Shifts in collateral and regulatory pressures mean there are new options for beneficial owners, as long as they are willing to be flexible, writes CIBC Mellon’s vice president of global securities lending, Jeffrey Alexander
Securities lending and alternative strategies have gained prominence in recent years. The practice continues to provide much-needed market liquidity in a capital-constrained world, as well as excellent risk-adjusted returns for owners.
On the flipside, both unintended and intended regulatory challenges continue, such as the use of short sale bans, as in Greece, which for all their good intentions have historically shown to do more harm than good.
Even in highly developed lending markets such as Canada, the regulatory environment can create an uneven playing field—for example, the domestic NI 81-102 regulations prevent mutual funds from taking equities as collateral in securities finance transactions, in contrast to the flexibility afforded to pension and insurance players.
Some of the largest impacts for the securities lending industry, however, stem from outside pressures: velocity of regulatory change, new capital requirements and the resulting growth in the importance of high-quality liquid assets (HQLAs). These pressures are transforming the opportunity equation for beneficial owners, as their own programme choices around collateral, terms and structures either open up large volumes of new business or turn formerly fertile grounds hardscrabble.
Pre-2008, the market was comparatively flush in collateral. Global banks and other traditional borrowers were long on quality collateral, and able to structure an array of transactions using their own balance sheets. As a result, the market didn’t support nearly the same level of demand for HQLAs held by insurance companies, pension plans, and mutual funds, which in turn were able to set their collateral requirements in a multitude of structures without so substantially affecting the uptake and overall returns of their securities lending programmes.
Today’s regulatory environment has changed the equation. Banks now face expanded requirements to hold HQLAs on their balance sheets, even as they undertake activities that further bolster demand for those assets.
Pension plans, mutual funds, insurance companies and other beneficial owners are in position to fund this need—if they are willing to collateralise their securities lending transactions in ways that will aid this new market demand.
Constrained by their own balance sheet requirements, broker-dealers are looking to borrow securities against less traditional collateral instruments such as equities, exchange-traded funds, corporate bonds or alternative forms of debt, creating vast new demand for the HQLAs that beneficial owners hold. Choices around collateral have grown in focus and importance—a trend that we expect to continue to gain importance as a driver of securities
finance activity.
Canadian owners are well suited for the new collateral environment given their generally conservative holdings (and a home bias which has proven justified in recent years).
As opposed to global uptake of general collateral, with utilisations around 10 percent depending on the market and the season, usage of short-term US treasury instruments often exceeds 70 percent usage, while Canadian government issues under 10 years regularly approach 80 percent usage of available instruments.
For beneficial owners holding highly sought-after instruments, flexibility can help owners’ programmes more fully realise their holdings’ potential for lending, while adding an important return in persistent low rate environments.
For those holding high-quality government assets, being willing to consider transactions across a wide array of collateral choices or terms such as evergreen trades can enable owners to capture a greater share of the available demand.
We fully expect this demand to continue, with the increasing march of regulatory and balance sheet pressures strengthening demand. Liquidity coverage ratios and net stable funding ratios have affected the way borrowers need to structure securities finance transactions, as well as their broader business. In the years ahead, flexibility will likely play an even greater role in determining revenues, with direct fee and pricing impacts shaped by collateral acceptability, term length or central counterparty usage.
At the end of the day, the only reason owners participate in securities finance transactions is because there is value in the programme and they have confidence that the relevant collateral, contracts and counterparties appropriately protect the assets in question
Agent lenders must spend the time necessary to work with owners to help them understand the controls in place as well as the tenor of the opportunities available.
Ultimately, it is up to agent lenders to help beneficial owners and borrowers capitalise on changing opportunities in supply and demand with confidence.
Collateral usage has changed substantially over the last five to 10 years, and will no doubt continue to evolve in line with the changing demands of borrowers, regulators and other market participants.
The overall returns in the securities lending market may remain comparatively stable, but opportunities will increasingly accrue to those owners willing to move with agility and flexibility to meet the market’s changing demands.
