Dan Dougherty, EquiLend
Matt Wolfe, OCC
20 October 2017
Matt Wolfe, vice president of product development at OCC, and Dan Dougherty, COO of EquiLend Clearing Services, discuss their companies鈥� partnership and recent developments in the securities financing marketplace
Image: Shutterstock
In May, OCC and ECS partnered to bring greater access to central clearing in securities financing. What does this mean for you and the marketplace?
Matt Wolfe: The partnership has the potential to bring many opportunities to market participants. OCC has a robust stock loan clearing programme for broker-dealers called the Hedge programme, with approximately $75 billion in equities on loan. Hedge participants enjoy the benefits of substituting their counterparty鈥檚 credit rating for OCC鈥檚 AA+ credit rating with S&P, and taking advantage of the favourable accounting treatment afforded to cleared stock loans.
The Hedge programme has been live for almost 25 years and is experiencing strong growth, but there are some shortcomings that we intend to address through the partnership with EquiLend Clearing Services (ECS). New loans and returns for Hedge are submitted directly to DTC for settlement, and OCC is notified after settlement occurs.
This workflow frequently leads to participants鈥� books and records becoming out of balance with OCC鈥檚 version. Additionally, since the clearinghouse鈥檚 books are based on settlement activity, OCC鈥檚 guarantee is limited to the loaned stock and cash collateral. Loan terms such as the rebate rate, term, and dividends are direct obligations between the lender and borrower. OCC has a second stock loan programme called Market Loan, which is facilitated through ECS鈥檚 middle-office system.
OCC is working with ECS to enhance this system and provide additional connectivity into this programme to allow Hedge participants to migrate towards the Market Loan programme, where all transactions are automatically settled against OCC鈥檚 DTC account, which dramatically reduces reconciliation breaks. This allows OCC to have a complete record of the loan terms and provide a broader guarantee that includes accrued rebate fees and cash dividend payments.
These enhancements will benefit OCC and the marketplace by providing a more operationally efficient and effective infrastructure with reduced risk for all. We鈥檙e excited about the collaboration with ECS and look forward to the improvements it will bring to those who participate in this growing market.
Dan Dougherty: As evidenced by the continued growth in the OCC Hedge programme, there is a growing demand for industry participants to have access to centrally cleared venues. The partnership creates the ability for OCC to deliver a more robust, expandable solution to market participants. The Market Loan programme and supporting ECS
infrastructure have been in production since 2009 and continue to be run by ECS staff through a clearing agreement with OCC. By leveraging the ECS infrastructure, OCC has the ability to expand both controls and guarantees, while maintaining the advantages of its AA+ credit rating and favourable accounting treatment.
This partnership brings together two industry leaders to form a best-in-class central clearing solution for the securities financing market. ECS provides technical solutions for execution, messaging, settlement, position management and the management of all lifecycle events. Leveraging ECS technology allows OCC to bring the enhanced Market Loan programme to market in the most timely, efficient and effective way possible.
There appears to be an evolving ecosystem for securities lending transactions. Can you explain why?
Wolfe: The ecosystem in which securities lending transactions take place continues to evolve for several reasons. Regulatory change has sought to reduce risk in the financial system by increasing capital requirements, improving risk management systems and processes, and by encouraging activity to be cleared. This has resulted in demand for central counterparties (CCPs) such as OCC to expand the solutions they provide to the market. As a result, our programme has evolved over time from providing margin efficiencies to delivering capital and credit efficiencies, which makes OCC a compelling value proposition for market participants. We are working with an industry coalition to refine the clearing model to allow for expanded participation in our clearing solution.
The migration from non-cleared bilateral transactions to clearing will improve the resilience and profitability of market participants. This is consistent with OCC鈥檚 mission of promoting stability and market integrity through efficient and effective risk management, clearing, and settlement services.
Dougherty: Driven by regulatory change and the increased desire for automation and controls, the ecosystem for securities lending continues to evolve. Market participants continue to look for improved infrastructure and the ability to optimise their book of business. As a result, demand for central clearing of securities finance transactions is steadily increasing. The ability to net securities lending positions against other transactions, lower risk-weighted assets (RWA) and achieve preferential accounting treatment are some of the reasons driving CCP use. These factors have led to a requirement for ways to execute and manage this activity in an efficient manner.
ECS has the ability to execute and manage centrally cleared securities lending trades in a non-disclosed or fully disclosed manner by leveraging flexible technology, including EquiLend鈥檚 NGT and Post-Trade Suite. In addition, ECS has developed a standardised format for the facilitation of centrally cleared activity: the ECS Gateway. The ECS Gateway is open to all participants in the CCP and standardises all communication to CCPs for trades and the corresponding lifecycle events.
OCC鈥檚 monthly data reports show that securities lending volume are growing significantly. How do you explain this success?
Wolfe: Stock loan is an essential and substantial component of the global financial market, with the largest part of this market conducted through uncleared, bilateral transactions lacking the recognised benefits of clearing services with central counterparty substitution. Since OCC鈥檚 introduction of CCP services for the stock loan market in 1993, the volume of stock loans cleared by OCC has increased steadily.
From 1 January through to 31 August 2017, OCC processed just over 1.5 million new stock loan transactions, a 22 percent increase on the same period in 2016, and had a daily average of $77 billion in equity securities on loan.
Our goal is to provide greater capital efficiencies for our clearing members. OCC is implementing a number of enhancements to our stock loan programmes in order to reduce systemic risk, enhance transparency and, allow more efficient use of capital. Many clearing members appreciate these benefits and are encouraging their counterparties to engage through OCC, where borrowing is cheaper and larger balances can be maintained.
ECS is a relatively new division of EquiLend. Why get into the clearing space now?
Dougherty: EquiLend has always said it would be prepared to facilitate CCP flow as soon as the market is ready for it, and we will direct flow to any venue that our clients want us to, as well as any CCP. We have seen the demand for CCPs increase dramatically, with the growth of the OCC programme in the US and other programmes globally as clear indications of that.
CCPs are an important part of our clients鈥� trading strategies, so our objective is to offer our clients a best-in-class service to facilitate their business in the most efficient manner. By leveraging our experience and our established securities finance technology, our clients have the ability to manage all their securities lending activity for trade execution and the management of all lifecycle events.
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