The future is bright
31 October 2017
The securities lending industry has some much needed respite from new regulations, and the mood at this year鈥檚 RMA Conference was upbeat
Image: Shutterstock
The mood at the Risk Management Association鈥檚 (RMA鈥檚) 35th Annual Conference on Securities Lending was one of cautious optimism that, for the first time since the financial crash, the worst of the regulatory barrage is behind us.
Speaking ahead of the association鈥檚 event in Naples, the RMA鈥檚 director of securities lending Fran Garritt said: 鈥淪ince President Donald Trump has taken office some of the rule writing has slowed down.鈥�
Garritt added: 鈥淲e were expecting progress to be made on the final rule on qualified financial contract (QFC) restrictions for global systemically important banks (GSIBs), the net stable funding ratio, and the single counterparty credit limits in the first quarter of this year but so far, we鈥檝e only seen the final version of the QFC restrictions for GSIBs.鈥�
President Trump鈥檚 executive order on financial regulation earlier in the year threw everything we thought we knew about the roadmap for market oversight for the next few years into question.
Many commentators at this year鈥檚 conference speculated that, regardless of Trump鈥檚 threats to take an axe to the red tape that鈥檚 fallen on Wall Street in recent years, it was simply too unpalatable, both politically and economically, to table any major reforms to the likes of Dodd-Frank or Basel III. It was proposed that the general public would not accept anything that was perceived to be letting the banks off the hook. At the same time, for the banks themselves, implementation efforts for new rules frameworks such as the second Markets in Financial Instruments Directive (MiFID II) are simply too far along to consider turning back now. Nevertheless, the securities lending industry appears to have been given some much needed respite from new requirements coming down the pipeline.
European regulators also appear to have put their rule-writing pens down for a moment. The European Commission recently announced that 鈥渢o a large extent, the Financial Stability Board鈥檚 (FSB) recommendations on securities financing transactions (SFTs) have been addressed through the adoption of the Securities Financing Transactions Regulation (SFTR)鈥�.
It added: 鈥淭here does not seem to be a need for further regulatory action at this stage.鈥�
All for one, and one for all
The effect of this brief reprieve on this year鈥檚 conference was that panellists were able to leave discussions of the usual trials and tribulations to one side in favour of a more nuanced analysis of how the industry can work together to everyone鈥檚 benefit.
During the regulatory panel, it was proposed that securities lending industry participants must work together, even to their individual detriment, in order to move the industry forward as a whole.
From an agent lender perspective, one speaker noted that the lending industry is demand driven and reactive to borrowers鈥� needs, particularly as a result of the liquidity coverage ratio, the net stable funding ratio (NSFR), and even the Securities Financing Transactions Regulation. The speaker said: 鈥淭he type of activity that we have seen is definitely a higher demand for transactions secured by non-cash collateral, greater demand for term transactions, and in some cases, just the borrowers being more selective of lender type.鈥�
Another noted that adapting to borrowers鈥� needs can have a significant effect on the agent lenders themselves. For example, increased demand for non-cash collateral will effect the agent lander鈥檚 risk-weighted assets calculations. The speaker observed that the large brokers are generally part of larger banking institutions and so are indirectly subject to capital and liquidity ratios. Therefore, there is an understanding that the banks and brokers must work together to create a solution that works for everyone.
鈥淐learly the banks and the brokers are working together. There鈥檚 a commonality of interest here to a much bigger extent than there ever was.鈥�
The RMA has been working to push the concept of allowing non-cash collateral by broker-dealers. While this is 鈥渃ompletely contrary to the banks鈥� interests from a capital perspective鈥�, as it would lead to higher indemnification costs, banks are nonetheless working with brokers to bring that about, in order to further encourage demand.
Another speaker also pointed to the proposed new 鈥榩ledge鈥� global master securities lending afgreement (GMSLA) in Europe as an example of agent lenders and borrowers working together towards a solution that doesn鈥檛 necessarily benefit agent lenders, but the market as a whole. The established way of borrowing is currently through a GMSLA, however, the speaker said: 鈥淏ecause of capital concerns on the borrower side, there has been a push to come up with a different type of GMSLA, a pledge GMSLA.鈥�
According to the speaker, the International Securities Lending Association has been active in pushing an industry solution here, in order to address the inconsistencies brought about through different agent lenders and borrowers providing individual, bespoke documentation. The new pledge GMSLA is a solution that benefits only some of the industry participants, not including agent lenders, however 鈥渢here is going to be no business if the borrowers are not borrowing鈥�.
