1 settlement for the US, Canada, and Mexico; the overall lack of specialty (intrinsic value lending) in the US equity space; and the overarching theme of if or when we would see changes in monetary policy from the Federal Reserve and central banks around the world.
Simon Tomlinson: The trends in the US securities lending market have changed significantly this year compared with 2023. While there were several notable special issues last year, including AMC and JNJ, there has been a considerable decline in such issues over the past 12 months, with only a few names contributing substantial value.
The market is now saturated with equities, driven by long-bias activities and index arbitrage, resulting in greater internalisation and reduced borrower demand for equities compared to 2023. Conversely, increased inventory pools have made it necessary to finance more equities, resulting in substantial growth in both our upgrade and equity repo trading books.
There has also been a continued upward balance trend in the US corporate bond sector, bolstered by record-breaking new issues in investment-grade bonds, a surge in financing and refinancing activities in the high-yield sector, and an influx of new participants, which has driven increased demand.
US government securities have continued to grow following a robust performance in 2023. This sector is benefiting from the increase in upgrade and equity repo activities I mentioned before, as well as higher funding requirements amid the prevailing uncertainty surrounding interest rate policies.
What notable securities or asset classes have been particularly vibrant in terms of securities lending activity? What have been the primary drivers of this?
Lori Paris: Level 1 high-quality liquid asset (HQLA) securities, such as US Treasuries (UST), have been particularly well sought after in the securities lending market — several factors have contributed to this strong demand. Regulations such as the liquidity coverage ratio (LCR), net stable funding ratio (NSFR), and global systemically important bank (G-SIB) scores, led to borrower demand to source Level 1 HQLA securities and pledge back lower grade collateral, known as collateral upgrade trades.
Polseno: While it would be hard to argue that there has been a robust lending market for the majority of the year, certainly there were advantageous opportunities. In the first quarter, there were lending opportunities for shares of Manchester United (MANU), as well as the exchange offer as Cummings (CMI) split off their remaining holding of ATMUS Filtration. The second quarter brought the annual reconstitution of the Russell indices, historically an event which causes volatility in lending markets — the 2024 edition was fresh off the back of the move to the new T+1 settlement cycle and created a sense of uncertainty. Finally, in Q3 the market witnessed the long anticipated merging of SiriusXM with multiple Liberty Media Corporation tracking asset classes. The ETF sector is an asset class that has seen, and continues to see, interest and growth. Within the ETF world demand for trackers such as S&P and sector-specific names that follow real estate, utilities and banks, seem to garner a lot of interest.
Earlier in the year, with interest rates at historical highs, the broader market-tracking ETFs such as SPY saw a lot of borrower interest. As the interest rate decline cycle starts, the borrowing community has shifted focus to defensive names that track banks and utilities. In the government fixed income markets, US Treasury Bills have undoubtedly been the main attraction over the past year.
There have been fewer specials in current issues due to an inactive Fed and Federal Open Market Committee (FOMC) since July 2023, and larger issue sizes. T-Bills have especially picked up over recent months as speculation on Fed rate cuts has increased, and has forced more cash to be ‘parked’ in the front-end of the curve, creating sporadic illiquidity in various T-Bills and UST issues maturing less than six months, widening some spreads to 10 to 25 (or more) basis points.
Tomlinson: For BNY, US corporates and US Treasuries have been the most vibrant asset classes.
US corporations have continued to gain momentum. Given the previous challenges in the credit space as a result of higher interest rates and the constrained financing environment, there is now an influx of new market participants, at both banks and hedge funds. This additional demand has led to significantly higher balances over the past 12 months. The statistics are astonishing. According to LCD News, high-yield deal formation is up 42 per cent quarter-on-quarter, and year-to-date volumes have already surpassed the total for 2023, with US$220 billion compared to US$176 billion last year.
US Treasuries have largely remained steady in a general collateral (GC) market this year, albeit in an orderly and range-bound manner. The secured overnight financing rate (SOFR) has gradually moved higher in the second half of this year, due in part to increased issuance, quantitative tightening, reduced reverse repurchase agreement (RRP) usage, and increased sponsorship volumes.
