Growth of CCPs for Securities Lending Seemingly Inevitable

At the Finadium Conference in New York last month, industry veterans seemed to agree that like derivatives, securities lending will move from a bilateral model to a centrally cleared one, but there are still significant kinks to work out.

“CCPs are coming. It’s just a matter of when, not if,” says John Nicholson, managing director, Citi Prime Finance.

While the writing seems to be on the wall for the move to CCPs, change will probably not occur until certain regulations such as Basel III come into full effect; for now, the U.S. is still in the exploratory stage of CCPs, with the OCC serving as the only CCP and only for equities, so there’s still a ways to go.

“When it matters, people will use everything they can to minimize capital, but at the end of the day, you still don’t have a balance sheet netting provision in the U.S.,” says Peter Abric, managing director and head of securities finance at Wells Fargo.

Plus, CCPs still leave unanswered questions around indemnification, counterparty exposure as it relates to Dodd-Frank Section 165, accessibility by all market participants, etc., and they are unlikely to assume the entire market share. “There are pros and cons, and we have to find a middle ground. CCPs are part of the decision making toolkit,” says Abric.

“Some portion [of securities lending] will end up going through the CCP structure…there are enticing aspects to CCPs,” says Doug Brown, senior managing director and head of business development/relationship management, Americas, State Street. However, he says, CCPs could introduce new risks by lowering the bar for entry, meaning that smaller firms with less capital may be able to participate (as lender or borrower), and due to the sharing of risk concept in a CCP, there may be more risk for some participants than in the structure they utilize today.

Abric also wonders about the effects of CCPs essentially making all participants average, i.e. the differences between those with good credit ratings and poor credit ratings are washed away by the CCP, and some parties may be more comfortable continuing to deal on a bilateral basis with counterparties they trust.

For example, CCPs may be more accepted for more common securities, but when it comes to specials, the bilateral relationship could hold its ground.

“Would I rather borrow specials from someone I know than going through a CCP? Yes. CCPs will not become 100% of the market necessarily,” says Nicholson.