Regulation and Securities Lending: Considerations for Asset Managers
In recent years, agent-led product enhancements coupled with regulatory rule revisions have significantly altered the securities lending landscape. Under Basel III, for instance, agent lenders may be required to raise capital levels held against possible borrower defaults, potentially increasing the cost of indemnifying asset owners in the process. Closer to home, an updated UCITS framework from the Central Bank of Ireland includes new minimum liquidity and counterparty credit-rating requirements for UCITS funds that engage in securities lending.
With these changes comes greater demand from asset owners for more frequent and detailed reporting into their programme activities. Agent lenders have increased programme transparency and enhanced relationship-management capabilities in an effort to maintain client confidence.
New challenges and opportunities
Regulatory changes have led to new opportunities for asset owners. The need for banks to satisfy more rigorous capital-adequacy and leverage coverage ratio requirements under Basel III and Dodd-Frank has fuelled demand for borrowing high quality liquid assets (HQLA), such as government-backed securities. Asset owners may also benefit from the industry trend toward collateral optimisation and transformation strategies, a by-product of newly enhanced derivatives-clearing and trade-execution standards, in addition to increased demand for evergreen and term trades (in which a portion of high quality government securities are loaned out for a set period of time).
As outlined earlier, agent lenders typically provide their lending clients indemnification to protect against potential borrower default. With agent lenders facing increased Risk Weighted Asset (RWA)-calculated capital costs for providing indemnification, asset owners may be impacted by either the value of their indemnification being reduced and/or by having increased costs passed down to them. Additionally, asset owners’ returns may be impacted as agent lenders become increasingly challenged to justify certain lending transactions due to the prohibitive impact of increased capital costs, making them effectively a drag on overall programme performance.
Accordingly, central clearing will likely continue to gain traction within the lending industry, particularly as demand for more efficient capital management solutions rises. In a recent survey, securities finance research and consulting firm Finadium found that more than 1-in-4 asset managers believed using a central counterparty clearing house (CCP) to clear securities on loan could potentially eliminate the need for borrower default indemnification.
Though asset owners may be more engaged than in years past, they continue to rely on their agent lenders to help them identify and manage market risk. With regulation-fuelled complexity on the rise, agents now provide dashboard-based reporting platforms to offer clients a holistic view of the markets, including the ability to view key drivers of returns and sophisticated credit and collateral risk analytics tools. Customisation of service, including bespoke programmes tailored to asset owners’ unique risk-return characteristics, has become an essential part of the lending package, as the trend of value lending, as opposed to volume lending, continues.
Lending looking up
Despite the various changes and challenges impacting the industry, demand for lendable assets remains significant and according to DataLend research securities lending revenues totalled $8.6 billion globally last year. The asset owners that stay abreast of changes affecting indemnification, including the possible impact on their programme cost and structure, will be those most likely to take advantage of the new opportunities and options available. Additionally, maintaining open dialogue is increasingly required to ensure that programme objectives are both understood and met, ensuring the alignment of interests between both asset owners and agent lenders.
Alasdair King is Senior Vice President for Business Development with Boston-based securities lending agency eSecLending