Trading and technology
19 January 2021
Fran Garritt, the RMA鈥檚 director of global markets risk and securities lending, interviews Charles Schwab鈥檚 Eric Lytle and OCC鈥檚 Matt Wolfe about how institutions can ease the adoption of new platforms and products and achieve a downward sloping cost curve for the securities lending industry
Image: stock.adobe.com/NicoElNino
As head of trading in Charles Schwab鈥檚 securities lending group, Eric Lytle sees every day how rapid advances in data and technology, new vendor entrants, and products are shaping trading and securities finance. As the Options Clearing Corporation鈥檚 vice president of securities finance, Matt Wolfe has been involved for many years in the continual improvement and innovation of the world鈥檚 largest clearinghouse for equity derivatives and securities lending.
Can you talk about the history of how market participants connect to various platforms, vendors, and central clearing counterparties (CCPs) within securities lending?
Eric Lytle:聽 It鈥檚 an easy one word answer, 鈥榖espoke鈥�. I run the securities lending trading desk now and before that I managed the 15c3-3 portfolio. Every vendor and market that I wanted to adopt had its own unique connection protocol. It is like rebuilding the wheel every time you start the adoption process. This had and still has several negative effects on each individual firm and the industry: increased development time and cost, and increased complexity for your internal technology teams to monitor and maintain the unique connections. Considering these factors, it creates a mechanical barrier to entry for new vendors, limits pathways to market participants and venues (CCPs), and reduces price discovery options. At the end of the day you have a lack of operational efficiency and increased operating costs. Generally speaking, I would say there has been a lack of industry focus on standardisation.
Matt Wolfe: I agree that there has not been an industry focus on standardisation. I have worked on standardisation efforts with market participants and global CCPs for clearing options and futures. The benefits are clear in those markets. For context, the Options Clearing Corporation (OCC) clears for 16 US options exchanges and approximately 100 clearing members. As a result of standardisation, the process to introduce a new options exchange is a relatively small project that the options industry has done about once or twice a year over the last few years. That has enabled great innovation and a diversity of market models designed for different strategies to ensure deep liquidity and best execution for investors. We are continually looking for ways to apply that success to the securities lending industry.
What are the high-level benefits of message standardisation?
Lytle:聽 I try and think about this from every stakeholder鈥檚 perspective and believe the advantages outweigh the disadvantages. Let鈥檚 look at this from the perspective of the market participants (the lenders and borrowers) and the vendors (pre-trade data vendors, trade execution platforms, and post-trade platforms and CCPs) and then extend that view out to their constituents (beneficial owners, hedge funds and regulators). Standardised messaging will allow market participants to develop the necessary messages (on loan balances, availability, trading, and post-trade) once and then utilise those same messages multiple times with multiple vendors. This will make the implementation process much quicker and thus less expensive. If this is true then the barrier to entry for new vendors is lower, making for a true win-win scenario for the market participant and the vendor.
My argument goes one step further regarding the benefits to the industry if we are able to lower the barrier to entry for vendors. It is founded on a theory that competition in the industry is good for all stakeholders. Since I can鈥檛 say it any better, I will steal a quote from the new members exchange: 鈥淐ompetition in the marketplace brings out the best in all the participants and benefits investors. Increasing the diversity of exchanges improves overall market robustness, stability, and innovation, which will ultimately result in improved operational transparency and reduced fixed costs.鈥� In other words, competition will benefit all securities lending market stakeholders by driving innovation and transparency in the industry and driving down operating costs. That is something we can all get behind.
What are some common standard communication protocols that would work best for securities lending?
Wolfe: There are several messaging protocols that can be considered, but three stand out from the rest: FIX, ISO, and CDM.