The panel also noted that various cross-jurisdictional regulations such as the NSFR, capital floor rules under so-called Basel IV, and Standard Approach for Counterparty Credit Risk (SA-CCR) derivatives rules, there are significant differences in implementation status. For example, regarding SA-CCR, US regulators are still evaluating the rule, while in Canada implementation has been delayed until 2018, depending on the timing of implementation in 鈥榢ey foreign markets鈥�. In the EU, however, the rules have been adopted by the European Commission and are under consideration from the European Parliament and the European Council.
One panellist suggested that, while these discrepancies lead to uncertainty with regards to leverage, capital, credit risk, market risk, liquidity and derivatives, this uncertainty also provides 鈥渁 real possibility of making some changes鈥�, offering the industry the chance to make a positive impact on the industry. He added that the industry has a 鈥渨indow鈥� to 鈥渁rgue for certain things鈥�, and working in partnership with the industry is the right way to figure out what are the best points to tweak, and how to 鈥渓obby for the right edits鈥�.
However, while he expressed frustration at the length of time taken to finalise the rules, he said it鈥檚 equally important to resolve the discrepancies in implementation between regions. Ignoring these discrepancies would make things far more complicated in the long run, and could 鈥渟ignificantly alter the competitive landscape鈥�. The speaker concluded: 鈥淎 rule coming in is one thing, unwinding it, editing it 鈥� takes many many more years.鈥�
No rest for the risk weighted
Despite no new regulations expected in the immediate future, industry bodies such as the RMA and ISLA still have their work cut out for them to assist the regulators in refining existing rules that pose a threat to our industry.
In its letter to conference attendees, the RMA voiced 鈥渟erious concerns鈥� about the effect that the single counterparty credit limits (SCCL) could have on securities lending. Currently, the proposed methodologies banks must use to calculate their exposures from securities lending do not give any recognition of correlation or diversification within a netting set, which 鈥済rossly overstates credit exposure for agent banks鈥�.
The RMA is advocating for a risk-sensitive measure through comment letters and meeting with the Federal Reserve. The US Treasury has also recommended a more risk-sensitive risk calculation for SCCL. As previously mentioned, a new version of the SCCL was expected in the first half of 2017, but is now unlikely to be seen this year at all.
The RMA also noted that the final rule on the ISDA Stay Protocol in August 鈥渁ddressed many of the concerns raised by the RMA in its comment letters鈥�. A panel of RMA representatives praised the regulator鈥檚 decision to amend the rule and acknowledge issues raised by several industry bodies that the initial rule, without exemptions for securities lending translations, would be a major blow to the market.
The letter stated: 鈥淸The final version] included carve outs from amending agreements for irrelevant qualified financial contracts that would most probably cover securities lending authorisation agreements. Additionally, there is a carve-out for agents thereby not requiring agent lenders to sign on their behalf.鈥�
There is also a US Nexus carve out, meaning agreements signed on behalf of US clients under US law with global systemically important banks do not need to conform, as they will be captured under US special resolution regimes. An RMA spokesperson confirmed the association is working with the International Swaps and Derivatives Association on the US module of the Stay Protocol.
Stuck between a rock and a regulator
Beyond the ongoing battles of refining incoming regulations that are not currently fit for purpose, the securities lending industry is also facing the challenge of losing market participants to overburdensome compliance costs. As is so often the case, it鈥檚 the little guy that will suffer most from increasing costs and asset allocation requirements. According to conference panellists, the rising cost of compliance will likely prove too much for 鈥渉obby lenders鈥� and will force them to leave the market.
鈥淭he cost of compliance really won鈥檛 help growth. It will force out people who aren鈥檛 able to afford it,鈥� explained one speaker on the SFTR and MiFID II compliance panel. New reporting features such as the need for a unique trade identifier were accused of creating barriers to entry for smaller and less frequent lenders, but agent lenders will be expected to shoulder the costs.