While balances have grown as a result of demand for more term upgrades, the specials market has remained muted. Apart from the occasional short coupon or T-bill, the current 20-year bond has been the highlight in this market over the past 12 months. This has primarily been driven by a relative-value short base, coupled with relatively small issuance and limited system open market account (SOMA) availability, leading to short demand trading through fail levels.
Have there been any notable trends or changes on the supply side in terms of lendable assets?
John Fox: The majority of market participants and prospects are now very aware that a substantive income stream on the right type of assets can be attained with controlled low risk elements. Our industry’s lendable assets have just eclipsed US$40 trillion in assets, according to DataLend. This is a testament to the education securities finance market practitioners have successfully engaged in over the last 15 years. We will need to continue this to ensure that future changes, especially those regulatory in nature, are interpreted clearly and communicated by our industry to ensure a widespread understanding of the impact of those changes.
Polseno: The theme on the supply side this year has been one of continued growth, both due to asset appreciation as well as new assets entering the market. We are seeing even more client interest in lending, whether it is to help offset fees, better compete with other investment manager returns that participate in lending, or simply to earn incremental alpha on their fully-paid assets. The evolution of our risk management centric lending programme resonates with clients and brings comfort that lending returns can be generated with minimal value at risk exposures.
Tomlinson: There has been a clear expansion of lendable inventory. Notably, S&P Global reported a headline figure of US$40 trillion in lendable assets this year, which is a remarkable increase compared to the early post-global financial crisis (GFC) landscape. This reflects not only an influx of new market participants, but also a significant mark-to-market adjustment as equity markets have rallied post-pandemic.
We have seen interest from a wide array of clients, from those entirely new to the securities lending business to existing clients seeking to broaden their offerings. This widespread client engagement underscores a collective intent to participate in the securities lending market, leveraging opportunities to achieve ancillary returns that align with risk management strategies.
Paris: Lendable assets have grown at a faster clip than revenue, standing at US$38 trillion across international and domestic equities, corporate and government bonds, exchange traded products (ETPs) and other products, with around US$2.7 trillion on loan, according to DataLend.
The increase in lendable assets is attributed to three factors: first, increased client interest in securities lending to generate alpha to increase fund performance or to offset costs. Second, government bonds made available for lending in increasing amounts, with new supply coming into the market — government bond lending is about 36 per cent of on-loan balances and contributes to overall secondary market liquidity and the role of lending in sourcing HQLA. Third, US equity markets have increased year-over-year, resulting in increased lendable asset values (for the 10 years ending in August 2024, the S&P 500 has outpaced the historical average, returning an annual average of 12.9 per cent with dividends reinvested).
What new pressures are facing firms’ securities lending activities in the US in anticipation of Basel III Endgame? How will industry participants and banks cope with the three-year transition period, starting from 1 July 2025?
Tomlinson: Market participants are well-versed in navigating the implementation of global regulations, and we do not anticipate any significant challenges as a result of the Basel Endgame. All regulatory changes present both opportunities and constraints for individual market participants, and it is expected that the market will naturally adjust to these modifications. It is crucial to understand that, while regulations apply uniformly to firms, their impact varies depending on each firm’s unique business mix, balance sheet structure, growth strategy, and the systems employed to measure resource consumption. Consequently, these impacts will be nuanced rather than binary.
The nuanced nature of these impacts is particularly evident in the context of overall capital costs, leading to elevated funding pressures and a reduction in some balance sheet capacities. Over the years, there has been a considerable discussion about central clearing, and our position is unchanged: an increasing focus on risk-weighted assets (RWA) by primary dealers, coupled with additional supply, has heightened this need.
Polseno: In short, capital usage is always a consideration, this past year we saw a continuation of borrowers being more discerning with regards to the beneficial owners with which they face off from a regulatory capital classification standpoint. With capital constraints at the forefront of borrowers’ minds, borrowers look for more efficient, low risk weighted lenders which tend to be government associated entities. From a supply side standpoint, this creates an unlevel playing field for some types of clients to match market demand. This is spurring further innovation in terms of capital efficient structures that will allow a wider lender base to receive similar low risk weighted treatment.