FIX was developed about 30 years ago to support electronic trading. The first asset class to adopt FIX was the equities market and it has since seen wide-scale adoption in the exchange-traded derivatives markets. It is the de-facto standard to connecting to exchanges and CCPs around the world. FIX is a community led standard and continues to evolve according to the needs of the financial markets. FIX has a flexible tag = value format (e.g., Qty=鈥�100鈥�) that is easy to understand and flexible to use. There is a robust set of supporting tools for validating, parsing, viewing, and creating FIX messages. The broad adoption for trading equities and the fact that most securities lending market participants already use FIX makes it an obvious choice.
ISO is another widely used messaging standard that could be a good fit for securities lending. ISO is used primarily within the custody, payments, and settlement space 鈥� another area closely-related to securities lending. ISO messaging standards are registered with and supported by SWIFT, the global payments network. ISO messages are more structured than FIX messages, with greater specificity on the format of data elements that are required in different messages. Most securities lending participants already use ISO for communicating with depositories and banks, so ISO is another good standard that the industry could rally around.
A third protocol is a relatively new standard called the common domain model (CDM). FIX and ISO have defined record layouts for expressing different events, such as a trade. Those record layouts include mandatory, optional, and conditionally required data elements; the meaning of those elements; and the format of those elements (e.g., text, currency code, integer, etc.). The FIX and ISO standards also have suggested workflows for how interactions should occur 鈥� for example, what message the recipient of a request for quote message should respond with. CDM does all these things and goes one step further: It includes embedded logic and code for performing certain actions. This allows both parties to a transaction to perform the same calculations, which helps reduce discrepancies. CDM is supported by the International Swaps and Derivatives Association, and has been adopted by much of the derivatives markets. CDM has not yet been extended to support securities lending, but it certainly could be.
Why is now the time to talk about message standardisation?
Lytle: This has been such a tumultuous and volatile year for all of us, I can鈥檛 help but think about how we further risk-proof and grow our industry and grow our respective businesses, all while working from home. My brain tells me, don鈥檛 fight the tape, the market will not slow down for you nor accommodate the status quo. The Securities Financing Transactions Regulation is here, DTCC and the OCC are developing their CCP offerings for the securities lending industry, and there are a multitude of really interesting new vendors looking to compete in the US market. It really feels to me that the industry is ready for the next big step forward.
In my opinion, EquiLend鈥檚 Next Generation Trading (NGT), a multi-asset class trading platform accessed through a web-based user interface or via full automation using EquiLend鈥檚 proprietary messaging protocol, opened the industry鈥檚 eyes as to what could be accomplished with trade automation. So then the industry鈥檚 question becomes, what is next and who is next?
In the pre-trade analytics space, we have all become familiar with the big three data providers (Markit-DataExplorer, Astec Analytics-Lending Pit, and DataLend), but we want more. We want option implied borrow rates and swap rates side-by-side in an easy-to-compare fashion, exchange data on short interest, expiry lockup dates, dividend dates, balance and availability day-over-day changes, utilisation, etc.
In the trade execution space, as I mentioned the industry has become familiar with trade automation via NGT, but we want more. We want competition in the execution space and we want to see the analytics on the same screen we use for executions, cost differences based on collateral types and mark parameters, two-sided market with depth of market in real-time, and real industry-wide locates that decrement as new shorts are executed.
In the post-trade space, we have overnight batch processing on main frames but we want more. We want real-time comparison, perhaps utilising distributed ledger and competition in the space that arguably is the last area within securities lending to adopt new technologies to drive efficiency higher and costs lower.
Generally speaking, the industry is ready to do the work necessary to make efficiency a priority, with the intended goal of improving our trade decisions and driving our cost structure lower.
What are the next steps towards the message standardisation for the SL industry and how is it going?
