Winds of change
15 October 2019
Market participants must learn to do more with less if they want to control the narrative of change in an evolving securities finance market, or risk being left behind in the push towards greater efficiency. David Lewis of FIS explains
Image: Shutterstock
The increasing rapidity of change is discussed across almost every medium and every subject imaginable, from the environment, technology, economics and politics to industry and beyond.
The securities finance industry is every bit as susceptible to the winds of change as any other industry, financial or otherwise. It’s facing both megatrends that affect all industries (you may have noticed that nothing can be an ordinary size anymore if the attention of a reader or consumer is desired; as such, to identify a simple “trend” is insufficient) and pressures that are specific to finance and collateral management. The variable is how we choose to respond to them.
Consider the megatrend of productivity. Very few organisations in our industry are not reacting to, or even driving ahead with, the “do more with less” mantra. In an environment of faltering demand that’s pushing down revenues and margins for market participants, growth can be hard to come by.
One previously popular ‘silver bullet’ strategy of opening new markets has mostly run out of steam; significant potential remains untapped in some markets, but the real impact of expanding into those remaining countries is still on the horizon and some distance from boosting the bottom line.
The introduction of new product types is another well-used strategy. This still has legs as markets look to create other transactions with the economic equivalence of the more traditional securities finance trades such as repo, buy/sell back and securities loans. But this is where the market is crossing back into the do-more-with-less-approach. A new synthetic transaction type or new technology such as tokenisation or blockchain will not necessarily drive activity to new heights. But they may improve market efficiency through lower transaction costs, fewer fails or improved levels of automation.
At the recent International Securities Lending Association (ISLA) Annual Post Trade Conference, some drew a parallel between the cash equity and the securities finance market. The implication was that the improved access, cheaper technology and greater transparency that has driven the equity market to undreamed heights of volume and value (ignoring the last few quarters’ stumbles) will bring the same explosive growth to securities finance.
The lowering of barriers to entry in the cash equity markets has indeed welcomed untold numbers of new entrants who trade through cheap online brokers, banks or any other firm that wants to provide market access. However, the growth in activity in a market where a security, or its derivative, can be bought or sold an infinite number of times does not translate easily into a borrow and loan market.
Lowering the barriers to entry, a prerequisite to dis-intermediation, is certainly advantageous to the vibrancy of a market because new entrants drive competition and innovation. But making a transaction easier does not necessarily attract new demand. It has long been the mantra of agent lenders that they cannot drive demand, but they can make themselves attractive lenders through flexible collateral and lower-cost post-trade performance (re-rates, recalls etc). The arrival of new direct lenders, such as large asset managers entering the market to disintermediate their agents, certainly affect the marketplace, but their ability to grow the space must be limited by the levels of demand.
Certain changes in the wider financial markets–notably the increase of collateralisation standards across the financial industry, including margin requirements for uncleared derivatives (UMR)–are expected to create more demand. However, is that demand sufficient to compensate for the acceleration in market supply? If it isn’t, then margins and incomes must fall as a simple response to the laws of supply and demand.
If they are not doing so already, agent lenders are very likely going to be looking at their client list and how much each client costs them to maintain. You don’t need complex mathematics to assess the impact, or lack of impact, of a reduction in clients on the income an agent generates across that client base and for itself.
The same analysis should be applied to the drive for adding new clients to the roster and how much net revenue growth is achieved by including their assets into the lendable pool. If the answer is zero, then every client will see their share of revenues fall, and the revenue estimates given to the new client may be missed. What follows will be an awkward conversation about fee splits for the following year, piling further pressure on service providers.
Doing more with less is vital to keeping ahead; automating pre- and post-trade activities is key to enabling that change and driving progress. Regulatory changes bring both benefits and costs, with the rise of collateral demands from an increasingly consumer protection-led regulatory agenda adding demand for assets to borrow, while punitive risks from fines from the Central Securities Depositories Regulation and invasive data gathering from the Securities Financing Transactions Regulation may well drive costs up and some participants out. Enterprise-wide asset mobilisation can drive efficiency, reducing participants’ reliance on counterparts that can drag heavily on their balance sheet and capital costs – but these are just the start.
Disintermediation of the industry has been discussed for a very long time. Both large players and new start-ups are disrupting the traditional transaction chain as they search for new markets and demand. In reality, the same pie is being cut into ever thinner slices, with the overall market demand being at the mercy of larger pressures affecting the financial markets as a whole.
