In collaboration with Global Pensions, Data Explorers brings you the latest global trends and analysis on securities transactions. John Arnesen reports
The world of securities lending can be quite reactionary and rarely does a game changing event produce wholesale shifts in the modus operandi. Perhaps the quip “if it ain’t broke, don’t fix it” is why the industry has been slow to change. The default of Lehman Brothers did produce changes to margining and counterparty selection however, the mechanics remain largely the same.
It is therefore somewhat curious to be bombarded at conferences and in the industry press with the notion of introducing central counterparties (CCPs) to securities lending as if somehow, their absence has left practitioners missing out on some wonderful opportunities.
The concept is relatively straightforward. Rather than lending securities on a bilateral basis to myriad counterparties, lending is conducted on an electronic trading platform that links to a central counterparty. The CCP effectively becomes the “buyer” and “seller” of all securities lending transactions on an anonymous basis. Conceptually this would be a sound development. Agent lenders would be able to eliminate exposures to the multiple borrowers to which they currently lend and effectively have one counterparty, the CCP. Access to the CCP is via membership of varying degrees of status and will be made up of the very same participants that borrow on a bilateral basis.
For borrowers, the concept is even more compelling. Less balance sheet usage through netting provisions, greater transparency in price discovery given the electronic nature of how prices will be displayed and a host of other benefits which may well include regulatory requirements. Regulators have made a number of overtures to the fact that over the counter activity, which securities lending most certainly is, will require more stringent counterparty capital requirements to incentivise movement to CCPs which will lower the costs of those requirements.
Without getting into the complexities of how such platforms may operate, the question that perhaps is not posed as much as it should is, how will the introduction of these platforms (there will never be one CCP) benefit beneficial owners that provide a huge amount of supply to the securities lending market place?
Agents, acting on behalf of the beneficial owner provide a number of services, not the least of which is indemnification against borrower insolvency and the maintenance of collateral and margin. In a CCP cleared transaction there will be no margin on the collateral posted by the borrower. In fact, membership to access the CCP will require margin to be posted to the CCP as well as the additional requirement of member firms to contribute to a guarantee fund.
This would be a radical departure from the current arrangement and one that isn’t necessarily insurmountable. It is possible that agent lenders will develop a method to deal with these costs. The question remains however as to what will compel beneficial owners to divert from current practice in which they appear comfortable with lending to a selection of highly rated institutions and receiving indemnification against their insolvency, to now concentrate all of their risk into a single entity, admittedly with a AAA rating?
The debate to date has centred on the intermediary chain in the process, namely the agents and borrowers. Engagement with the beneficial owners is where it really needs to go and to answer some of the fundamental questions. A comprehensive description of CCPs has been produced by Zimmerhansl Consulting Ltd and Howieson Consulting Ltd and is a recommended read. The debate will no doubt continue, as it should but perhaps steer in the direction of the supply side of the securities lending chain without which, CCPs will struggle to become effective.
Here are key takeaways from our 2019 Asset Allocation Outlook on how we are positioning asset allocation portfolios in light of our outlook for the global economy and markets.
This week's top stories included a Freedom of Information request revealing more than 100,000 savers could face six-figure tax bills as a result of GMP equalisation.
The Pearson Pension Plan has entered into a £500m pensioner buy-in with Legal & General (L&G) in the insurer's first deal of 2019.