Teaching an old market new tricks
13 September 2016
Innovation can be difficult to come by, but there are a number of key opportunities in an environment that is not yet fully harmonised,
says Dan Copin of CACEIS
Image: Shutterstock
The past few years brought some major new challenges to the financial markets and to the securities lending world specifically. The securities lending market is a well-established part of the financial landscape, especially for the leading players in the asset servicing industry, where a securities lending offer is seen as an extension of the custodian鈥檚 role.
Despite the market鈥檚 maturity, there are a host of forces that act to drive change in the practices and practitioners of securities lending.
Performance pressure rising
With the growing competition on absolute performance in the investment industry, enabled by greater transparency of data and increasingly granular analysis, there has been a shift in attitude toward securities lending, from a handy way of offsetting custody fees to the increasingly common view of it as being a part of the investment strategy. This shift in attitudes has triggered a rising interest in the performance enhancing opportunities of joining a lending program, along with new demands on the lending service providers.
As end investors鈥� performance optimisation focus shines its light on securities lending, many are no longer content with simply knowing they are generating additional revenue. With the investment management strategy mindset, comes a need to better understand how well the lending service is performing. Demands for benchmarking are all the more frequent today as regulators, and end investors in direct contact with managers, attempt to compare a lending desk鈥檚 performance to the market. This is no easy task considering the market鈥檚 transactions are over-the-counter, so desks often turn to a third party for the data needed for making the analysis.
To provide end investors with benchmarked performance data, lending desks often engage a data provider that can provide a global view on the market transactions. Experience of providing performance analyses to investors puts custodian-linked lending desks in an ideal position to generate reports on its own performance, and the combination of automated report generation and fully integrated services makes this a relatively simple task.
But despite the best data and analysis techniques, it is clear that no perfect benchmark exists. Demand for reports and other performance monitoring tools will definitely increase in future. However, the technology and data transparency that it requires will be the major obstacles to achieving those goals.
New market entrants
In the context of market volatility and negative interest rates on the one hand, and increasing performance competition and the growth in awareness of securities lending鈥檚 optimisation potential on the other, there has been considerable interest from beneficial owners that are eager to capture opportunities in the lending market. However, many entrants are new to this mature business and require guidance and market knowledge to participate efficiently.
The major risk here would be creating inefficiencies by pulling the market down, and on the other side, lending securities against insufficient or higher risk collateral. A custodian-backed lending desk has a responsibility to ensure a fair value for lent assets, verifies that market risk is effectively covered by suitable collateral, and provides guidance to clients so they can operate in an environment they are comfortable with.
Rising costs and complexity
The impact of numerous regulatory changes has been significant on the securities lending market. One of the major consequences has seen a general push by securities lending providers to move clients from a principal-type programme to agency programme in order to offset risk from the balance sheet and better meet capital adequacy ratios.
In order to protect lenders working under an agency-based programme, securities lending desks are responding to lenders鈥� market risk exposure concerns by offering indemnification clauses, which provide a form of insurance-type protection. Of course, providing such protection against market risk triggers a further source of risk for the custodian-backed lending desk, therefore countering the positive impact of lenders moving from a principal to agency based programme in the first instance.
Therefore, despite providing extra protection for the end investor, which is a key concern for the European regulatory agenda, it also has a clear and measurable impact on the end investor鈥檚 potential returns and increases the complexity of doing business for financial institutions.
Continued innovation
In a market as mature and now heavily regulated as the securities lending business, innovation is difficult to come by. Nevertheless, there remain a number of key opportunities in an environment that is not yet fully harmonised, and experienced securities lending desks, like that of CACEIS, have the in-depth market knowledge to guide clients and optimise their lending activities.
Furthermore, by offering a service that is fully tailored to each client鈥檚 profile, an area where CACEIS has particular expertise, they benefit from a programme that precisely fits their individual risk/return objectives.
Despite the market鈥檚 maturity, there are a host of forces that act to drive change in the practices and practitioners of securities lending.
Performance pressure rising
With the growing competition on absolute performance in the investment industry, enabled by greater transparency of data and increasingly granular analysis, there has been a shift in attitude toward securities lending, from a handy way of offsetting custody fees to the increasingly common view of it as being a part of the investment strategy. This shift in attitudes has triggered a rising interest in the performance enhancing opportunities of joining a lending program, along with new demands on the lending service providers.
As end investors鈥� performance optimisation focus shines its light on securities lending, many are no longer content with simply knowing they are generating additional revenue. With the investment management strategy mindset, comes a need to better understand how well the lending service is performing. Demands for benchmarking are all the more frequent today as regulators, and end investors in direct contact with managers, attempt to compare a lending desk鈥檚 performance to the market. This is no easy task considering the market鈥檚 transactions are over-the-counter, so desks often turn to a third party for the data needed for making the analysis.
To provide end investors with benchmarked performance data, lending desks often engage a data provider that can provide a global view on the market transactions. Experience of providing performance analyses to investors puts custodian-linked lending desks in an ideal position to generate reports on its own performance, and the combination of automated report generation and fully integrated services makes this a relatively simple task.
But despite the best data and analysis techniques, it is clear that no perfect benchmark exists. Demand for reports and other performance monitoring tools will definitely increase in future. However, the technology and data transparency that it requires will be the major obstacles to achieving those goals.
New market entrants
In the context of market volatility and negative interest rates on the one hand, and increasing performance competition and the growth in awareness of securities lending鈥檚 optimisation potential on the other, there has been considerable interest from beneficial owners that are eager to capture opportunities in the lending market. However, many entrants are new to this mature business and require guidance and market knowledge to participate efficiently.
The major risk here would be creating inefficiencies by pulling the market down, and on the other side, lending securities against insufficient or higher risk collateral. A custodian-backed lending desk has a responsibility to ensure a fair value for lent assets, verifies that market risk is effectively covered by suitable collateral, and provides guidance to clients so they can operate in an environment they are comfortable with.
Rising costs and complexity
The impact of numerous regulatory changes has been significant on the securities lending market. One of the major consequences has seen a general push by securities lending providers to move clients from a principal-type programme to agency programme in order to offset risk from the balance sheet and better meet capital adequacy ratios.
In order to protect lenders working under an agency-based programme, securities lending desks are responding to lenders鈥� market risk exposure concerns by offering indemnification clauses, which provide a form of insurance-type protection. Of course, providing such protection against market risk triggers a further source of risk for the custodian-backed lending desk, therefore countering the positive impact of lenders moving from a principal to agency based programme in the first instance.
Therefore, despite providing extra protection for the end investor, which is a key concern for the European regulatory agenda, it also has a clear and measurable impact on the end investor鈥檚 potential returns and increases the complexity of doing business for financial institutions.
Continued innovation
In a market as mature and now heavily regulated as the securities lending business, innovation is difficult to come by. Nevertheless, there remain a number of key opportunities in an environment that is not yet fully harmonised, and experienced securities lending desks, like that of CACEIS, have the in-depth market knowledge to guide clients and optimise their lending activities.
Furthermore, by offering a service that is fully tailored to each client鈥檚 profile, an area where CACEIS has particular expertise, they benefit from a programme that precisely fits their individual risk/return objectives.
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