Audience members heard that the debate of whether to build or buy a solution was a persistent dilemma for in-scope participants, and US entities should not neglect to solve the problem themselves. One speaker urged: 鈥淒on鈥檛 leave it up to your European counterparties to take on SFTR, you have to be on the ball.鈥�
It was noted by a beneficial owner representative that the build for SFTR was much simpler than that for MiFID II.
Concerns over cost of compliance flew in the face of reassuring messages offered by ISLA CEO Andy Dyson, who assured attendees of the IMN Annual Beneficial Owners鈥� International Securities 麻豆影视传媒 conference in London in September that, although cost increases were inevitable, they would be minimal.
Market participants would have to start reporting their transactions to trade repositories 12 months after the publication in the Official Journal of the EU, and the reporting obligation will be phased in over nine months. The compliance deadline for MiFID II is set for 3 January 2018.
The up and coming
It has been nine years since RMA hosted a dedicated forum on Latin American securities lending and the region has come along leaps and bounds since then. In response, this year鈥檚 RMA conference offered a Latin America-focused panel that allowed representatives from the region鈥檚 markets, including Peru and Mexico, to showcase recent growth.
It was revealed that Argentina鈥檚 securities regulator is expected to confirm plans for an on-exchange securities lending programme by the end of the year. The Comision Nacional de Valores (CNV) first proposed plans for the programme in September, but no official statements are available yet. CNV intends for the programme to facilitate short selling of equities and fixed income through local brokers.
According to panellists, unofficial discussions indicated that Argentina would likely model its securities lending programme on the established Brazilian model, meaning it would feature mandatory use of a central counterparty. Brazil is currently Latin America鈥檚 largest securities lending market, with its B3 exchange recording BRL 64.90 billion ($20.62 billion) in lending volume in April. Argentina鈥檚 lending programme will be guaranteed by the country鈥檚 stock exchange and central securities depository. CNV will show securities on-loan at the lender鈥檚 account and will accept responsibility for returning corporate actions to the beneficial owner.
The securities lending facility comes as part of a package of capital market developments aimed at raising Argentina up to 鈥榚merging market鈥� status from its current 鈥榝rontier鈥� classification. Argentina is the the only Latin American country yet to evolve into a recognised emerging market among its clearest peer group, which also includes Mexico, Peru and Colombia. Another conference speaker added that delegates should expect to hear a lot more from Argentina in the next few months and into next year, as the capital market reforms take hold.
Speaking ahead of the association鈥檚 event in Naples, the RMA鈥檚 director of securities lending Fran Garritt said: 鈥淪ince President Donald Trump has taken office some of the rule writing has slowed down.鈥�
Garritt added: 鈥淲e were expecting progress to be made on the final rule on qualified financial contract (QFC) restrictions for global systemically important banks (GSIBs), the net stable funding ratio, and the single counterparty credit limits in the first quarter of this year but so far, we鈥檝e only seen the final version of the QFC restrictions for GSIBs.鈥�
President Trump鈥檚 executive order on financial regulation earlier in the year threw everything we thought we knew about the roadmap for market oversight for the next few years into question.
Many commentators at this year鈥檚 conference speculated that, regardless of Trump鈥檚 threats to take an axe to the red tape that鈥檚 fallen on Wall Street in recent years, it was simply too unpalatable, both politically and economically, to table any major reforms to the likes of Dodd-Frank or Basel III. It was proposed that the general public would not accept anything that was perceived to be letting the banks off the hook. At the same time, for the banks themselves, implementation efforts for new rules frameworks such as the second Markets in Financial Instruments Directive (MiFID II) are simply too far along to consider turning back now. Nevertheless, the securities lending industry appears to have been given some much needed respite from new requirements coming down the pipeline.
European regulators also appear to have put their rule-writing pens down for a moment. The European Commission recently announced that 鈥渢o a large extent, the Financial Stability Board鈥檚 (FSB) recommendations on securities financing transactions (SFTs) have been addressed through the adoption of the Securities Financing Transactions Regulation (SFTR)鈥�.
It added: 鈥淭here does not seem to be a need for further regulatory action at this stage.鈥�
All for one, and one for all
The effect of this brief reprieve on this year鈥檚 conference was that panellists were able to leave discussions of the usual trials and tribulations to one side in favour of a more nuanced analysis of how the industry can work together to everyone鈥檚 benefit.
