Rising from the ashes of the credit crunch, peer-to-peer securities lending has opened doors for investors and borrowers, seemingly providing an attractive alternative to traditional lending mechanisms. Built for the new age, could this be the way forward for securities lending and repo markets?
Investors are continuously looking for efficient ways to generate return from their assets, typically with as little risk as possible. For larger institutions, one emergent opportunity is through peer-to-peer (P2P) securities lending, offering lenders and borrowers an alternative to traditional sources of intermediated finance.
Beneficial owners, including pension funds, asset managers and insurance companies could reap the rewards of P2P lending. After the financial crisis of 2008, a credit crunch left many at a loss with lending activity from financial institutions declining significantly.
P2P securities lending is a process of lending and borrowing that takes place without the use of traditional bank counterparts. For example, a pension plan will lend its eligible securities directly to a borrower counterparty, often against standardised collateral sets.
One P2P platform in particular has attracted almost 20 members to its hub of beneficial owners in the span of a year. The Global Peer Financing Association (GPFA), which formed in July 2020, encourages the use and development of P2P lending. The Ontario Municipal Employees Retirement System (OMERS) is the most recent company to join GPFA as a member. Other members include US-based insurance company Pacific Life, Australia’s largest superannuation and pension fund Australia Super and Norges Bank Investment Management.
The highs and lows
In the 283 issue of SFT, Rob Goobie, GPFA chair comments on P2P lending and its popularity among its members. He says: “The importance of this has never been greater, especially amongst beneficial owners who are relatively new to financing and liquidity management.” With interest rates expected to stay low for the foreseeable future, “it is all the more critical that we help organisations grow their financing business and bring these functions to the heart of their portfolio construction process”.
P2P lending has gained greater momentum recently, because of the lack of capital in the ecosystem to support demands and aspirations of both lenders and borrowers at different ends of the value chain, according to Andrew Dyson, CEO of the International Securities Lending Association (ISLA).
He says: “Lenders in the form of institutional investors have lent their securities often through an intermediary, such as a custodian bank, to a prime broker in the form of an investment bank. Subsequent to the 2007/8 global financial crisis, we have seen regulators impose increased capital charges for all types of risk exposure, which has in some cases reduced the appetite for agents and principal borrowers to intermediate in the securities lending chain as they have done in the past.
“Consequently we have seen larger players at either end of the value chain looking to disintermediate the traditional lending construct and deal directly with one another,” says Dyson.
Jerry May, senior portfolio manager of Ohio Public Employees Retirement System (OPERS) and a founding member of GPFA, tells SFT that those in the securities finance industry are turning their heads to this method of lending because it is a “viable option”.
He says: “It holds promise for limiting volatility in the financing industry and that produces an effect that most industry participants and stakeholders would likely think is a positive benefit. As more peers begin to think through those benefits, it is likely that they may see opportunities for their own plan to participate in some way.”
Other benefits of this lending strategy may include diversifying counterparty exposure, reducing cash financing volatility around month end, and providing the industry with stability in having high-quality counterparties that are actively involved in this sector.
Dyson says there is a greater desire from some predominantly larger lenders to capture more of the lending spread. He adds: “By taking out any revenue share for the lending agent and the implied cost of facing a prudentially regulated entity in the form of a principal borrower, rather than a potentially unregulated fund, the lender can capture all of the available spread on a given transaction.”
As with many lending strategies there are drawbacks and concerns. However, Dyson does not believe there to be major concerns surrounding P2P lending at this moment in time, but admits these platforms do pose questions for lenders.
He tells SFT: “Within a P2P framework the lender faces the ultimate borrower directly, without the cushion of a prudentially regulated entity in the chain and they are unlikely to enjoy the benefit of an indemnity from their agent. The question here is one of risk and of course return. “Another point that all of the P2P participants have to think about is the provision of operational support that prime brokers and agents have traditionally performed, particularly around safe and efficient settlement and the management of collateral.
“The traditional securities lending operational model typically sees the management of collateral, for example, being handled by the intermediaries in the chain. In a pure P2P perspective, lenders and borrowers will need to agree how this will be done and by whom.”
Peer-to-peer lending operates in the same manner that traditional financing trades do. Once a plan or executive understands the traditional process and uses of securities finance, peer-to-peer financing simply involves adding a different counterparty to the diagram in place of a traditional lender or borrower, according to May.
He says: “The biggest hurdle is recognising the differences between these non-traditional highly-rated counterparties and those that have been used historically. This may mean that each plan’s internal analysis of the uses of cash and economic market dynamics may need to be re-assessed in their impact on this type of counterparty.”
The aftermath
As interest in P2P lending platforms continue to grow, Dyson discusses whether this could displace traditional sources of finance.
ISLA’s Dyson says: “As these new and novel ways of doing business develop, there is always a possibility that this will eat into the franchises of the existing incumbents. However, due to the additional complexities associated with counterparty assessment and the management of things like collateral, this is a market that will only be attractive to larger institutions, at least in the short term, who may already have well developed credit departments and back office groups covering other products.
“Consequently whilst we do see a very real place for P2P in our markets, our view is that it is likely to be additive to the overall markets rather than dilute the participation of others.”
OPERS’ May adds: “Just as with any new opportunity within the investment industry, participants will investigate the issues surrounding this effort and incorporate the strategy if it is found to be useful to their organisation.”