In May, the US, Canada and Mexico moved to T+1. How has the move impacted the US securities lending market? How will this achievement guide other regions looking to implement the shorter settlement cycle?
Fox: The T+1 transition in the US, Canada, and Mexico went extremely smoothly due to a tremendous amount of preparation in the 18 months leading up to implementation. Risk reduction, reduced counterparty and settlement risk, and further automation were great outcomes that may motivate other markets to move on a more accelerated basis to a shorter settlement cycle. Given that the US equity market is the largest in the world, it was obvious that each institution had to adopt a global implementation approach. Many will find this as a good case study with many applicable elements for future market adaptations.
Tomlinson: The impact of the transition to T+1 on the securities lending market has been minimal, primarily due to the high level of automation in the market prior to implementation and existing market practices, including T+0 settlement capabilities for US securities. These factors had already resulted in most securities lending transactions settling on T+1 or earlier before the change was enacted.
For other markets considering a similar transition, it is imperative to have the same level of automation, same-day settlement capabilities, and market liquidity depth before implementing such a major change. Failure to have these capabilities in place may result in increased transaction problems, which could deter market participation and ultimately harm liquidity.
Paris: The transition to the shortened settlement cycle of T+1 went smoothly. One measure of this is the amount of failed trades across the industry. At Northern Trust, fails of securities lending transactions have not changed materially since the advent of T+1.
One area where we saw benefit from T+1 was the engagement with borrowers to improve automated communication in the lead up to the transition. Northern Trust worked with borrowers across the industry to ensure we had robust and timely recall notifications. This included using vendors to automate the notification, tracking and settlement process. This was viewed as a positive step forward to ensure our clients and their securities lending programmes were not impacted by this significant industry change.
In Canada, Northern Trust worked with borrowers to automate our loan recall process as part of our overall efforts to prepare for T+1. The Canadian market is going to add a communications hub for securities lending loan recalls and Northern Trust will participate in this automation when it is ready.
Using the US and Canada as a model, other markets in Europe and Asia will see the success as a path forward to moving their markets to T+1.
Polseno: The implementation of a shorter settlement cycle has forced the entire market to focus on efficiency and the reduction of manual workflows. A shorter settlement cycle has led to firms adopting and implementing automated processes. This focus on a shorter settlement cycle has also started the conversation across the Street on the readiness for T+0.
Most firms have taken this opportunity to take a long, hard look at their T+0 capabilities and are using the existing technological budget to make sure T+0 readiness is also part of the equation. Other regions have seen no major disruption due to this move and have taken note of the headwinds that were faced during the preparation phase. Given that global asset managers now have to deal with multiple settlement time frames across their books, a push for more uniform settlement schedules globally will be to their benefit as well.
What implications will the proposed US Treasury clearing mandate have for your securities lending business (or the clients you support)? What adaptations will you need to make ahead of this enactment on cash and repo transactions?
Polseno: We have a long history of centrally cleared repo and see this impending mandate as an opportunity for our clients to potentially source even more liquidity than they previously have been able to. The largest initial impact will be for our reinvestment funds, where we will amend contracts and build our access to centrally cleared repo over the coming year. Overall, given the adoption of sponsored repo, our current use and comfort with the structure, we do not see the move to centrally cleared UST repo as a significant disruption but rather the end state of an evolution that is already occurring for our clients.
Tomlinson: The US Treasury clearing mandate will have significant implications for our securities lending business given our unique position as both an agent lender and a sponsoring member of the Fixed Income Clearing Corporation (FICC). Our clients across the franchise will certainly be impacted as well.
Currently, only 15 to 20 per cent of the repo market is cleared, but the goal is to clear most of the market, which is a daunting challenge. The new rules could bring an estimated US$2-3 trillion in daily activity into scope, a substantial increase that the market will need to digest. There is a significant amount of work involved for both dealers and clients to arrange sponsored or agent clearing relationships. The process typically takes 6-12 months, given the length and complexity of the required documentation.