During the regulatory panel, it was proposed that securities lending industry participants must work together, even to their individual detriment, in order to move the industry forward as a whole.
From an agent lender perspective, one speaker noted that the lending industry is demand driven and reactive to borrowers鈥� needs, particularly as a result of the liquidity coverage ratio, the net stable funding ratio (NSFR), and even the Securities Financing Transactions Regulation. The speaker said: 鈥淭he type of activity that we have seen is definitely a higher demand for transactions secured by non-cash collateral, greater demand for term transactions, and in some cases, just the borrowers being more selective of lender type.鈥�
Another noted that adapting to borrowers鈥� needs can have a significant effect on the agent lenders themselves. For example, increased demand for non-cash collateral will effect the agent lander鈥檚 risk-weighted assets calculations. The speaker observed that the large brokers are generally part of larger banking institutions and so are indirectly subject to capital and liquidity ratios. Therefore, there is an understanding that the banks and brokers must work together to create a solution that works for everyone.
鈥淐learly the banks and the brokers are working together. There鈥檚 a commonality of interest here to a much bigger extent than there ever was.鈥�
The RMA has been working to push the concept of allowing non-cash collateral by broker-dealers. While this is 鈥渃ompletely contrary to the banks鈥� interests from a capital perspective鈥�, as it would lead to higher indemnification costs, banks are nonetheless working with brokers to bring that about, in order to further encourage demand.
Another speaker also pointed to the proposed new 鈥榩ledge鈥� global master securities lending afgreement (GMSLA) in Europe as an example of agent lenders and borrowers working together towards a solution that doesn鈥檛 necessarily benefit agent lenders, but the market as a whole. The established way of borrowing is currently through a GMSLA, however, the speaker said: 鈥淏ecause of capital concerns on the borrower side, there has been a push to come up with a different type of GMSLA, a pledge GMSLA.鈥�
According to the speaker, the International Securities Lending Association has been active in pushing an industry solution here, in order to address the inconsistencies brought about through different agent lenders and borrowers providing individual, bespoke documentation. The new pledge GMSLA is a solution that benefits only some of the industry participants, not including agent lenders, however 鈥渢here is going to be no business if the borrowers are not borrowing鈥�.
The panel also noted that various cross-jurisdictional regulations such as the NSFR, capital floor rules under so-called Basel IV, and Standard Approach for Counterparty Credit Risk (SA-CCR) derivatives rules, there are significant differences in implementation status. For example, regarding SA-CCR, US regulators are still evaluating the rule, while in Canada implementation has been delayed until 2018, depending on the timing of implementation in 鈥榢ey foreign markets鈥�. In the EU, however, the rules have been adopted by the European Commission and are under consideration from the European Parliament and the European Council.
One panellist suggested that, while these discrepancies lead to uncertainty with regards to leverage, capital, credit risk, market risk, liquidity and derivatives, this uncertainty also provides 鈥渁 real possibility of making some changes鈥�, offering the industry the chance to make a positive impact on the industry. He added that the industry has a 鈥渨indow鈥� to 鈥渁rgue for certain things鈥�, and working in partnership with the industry is the right way to figure out what are the best points to tweak, and how to 鈥渓obby for the right edits鈥�.
However, while he expressed frustration at the length of time taken to finalise the rules, he said it鈥檚 equally important to resolve the discrepancies in implementation between regions. Ignoring these discrepancies would make things far more complicated in the long run, and could 鈥渟ignificantly alter the competitive landscape鈥�. The speaker concluded: 鈥淎 rule coming in is one thing, unwinding it, editing it 鈥� takes many many more years.鈥�
No rest for the risk weighted
Despite no new regulations expected in the immediate future, industry bodies such as the RMA and ISLA still have their work cut out for them to assist the regulators in refining existing rules that pose a threat to our industry.
In its letter to conference attendees, the RMA voiced 鈥渟erious concerns鈥� about the effect that the single counterparty credit limits (SCCL) could have on securities lending. Currently, the proposed methodologies banks must use to calculate their exposures from securities lending do not give any recognition of correlation or diversification within a netting set, which 鈥済rossly overstates credit exposure for agent banks鈥�.
