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In a wide-ranging discussion, the Bank of England’s Securities Lending Committee addressed agent lender disclosures, problems of lending UCITS, and pressure on lending revenues, according to the newly-released minutes of its November meeting.
Committee members observed that while UCITS offers a broad selection of benefits as the most common investment wrapper in Europe, the UCITS directive sometimes restricts securities lending for UCITS funds in its current form.
Some members proposed that the regulatory authorities need to look closely at the terms of UCITS funds to make them “more lendable”, while retaining the benefits of investor protection, efficiency and ease of cross-border marketing and distribution long offered by the UCITS fund model. Without these changes, participants warned that there could be greater risk of credit and liquidity squeezes.
The Committee discussed a need to improve disclosure frameworks for agent lending activity. Some members questioned whether the existing agent disclosure model is “fit for purpose” — and a number pointedly said that it is not. Responding to this concern, members observed that industry associations are currently drafting alternative procedures and will report on progress at a future meeting of the Committee.
The discussion looked back on what has been a challenging and volatile two years for the financial service world — with the COVID-19 pandemic at the forefront. Reflecting on some recent areas of revenue weakness, the Committee observed that ‘specials’ revenue had partially compensated for reduced underlying volume flows in the market, which had fallen behind the levels of recent years.
Although 2021 was a tougher year for specials, several Committee members were optimistic for stronger trading opportunities around the year end linked to companies that had benefited from the pandemic (home gym companies being a prime example) and the ongoing semiconductor shortages which continued to impact certain industries.
Evaluating key trends around collateral use, International Capital Markets Association’s (ICMA’s) analysis of transaction data reported under the Securities Financing Transactions Regulation (SFTR) reveals that up to 90 per cent of European collateral borrowing during 2021 was sourced from funds located outside of the European Economic Area — with US and Middle Eastern funds being particularly prominent. ICMA research indicates that this figure has increased from 60 per cent just a few years ago.
Participants noted that sourcing US collateral is likely to become more difficult during 2022 — with CSDR liquidity challenges for borrowed securities, for example the need to borrow against US cash collateral, accentuating this concern. It can be difficult to position collateral in the time available and this is a common cause of settlement failure. With the Central Securities Depositories Regulation (CSDR) fails penalty regime becoming active on 1 February 2022, this will now trigger a CSDR penalty for the failing party.
In considering the evolution of securities lending practice, Committee members reported that 15 per cent of securities lending transactions are now executed using pledge rather than traditional transfer of title.
Continuing its ongoing analysis on the application of ESG principles to securities lending, the Committee indicated that misunderstandings associated with ESG regulations have potentially made UCITS funds less lendable than they could be. Gaps in current regulation reinforce this problem since market participants may not be clear how, and to what extent, ESG concepts need to be applied to securities lending collateral.
On a positive note, the Committee noted that advances had been made in clarifying global ESG disclosure guidelines for investment products. A recent IOSCO paper on disclosure management marks an important step forward. Also, the formation of the Global Alliance of Securities Lending Associations (GASLA) in October, represented by five regional securities lending associations, will be significant in coordinating steps to establish clear best practice for the industry.
In reflecting on diversity and inclusion standards across securities lending markets, the Committee explored potential challenges associated with hybrid working — including the need to avoid stigma for people working remotely as more staff return to the office.
The Committee observed that there is a segment of the population that cannot return to the office (owing to disabilities, long-term illness, dependents) and will continue to need accommodations made for them in the form of hybrid working.