Wolfe: We worked with the FIX trading community to form a stock loan working group to expand the FIX standard to better support securities lending. With the support of the RMA FinTech and Automation Committee, we have been collaborating with market participants, vendors, and other CCPs to define a set of messages for communicating loans; contracts with marks; and other life cycle events such as rerates, recalls, returns, buy-ins, and corporate actions. These messages will work nicely with the already established reference data and other messages in the FIX standard. FIX is community-led and anyone is welcome to contribute. Collaboration by the entire industry helps ensure that the messages support all our use cases and are developed using the collective wisdom of the industry. Having an industry-backed and developed standard will help ensure wide-scale adoption and help to realise the benefits of lower costs, greater automation, innovation, improved efficiency, and higher quality data.
Can you talk about the history of how market participants connect to various platforms, vendors, and central clearing counterparties (CCPs) within securities lending?
Eric Lytle:聽 It鈥檚 an easy one word answer, 鈥榖espoke鈥�. I run the securities lending trading desk now and before that I managed the 15c3-3 portfolio. Every vendor and market that I wanted to adopt had its own unique connection protocol. It is like rebuilding the wheel every time you start the adoption process. This had and still has several negative effects on each individual firm and the industry: increased development time and cost, and increased complexity for your internal technology teams to monitor and maintain the unique connections. Considering these factors, it creates a mechanical barrier to entry for new vendors, limits pathways to market participants and venues (CCPs), and reduces price discovery options. At the end of the day you have a lack of operational efficiency and increased operating costs. Generally speaking, I would say there has been a lack of industry focus on standardisation.
Matt Wolfe: I agree that there has not been an industry focus on standardisation. I have worked on standardisation efforts with market participants and global CCPs for clearing options and futures. The benefits are clear in those markets. For context, the Options Clearing Corporation (OCC) clears for 16 US options exchanges and approximately 100 clearing members. As a result of standardisation, the process to introduce a new options exchange is a relatively small project that the options industry has done about once or twice a year over the last few years. That has enabled great innovation and a diversity of market models designed for different strategies to ensure deep liquidity and best execution for investors. We are continually looking for ways to apply that success to the securities lending industry.
What are the high-level benefits of message standardisation?
Lytle:聽 I try and think about this from every stakeholder鈥檚 perspective and believe the advantages outweigh the disadvantages. Let鈥檚 look at this from the perspective of the market participants (the lenders and borrowers) and the vendors (pre-trade data vendors, trade execution platforms, and post-trade platforms and CCPs) and then extend that view out to their constituents (beneficial owners, hedge funds and regulators). Standardised messaging will allow market participants to develop the necessary messages (on loan balances, availability, trading, and post-trade) once and then utilise those same messages multiple times with multiple vendors. This will make the implementation process much quicker and thus less expensive. If this is true then the barrier to entry for new vendors is lower, making for a true win-win scenario for the market participant and the vendor.
My argument goes one step further regarding the benefits to the industry if we are able to lower the barrier to entry for vendors. It is founded on a theory that competition in the industry is good for all stakeholders. Since I can鈥檛 say it any better, I will steal a quote from the new members exchange: 鈥淐ompetition in the marketplace brings out the best in all the participants and benefits investors. Increasing the diversity of exchanges improves overall market robustness, stability, and innovation, which will ultimately result in improved operational transparency and reduced fixed costs.鈥� In other words, competition will benefit all securities lending market stakeholders by driving innovation and transparency in the industry and driving down operating costs. That is something we can all get behind.
What are some common standard communication protocols that would work best for securities lending?
Wolfe: There are several messaging protocols that can be considered, but three stand out from the rest: FIX, ISO, and CDM.
FIX was developed about 30 years ago to support electronic trading. The first asset class to adopt FIX was the equities market and it has since seen wide-scale adoption in the exchange-traded derivatives markets. It is the de-facto standard to connecting to exchanges and CCPs around the world. FIX is a community led standard and continues to evolve according to the needs of the financial markets. FIX has a flexible tag = value format (e.g., Qty=鈥�100鈥�) that is easy to understand and flexible to use. There is a robust set of supporting tools for validating, parsing, viewing, and creating FIX messages. The broad adoption for trading equities and the fact that most securities lending market participants already use FIX makes it an obvious choice.
