David Raccat, CEO of Wematch.SecuritiesFinancing, offers a technological recipe for success as the market becomes more demanding and complex
The securities financing industry is going through a major change on different fronts. First of all, the picture of the market is changing dramatically. The $15 trillion lendable assets are showing a $1.8 trillion on-loan balance with a changing face. The business, which was for a long-time mainly equity-driven and US-centric, is moving towards an equal split between equities and fixed-income. Also, two other regions (Europe and the Asia Pacific) are growing significantly in terms of balance. The average maturity of the trades is pushed as well, and fixed-income securities are being lent on longer maturities, with 14 percent of the balance being lent over three months for European government bonds, as per the seventh International Securities Lending Association market report published in June.
Regulation-wise, both lenders and borrowers are being affected by major requirements. Lenders are seeing much more emphasis on best execution and reporting/transparency, while borrowers are heavily affected by capital and balance sheet constraints triggering additional costs.
The European Markets Infrastructure Regulation (EMIR) and the US Dodd-Frank Act are pushing banks to borrow more quality assets in order to meet their new margin requirements. Regulation can create complexity when, for example, lenders cannot lend their securities on a term basis (for example UCITS, in order to guarantee liquidity to the retail customers) whereas borrowers need to borrow for longer-term tenors in order to comply with regulatory ratios (liquidity coverage ratio and the net stable funding ratio).
The economy has gone through an unprecedented crisis and the market has been dramatically affected: negative interest rates; exacerbated spreads; surprising volatility, especially in the last days of 2016; and strong intervention from central banks trying to support the economy through massive purchasing programmes.
The consequences for banks are not only changing strategies (with portfolio rebalancing) but the market has also seen intense tension on quarter-ends, especially regarding the availability of high-quality liquid assets. The question of a potential squeeze has been asked, even though supply seems to be far above current and future demand. The International Swaps and Derivatives Association estimates that unencumbered collateral potentially supporting additional margin requirements is reaching $800 billion.
An industry entering in a new era
As a consequence, the dealing of securities lending is becoming more demanding and complex. The value of a trade relies not only on the securities lent, but also on multiple parameters, such as counterparty rating or risk-weighted assets, collateral schedules, collateral type (title transfer or pledge), and tenor.
At the same time, there is a growing need for automation in order to embrace the best execution principles, and to be able to face the whole market that is moving from a ‘might do’ to a ‘must do’.
As with any other industry, securities financing is going through its digital transformation. The switch can be more or less gradual, depending on the institution or segment, however, the trend is pretty visible and tangible. Dealing platforms are changing the front-end landscape, and post-trade automation has never been so critical.
Looking first at the dealing side of things, dealers are expecting not only automation and user-friendly interfaces and features, but as well liquidity and a wide access to the market. This is a two-fold challenge for platform providers and the name of the game is to offer the best client experience with a superior access to market. Additionally, platforms will grow with their users and, with time, process the data smartly and to proactively suggest and push opportunities. The platform should aim at becoming a strong partner for its user, who can then focus on creating value and feeding the system with their expertise.
Working on a wider, and a more open and transparent market is another growing trend that deeply impacts the dealing process. The consequences are two-fold. Changing the trading pattern among existing market players might modify the dynamics of the market and more opportunities could arise. The other impact is the emergence of a peer-to-peer market, where agent lenders and prime brokers would end up disintermediated with beneficial owners facing directly the end borrowers.
There are multiple hurdles ahead before this happens in the short term, such as credit impacts, market risk management, the ability for borrowers to onboard multiple lenders, the management of the lifecycle of the trade, and potential capital and balance sheet considerations. Peer-to-peer lending might not be a short-term transformation, however, there is still room for improvement and for more efficiency.
Automation is also critical on the post-trade side of things, and no setup will be viable without straight-through processing flows allowing trade capture, lifecycle events, settlement, billing, and regulatory reporting. No risk can be taken on that front, and any solution does need to invest time and resource on post-trade management.
The recipe for tomorrow’s industry
The industry is being shaken, the ingredients are being changed, and the length of preparation is pretty uncertain. However, it is a formidable and a very exciting time that we are living in, and the change is a reality in motion. All parties are now involved and playing for a better future with more automation, more efficiency, and more liquidity. And liquidity is obviously key when you have a shaker in your hands.