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Changes in the monetary policy environment are driving far-reaching shifts in how securities finance markets operate, the International Securities Lending Association’s (ISLA’s) chief executive Andrew Dyson told attendees at the Association’s 30th Annual Conference in Lisbon.
In a little more than 12 months, the US federal funds rate has climbed from 0.5 per cent in March 2022 to 5.25 per cent in early May. In parallel, the EU has witnessed a seven-fold increase in the ECB interest rate for main refinancing operations.
“Funding markets are currently stressed and, at times, are operating at close to their limits,” explains Dyson.
This period has been characterised by bouts of volatility and has highlighted just how quickly stress conditions can develop, translating into a sharp rise in activity for some market participants, says Eric Badger, managing director and global head of clearing and collateral management client coverage at BNY Mellon.
In negotiating these periods of market stress, Badger suggests that recent experience has confirmed how well triparty functions as a risk management tool and as a mechanism for protecting access to funding.
For State Street's global head of agency lending Patricia Hostin, the sharp tightening in monetary conditions over the past 12 months has fuelled a surge in demand for alternative financing solutions, driving strong flows through the bank's peer-to-peer repo platform and sponsored clearing solutions connecting to the DTCC’s Fixed Income Clearing Corporation (FICC).
In parallel, consolidation has continued across the banking sector and this has resulted in further concentration of counterparty risk, requiring lenders to do business in testing market conditions against a contracting group of sell-side counterparties. Central clearing could play a key role in managing this credit risk, Hostin indicates, releasing some of the pressure in terms of managing both counterparty concentration and risk-weighted assets (RWA).
For Société Générale head of financing solutions and client profitability Geraldine Trippner, banks have been progressively adjusting over a number of years to managing securities finance trading efficiently in line with Basel capital rules. While continuing to push for greater balance sheet efficiency, this borrower community has strengthened its ability to monitor capital consumption and the cost of RWA.
According to another panellist, managing director at a large transatlantic asset management company, trading strategies in securities finance markets are evolving with investors' asset allocation decisions as they rebalance portfolios to adjust to changes in economic conditions and monetary policy. More broadly, securities lending continues to provide an important generator of revenue as allocations to exchange-traded funds (ETFs) and index-linked products have continued to grow.
For BNY Mellon's Badger, securities financing and collateral markets are currently at an inflection point with the future likely to be defined by how traditional ways of working will coexist with, and benefit from, advances in technology — for example those offered by distributed ledger technology — and the drive for sustainable lending and borrowing.
Securities finance market participants will continue to develop their network coverage to accommodate lending and borrowing in new and emergent locations, with Indonesia, Malaysia and South Korea currently top of mind for BNY Mellon as it expands its coverage in the Asia Pacific region.
In Japan, Badger finds that market participants are increasingly moving from bilateral to triparty structures to manage their collateral movements. In Europe, there is rising appetite from clients to employ pledge-based collateral arrangements to secure securities financing transactions.
According to the buy-side representative on the panel, a fundamental challenge will be to assess the price impact of monetary tightening on securities financing transactions. After an extended period of accommodative monetary policy, when investors received near-zero returns on their fixed income investments, interest rates have risen sharply over the past 12 months, enabling investors to achieve a more attractive yield on their fixed income portfolios. This will potentially impact beneficial owners’ asset allocation decisions, and the balance of government debt and equities that they hold as lendable inventory or as eligible collateral.
Against this background, market participants need to continue to adjust to living with inflation, with recent geopolitical events, including the Russia-Ukraine conflict, continuing to have an inflationary impact as they cause supply chains to be rewired globally.
For State Street's Hostin, the level of sophistication in conversations with clients and counterparties is unprecedented and this provides for an exciting future. The challenge is to deliver varied and flexible solutions to address the pinch points in the industry, a journey that the agent lender community has been making since the 2008 financial crisis.
In reflecting on whether these developments are driving a shift in attitudes to risk in securities finance markets, BNY Mellon’s Badger concludes that there has been little observable change across the bank’s client community. “Recent experience confirms that triparty works well as a risk management tool and as a means to access secured funding,” he explains. “The key, in providing this support, is to ensure that the right collateral is moving to the right place at the right time. This demands, among other factors, the ability to help counterparties to negotiate collateral schedules quickly and easily.”