ISO is another widely used messaging standard that could be a good fit for securities lending. ISO is used primarily within the custody, payments, and settlement space 鈥� another area closely-related to securities lending. ISO messaging standards are registered with and supported by SWIFT, the global payments network. ISO messages are more structured than FIX messages, with greater specificity on the format of data elements that are required in different messages. Most securities lending participants already use ISO for communicating with depositories and banks, so ISO is another good standard that the industry could rally around.
A third protocol is a relatively new standard called the common domain model (CDM). FIX and ISO have defined record layouts for expressing different events, such as a trade. Those record layouts include mandatory, optional, and conditionally required data elements; the meaning of those elements; and the format of those elements (e.g., text, currency code, integer, etc.). The FIX and ISO standards also have suggested workflows for how interactions should occur 鈥� for example, what message the recipient of a request for quote message should respond with. CDM does all these things and goes one step further: It includes embedded logic and code for performing certain actions. This allows both parties to a transaction to perform the same calculations, which helps reduce discrepancies. CDM is supported by the International Swaps and Derivatives Association, and has been adopted by much of the derivatives markets. CDM has not yet been extended to support securities lending, but it certainly could be.
Why is now the time to talk about message standardisation?
Lytle: This has been such a tumultuous and volatile year for all of us, I can鈥檛 help but think about how we further risk-proof and grow our industry and grow our respective businesses, all while working from home. My brain tells me, don鈥檛 fight the tape, the market will not slow down for you nor accommodate the status quo. The Securities Financing Transactions Regulation is here, DTCC and the OCC are developing their CCP offerings for the securities lending industry, and there are a multitude of really interesting new vendors looking to compete in the US market. It really feels to me that the industry is ready for the next big step forward.
In my opinion, EquiLend鈥檚 Next Generation Trading (NGT), a multi-asset class trading platform accessed through a web-based user interface or via full automation using EquiLend鈥檚 proprietary messaging protocol, opened the industry鈥檚 eyes as to what could be accomplished with trade automation. So then the industry鈥檚 question becomes, what is next and who is next?
In the pre-trade analytics space, we have all become familiar with the big three data providers (Markit-DataExplorer, Astec Analytics-Lending Pit, and DataLend), but we want more. We want option implied borrow rates and swap rates side-by-side in an easy-to-compare fashion, exchange data on short interest, expiry lockup dates, dividend dates, balance and availability day-over-day changes, utilisation, etc.
In the trade execution space, as I mentioned the industry has become familiar with trade automation via NGT, but we want more. We want competition in the execution space and we want to see the analytics on the same screen we use for executions, cost differences based on collateral types and mark parameters, two-sided market with depth of market in real-time, and real industry-wide locates that decrement as new shorts are executed.
In the post-trade space, we have overnight batch processing on main frames but we want more. We want real-time comparison, perhaps utilising distributed ledger and competition in the space that arguably is the last area within securities lending to adopt new technologies to drive efficiency higher and costs lower.
Generally speaking, the industry is ready to do the work necessary to make efficiency a priority, with the intended goal of improving our trade decisions and driving our cost structure lower.
What are the next steps towards the message standardisation for the SL industry and how is it going?
Wolfe: We worked with the FIX trading community to form a stock loan working group to expand the FIX standard to better support securities lending. With the support of the RMA FinTech and Automation Committee, we have been collaborating with market participants, vendors, and other CCPs to define a set of messages for communicating loans; contracts with marks; and other life cycle events such as rerates, recalls, returns, buy-ins, and corporate actions. These messages will work nicely with the already established reference data and other messages in the FIX standard. FIX is community-led and anyone is welcome to contribute. Collaboration by the entire industry helps ensure that the messages support all our use cases and are developed using the collective wisdom of the industry. Having an industry-backed and developed standard will help ensure wide-scale adoption and help to realise the benefits of lower costs, greater automation, innovation, improved efficiency, and higher quality data.
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