At the recent ISLA conference, an attendee made the sage comment that the disintermediation of inefficiencies is driving activity in this market, whether they be technological changes affecting straight-through processing rates or the broader structural changes to the traditional players in the transaction chain. And we need to focus on this if we are going to reinvent the business of securities finance–not only weathering the winds of change but driving them.
The securities finance industry is every bit as susceptible to the winds of change as any other industry, financial or otherwise. It’s facing both megatrends that affect all industries (you may have noticed that nothing can be an ordinary size anymore if the attention of a reader or consumer is desired; as such, to identify a simple “trend” is insufficient) and pressures that are specific to finance and collateral management. The variable is how we choose to respond to them.
Consider the megatrend of productivity. Very few organisations in our industry are not reacting to, or even driving ahead with, the “do more with less” mantra. In an environment of faltering demand that’s pushing down revenues and margins for market participants, growth can be hard to come by.
One previously popular ‘silver bullet’ strategy of opening new markets has mostly run out of steam; significant potential remains untapped in some markets, but the real impact of expanding into those remaining countries is still on the horizon and some distance from boosting the bottom line.
The introduction of new product types is another well-used strategy. This still has legs as markets look to create other transactions with the economic equivalence of the more traditional securities finance trades such as repo, buy/sell back and securities loans. But this is where the market is crossing back into the do-more-with-less-approach. A new synthetic transaction type or new technology such as tokenisation or blockchain will not necessarily drive activity to new heights. But they may improve market efficiency through lower transaction costs, fewer fails or improved levels of automation.
At the recent International Securities Lending Association (ISLA) Annual Post Trade Conference, some drew a parallel between the cash equity and the securities finance market. The implication was that the improved access, cheaper technology and greater transparency that has driven the equity market to undreamed heights of volume and value (ignoring the last few quarters’ stumbles) will bring the same explosive growth to securities finance.
The lowering of barriers to entry in the cash equity markets has indeed welcomed untold numbers of new entrants who trade through cheap online brokers, banks or any other firm that wants to provide market access. However, the growth in activity in a market where a security, or its derivative, can be bought or sold an infinite number of times does not translate easily into a borrow and loan market.
Lowering the barriers to entry, a prerequisite to dis-intermediation, is certainly advantageous to the vibrancy of a market because new entrants drive competition and innovation. But making a transaction easier does not necessarily attract new demand. It has long been the mantra of agent lenders that they cannot drive demand, but they can make themselves attractive lenders through flexible collateral and lower-cost post-trade performance (re-rates, recalls etc). The arrival of new direct lenders, such as large asset managers entering the market to disintermediate their agents, certainly affect the marketplace, but their ability to grow the space must be limited by the levels of demand.
Certain changes in the wider financial markets–notably the increase of collateralisation standards across the financial industry, including margin requirements for uncleared derivatives (UMR)–are expected to create more demand. However, is that demand sufficient to compensate for the acceleration in market supply? If it isn’t, then margins and incomes must fall as a simple response to the laws of supply and demand.
If they are not doing so already, agent lenders are very likely going to be looking at their client list and how much each client costs them to maintain. You don’t need complex mathematics to assess the impact, or lack of impact, of a reduction in clients on the income an agent generates across that client base and for itself.
The same analysis should be applied to the drive for adding new clients to the roster and how much net revenue growth is achieved by including their assets into the lendable pool. If the answer is zero, then every client will see their share of revenues fall, and the revenue estimates given to the new client may be missed. What follows will be an awkward conversation about fee splits for the following year, piling further pressure on service providers.
Doing more with less is vital to keeping ahead; automating pre- and post-trade activities is key to enabling that change and driving progress. Regulatory changes bring both benefits and costs, with the rise of collateral demands from an increasingly consumer protection-led regulatory agenda adding demand for assets to borrow, while punitive risks from fines from the Central Securities Depositories Regulation and invasive data gathering from the Securities Financing Transactions Regulation may well drive costs up and some participants out. Enterprise-wide asset mobilisation can drive efficiency, reducing participants’ reliance on counterparts that can drag heavily on their balance sheet and capital costs – but these are just the start.
Disintermediation of the industry has been discussed for a very long time. Both large players and new start-ups are disrupting the traditional transaction chain as they search for new markets and demand. In reality, the same pie is being cut into ever thinner slices, with the overall market demand being at the mercy of larger pressures affecting the financial markets as a whole.
At the recent ISLA conference, an attendee made the sage comment that the disintermediation of inefficiencies is driving activity in this market, whether they be technological changes affecting straight-through processing rates or the broader structural changes to the traditional players in the transaction chain. And we need to focus on this if we are going to reinvent the business of securities finance–not only weathering the winds of change but driving them.
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