Securities lending agents, prime brokers, regulators, law firms, vendors and other stakeholders in the securities lending chain have convened in Miami, Florida, to participate in the Risk Management Associations Securities Lending Conference this week. The common theme has been regulation, regulation, regulationand the trickle-down impacts it is having on the industry, from the demand for more high-quality collateral to the potential use of central counterparty clearing houses (CCPs) for securities lending.
When it comes to regulation, you think about securities lendingit was not the biggest causer of trouble during the credit crisis, but it seems to have attracted the most amount regulation out of everything that you can think of, Nick Bonn, executive vice president and head of Securities Finance and Portfolio Solutions at State Street, told Global Custodian in a video interview. (Click here to watch.)
Bonn continued: So whether its trying to limit the credit that we expose ourselves to with other banks, whether its the capital that we have to apply to the business, short selling restrictions, transaction taxesquite frankly, securities lending is surrounded by enormous bodies of pending regulation that could change, really, the nature of how we do the business.
Bonn spoke on the Future of Securities Finance panel, which featured two agent lenders, whose clients lend out securities, and two prime brokers, whose clients borrow them. The two camps were not always in agreement. The first area of contention was regarding rebate rates, which have been less favorable to hedge fund borrowers as of late as beneficial owners are said to be paying closer attention to the pricing of securities.
Beneficial owners are increasingly focused on returns to benchmarks and prices seen in the market, said James Slater, global head of Securities Lending at BNY Mellon, on the panel. Bonn added that this is part of the price discovery process, calling re-rating a necessary evil. He pointed out that it is not in an agent lenders best interest to drive alpha out of any loan, and while feedback from prime brokers is important, it is the agent lenders fiduciary duty to get the best price for beneficial owners.
Alan Pace, head of Americas Prime Finance at Citi, commented on re-rating, saying the firms hedge fund clients are not willing to accept less favorable rates as a new reality. Thomas Wipf, a managing director at Morgan Stanley, was more understanding, calling it a fundamental change that should not surprise any market participants.
Meanwhile, the panelists also took varied stances on CCP- or exchange-based lending.
Pace said Citi believes in the model and said it is one of the tools that should be in the toolkits of securities lending participants. He said there was hope there would be more early adopters of the model but that there is opportunity for CCP-based lending to grow as it offers a new way of price discovery.
Bonn countered that State Street handles everything bilaterally as this is the best way to manage risk and deliver returns to clients. Regulations eventually may force the use of CCPs in the securities lending space, but until that happens or until CCPs offer some added benefits to clients then were not going to go there, he said.
Slater said there are some fundamental problems with the CCP model in securities lending and that the model does not fit the agency program or structure. He did, however, tout the added benefits around transparency that CCPs would bring to the securities lending industry, which regulators are keen on. For his part, Wipf said his clients see no benefit to using CCPs in securities lending.
Panelists also commented on the need for high-quality collateral given various regulators mandates to shift derivatives on exchange and through clearing houses.
Slater mentioned that CCPs will have to become more flexible with the types of collateral they accept due to the increased demand for collateral and the stress placed on the system from various policies and regulations. He cited quantitative easing, which pulls collateral out of the system, as an example of this, as well as capital and balance sheet requirements in Dodd-Frank.
Bonn pointed out that if CCPs begin accepting sub-standard collateral, it actually creates another problem whereby risk is shifted rather than eliminated.
Simon Mendelson, a managing director at BlackRock, who moderated the panel, asked the panelists to comment on the seemingly contradictory facts that hedge fund returns have reduced in recent years while securities lending revenues have increased.
Pace said he is bullish on alternative assets but that he does not see the hedge fund industry growing significantly in 2013. It is a difficult time for hedge funds to launch, and the size of the startup funds that do launch has greatly reduced, he said. As to securities lending, Slater said BNY Mellon and other agent lenders have experienced double-digit growth in the space in recent years; he is bullish on the industry and cautiously optimistic about opportunities ahead.
Wipf said he is bullish on the business but cited caveats including regulatory uncertainty, rate changes and building safer and sounder platforms. The industry has never been better capitalized, he said.
Bonn concluded by noting that the industry is undergoing a secular change in the face of pending regulations, and whether an institution is bullish or bearish on the business depends on how well it is spotting those trends. There [are] going to be winners and losers, he said.
Christopher Gohlke