The RMA is advocating for a risk-sensitive measure through comment letters and meeting with the Federal Reserve. The US Treasury has also recommended a more risk-sensitive risk calculation for SCCL. As previously mentioned, a new version of the SCCL was expected in the first half of 2017, but is now unlikely to be seen this year at all.
The RMA also noted that the final rule on the ISDA Stay Protocol in August 鈥渁ddressed many of the concerns raised by the RMA in its comment letters鈥�. A panel of RMA representatives praised the regulator鈥檚 decision to amend the rule and acknowledge issues raised by several industry bodies that the initial rule, without exemptions for securities lending translations, would be a major blow to the market.
The letter stated: 鈥淸The final version] included carve outs from amending agreements for irrelevant qualified financial contracts that would most probably cover securities lending authorisation agreements. Additionally, there is a carve-out for agents thereby not requiring agent lenders to sign on their behalf.鈥�
There is also a US Nexus carve out, meaning agreements signed on behalf of US clients under US law with global systemically important banks do not need to conform, as they will be captured under US special resolution regimes. An RMA spokesperson confirmed the association is working with the International Swaps and Derivatives Association on the US module of the Stay Protocol.
Stuck between a rock and a regulator
Beyond the ongoing battles of refining incoming regulations that are not currently fit for purpose, the securities lending industry is also facing the challenge of losing market participants to overburdensome compliance costs. As is so often the case, it鈥檚 the little guy that will suffer most from increasing costs and asset allocation requirements. According to conference panellists, the rising cost of compliance will likely prove too much for 鈥渉obby lenders鈥� and will force them to leave the market.
鈥淭he cost of compliance really won鈥檛 help growth. It will force out people who aren鈥檛 able to afford it,鈥� explained one speaker on the SFTR and MiFID II compliance panel. New reporting features such as the need for a unique trade identifier were accused of creating barriers to entry for smaller and less frequent lenders, but agent lenders will be expected to shoulder the costs.
Audience members heard that the debate of whether to build or buy a solution was a persistent dilemma for in-scope participants, and US entities should not neglect to solve the problem themselves. One speaker urged: 鈥淒on鈥檛 leave it up to your European counterparties to take on SFTR, you have to be on the ball.鈥�
It was noted by a beneficial owner representative that the build for SFTR was much simpler than that for MiFID II.
Concerns over cost of compliance flew in the face of reassuring messages offered by ISLA CEO Andy Dyson, who assured attendees of the IMN Annual Beneficial Owners鈥� International Securities 麻豆影视传媒 conference in London in September that, although cost increases were inevitable, they would be minimal.
Market participants would have to start reporting their transactions to trade repositories 12 months after the publication in the Official Journal of the EU, and the reporting obligation will be phased in over nine months. The compliance deadline for MiFID II is set for 3 January 2018.
The up and coming
It has been nine years since RMA hosted a dedicated forum on Latin American securities lending and the region has come along leaps and bounds since then. In response, this year鈥檚 RMA conference offered a Latin America-focused panel that allowed representatives from the region鈥檚 markets, including Peru and Mexico, to showcase recent growth.
It was revealed that Argentina鈥檚 securities regulator is expected to confirm plans for an on-exchange securities lending programme by the end of the year. The Comision Nacional de Valores (CNV) first proposed plans for the programme in September, but no official statements are available yet. CNV intends for the programme to facilitate short selling of equities and fixed income through local brokers.
According to panellists, unofficial discussions indicated that Argentina would likely model its securities lending programme on the established Brazilian model, meaning it would feature mandatory use of a central counterparty. Brazil is currently Latin America鈥檚 largest securities lending market, with its B3 exchange recording BRL 64.90 billion ($20.62 billion) in lending volume in April. Argentina鈥檚 lending programme will be guaranteed by the country鈥檚 stock exchange and central securities depository. CNV will show securities on-loan at the lender鈥檚 account and will accept responsibility for returning corporate actions to the beneficial owner.
The securities lending facility comes as part of a package of capital market developments aimed at raising Argentina up to 鈥榚merging market鈥� status from its current 鈥榝rontier鈥� classification. Argentina is the the only Latin American country yet to evolve into a recognised emerging market among its clearest peer group, which also includes Mexico, Peru and Colombia. Another conference speaker added that delegates should expect to hear a lot more from Argentina in the next few months and into next year, as the capital market reforms take hold.
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