There are additional benefits and complexities that arise from the rule. This includes reduced reserve requirements on the broker-dealer side, and potential indemnification relief for UST investments via cash collateral reinvestment programmes. On the other hand, trading efficiency could be impacted when it comes to block trading and allocations involving certain clients who are exempted from the rules.
Market participants will need access to a variety of options to help them comply with the new rule. This could mean execution using existing clearing models like the FICC’s sponsored member programme, or new clearing pathways like the ‘done away’ model, which allows clients to leverage diversified counterparty relationships without having to contract with each one.
BNY has unique capabilities that we use to ensure our clients retain access to liquidity and continue to invest in accordance with their risk guidelines. Our expertise is informed by our role as a provider of custody, clearing, collateral management, liquidity, margin, and financing services for US Treasuries. By taking a holistic view of our clients’ challenges and our capabilities, BNY is able to offer solutions that are precisely aligned with our clients’ objectives.
What new technologies or processes will you be adopting or expanding on in the coming year?
Tomlinson: The securities finance landscape is undergoing continuous transformation, propelled by technological advancements and regulatory changes. Looking ahead, several new technologies and processes are poised to further redefine the industry in the year ahead.
Artificial inteligence (AI) and machine learning (ML) are expected to play crucial roles in enhancing decision-making processes and operational efficiencies in securities finance. Key focus areas include risk management, using AI-driven analytics for predictive modelling and risk assessment, and developing more sophisticated automation for trading strategies and portfolio optimisation.
Asset tokenisation, which involves creating digital representations of real assets to facilitate transfers and trading, is expected to gain significant traction. Our ongoing collaboration with HQLAx demonstrates our commitment to innovations in this space.
Central counterparties (CCPs) will play an increasingly important role in the securities finance ecosystem by mitigating counterparty risk and enhancing market stability. Cboe Clear will be launched in Europe sometime in the next 12 months, with the US strategy currently being refined. Additionally, we continue to explore opportunities with the National Íø±¬³Ô¹Ï Clearing Corporation (NSCC) regarding their offerings.
Lastly, the importance of resilience was underscored by the challenges faced by a key market vendor. Alternative options are needed to address this situation, either through direct connectivity or one of the new offerings that enable business continuity.
Polseno: We are focused on our ongoing re-platforming internally and how the investments we are making in key technologies will create a more seamless lending and borrowing experience by more fully integrating automations into our daily business. We are doing so with specific attention paid to interoperability of systems, especially as we move towards more of a multi-venue approach to lending. A key component of this is our proprietary bilateral lending platform, Venturi ALP, which allows borrowers to directly source lendable supply from State Street against a full suite of collateral offerings. Additionally, we are always looking at the breadth and depth of our data offerings, and are working with our research partners to leverage the enormity of our internal data sets to create predictive modelling for lending rates.
Where do you identify the strongest opportunities for the growth of your US securities lending activities in the 12 months ahead?
Paris: The strongest opportunities for growth lie with clients with collateral flexibility. First, clients who accept equity collateral may take advantage of equity versus equity trades or government debt versus equity trades. Borrowers continue to optimise their balance sheet by obtaining HQLA. Second, clients who are open to collateral pledge or pledge-back models, where the collateral remains in the borrower’s name throughout the lifecycle of the loan, may see additional volume from borrowers who are looking to significantly reduce their regulatory capital burden.
Polseno: The two items that are top of mind for growth in the coming year are ones we have touched upon in this conversation. Such as creating structures and solutions to reduce the capital impact of our clients on borrowers, making our assets as commercial as possible. And, using our technology stack from our trading and post-trade management system to connect with counterparties over a growing network of electronic trading platforms.
Tomlinson: With the evolving macro and regulatory environment including shifts in global rates and the geopolitical landscape, working with our clients to ensure they are well positioned for whatever lies ahead will be key.
Given increasing supply and decreased central bank intervention, prioritising efficiency and optimisation will be crucial. We believe that the most promising opportunities will come from partnering closely with clients to offer integrated solutions — rather than individual products — tailored to clients’ specific needs. Clients want comprehensive solutions across financing, liquidity, and collateral. We are well-equipped to innovate and adapt by providing alternative funding options and using cutting-edge technology.
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