RMA Panelists Shift Tone Toward Securities Lending CCPs

At the 31st RMA Conference on Securities Lending, taking place in Naples, Florida, conference-goers took a much more positive view of central counterparties (CCPs) for securities lending, noting that the model will likely be part of the solution alongside the bilateral model going forward.

CCPs are not going to take out the bilateral market, said Chris Kunkle, managing director in securities finance at Wells Fargo. But Kunkle and other panelists at the RMA’s CCP Workshop: The Future of Securities Finance Transactions noted that the trend is moving in the direction of more CCP usage going forward.

“The conversation has changed so drastically over three years, and it will probably change at an exponentially faster rate in the coming years,” said Glenn Horner, managing director at State Street. In the past, the fear was that new trade platforms would cause prime brokers and agent lenders to disappear, he said, but “we’re certainly not seeing the market develop in that way currently. I think the agent lenders and prime brokers are still going to play a key role in this business.”

As evidence of the growing use of CCPs, Morgan Stanley is set to join Eurex Clearing’s securities lending CCP later this month. “We’ve always been a big supporter of CCPs for both mandatory and non-mandatory clearing processes,” said Susan O’Flynn, global head of CCP strategy and optimization, Morgan Stanley. “We think its important to work with CCPs to create products that work for both the borrower and agent lender. The key thing for me is that it creates three things: risk, resource, and operational efficiencies. And that’s for both sides.”

A key shift in acceptance of CCPs has been the growing realization of the benefits under Basel III and Dodd-Frank requirements, such as the Tier 1 Common Ratio, the Supplementary Leverage Ratio (SLR) and the Net Stable Funding Ratio (NSFR).

Horner said that he initially wanted to be light on regulatory issues for the CCP RMA panel, because regulation permeated many of the other panels. However, “it quickly became quite apparent that you can’t talk about CCPs without talking about regulation.”

From the dealers’ perspective, some of the key benefits of using a CCP include that there could be a significant reduction in counterparty risk weight, thereby improving their Tier 1 Common ratio. And if netting is allowed (the regulations have not been finalized), then transacting through a CCP can mitigate some of the challenges of the SLR and NSFR.

From an agent lender standpoint, there could also be reduced capital costs, and perhaps even a removal of indemnification costs by using a CCP.

With the CCP model, “I personally believe that indemnification is not needed because the CCP guarantees the transaction,” said Matthias Graulich, chief client officer, Eurex Clearing.

When looking at how securities lending transactions affect capital, Dean Sakati, head of strategy and business development for securities finance within BNY Mellon’s Global Collateral Services, pointed to the Tier 1 Common Ratio, where firms will need to hold more tangible common equity if the denominator, the risk weighted assets, are higher.

“If you think of how you can change the outcome (to keep the transaction capital efficient), one option might be to use CCPs more,” he said. “Another might be, from an agent lender perspective, a change in fee splits to retain more of the resulting profit and less for the beneficial owner…but that’s probably not the best option,” as the trade would probably still be unlikely to generate enough of a return to make it worthwhile.

“At the end of the day, it’s mathematical,” he said. If regulators make [the requirements] less onerous, then there’s less of an incentive to do things differently…As the variables change, the mathematical outcome changes, and therefore your actions may as well.”

CCPs could also help agent lenders from a counterparty concentration issue, but as of now, the regulations are not finalized, so there might be concentration limits at the CCP level too; regulators may be concerned they are replacing one form too big to fail with another.

However, Eurex’s Graulich said that he has a hard time understanding why regulators would treat the securities lending business so differently than the OTC derivatives business, where for derivatives, regulators are pushing for central clearing, yet they have not paved the same road for securities lending. “Logically, I say there’s no reasons these markets should be treated differently.”

At the same time, though, Eurex and OCC are not looking to just adopt the derivatives model, but rather they have been working with the industry to try to make securities lending CCPs operate with the industry’s needs in mind.

OCC’s Vice President Joe Pelligrini noted that the organization didn’t want to build a model that no one would use but is now in discussions with agent lenders and custodians, looking at different ways to expand the CCP beyond just broker-dealers as clearing members in a way that works for beneficial owners and agent lenders.

At Eurex, for example, the CCP wanted to avoid increasing the costs for beneficial owners, so it implemented the Specific Lender License, which allows users under this license to only clear their own business, and therefore they do not have to post margin or contribute to the Clearing Fund of Eurex Clearing.

For the securities lending CCP as a whole, Eurex plans to start allowing U.S. securities for European counterparts in the first half of 2015, and introducing U.S. securities for U.S. counterparts is on the radar for 2016 but will require regulatory approval.

BNY Mellon’s Sakati noted that there seems to be a real thoughtfulness that goes into developing these CCP models for securities lending, rather than just copying what’s used in the derivatives space.

Going forward, though, securities lending and derivatives transactions could become more connected via CCPs.

“What all these products have in common is a collateral management aspect,” says Eurex’s Graulich. “The whole objective is to integrate these service elements of the CCP, to make, for example, the collateral which is generated by a repo or securities finance transaction available to fund margin requirements on the OTC derivatives side. We see that clear trend of convergence of these product from a collateral management perspective.”