SFT speaks to industry representatives to gauge what the market can expect as it enters into 2023
Stepping into the new year after a storm of regulation, increasing interest rates and high volatility, the securities lending market is now bracing itself for what is to come in 2023.
Market participants map out their priorities for the year as an “aggressive” regulatory agenda is expected to bring a host of proposed rules for the buy- and sell-side. Risk-weighted assets are predicted to remain a binding constraint for many borrowers and lenders across the market, while central clearing models become a key to unlock significant liquidity.
A brisk pace
The Central Securities Depositories Regulation (CSDR) and the move to a T+1 settlement cycle in the US were key components of the regulatory landscape that impacted buy- and sell-side firms in 2022. With an objective to drive settlement efficiency, CSDR provided provisions of shorter settlement periods, mandatory buy-ins — that were postponed until 2025 after pushback from the Joint Trade Associations — and cash penalties, which came into force on 1 February 2022.
Further changes in February 2022 caused a buzz in the industry as the U.S Securities and Exchange Commission (SEC) proposed to shorten the settlement cycle to T+1, in an effort to reduce the credit, market and liquidity risks in securities transactions faced by market participants and US investors. “The move to T+1 will touch nearly every aspect of the front, middle and back offices. The accelerated timeframes will further pressure processes in security finance, and much of the industry is not ready from a technology perspective,” indicates Madhu Subbu, Clear Street’s head of securities finance engineering.
The pace of new regulation continues to be very brisk in the US and Europe, causing market participants to anticipate what regulatory challenges they will have to face in 2023. The regulatory landscape for the year will differ by region, according to Robert Lees, EMEA head of securities lending and global head of securities lending trading at Brown Brothers Harriman (BBH).
Lees reveals that, in Europe, 2023 focus areas include the implementation of the next phase of the Securities Financing Transactions Regulation (SFTR), including 31 additional data points subject to reconciliation that is scheduled to be implemented in January. Proposals to move towards a T+1 settlement cycle will be monitored closely by the industry, as evidenced by the UK government’s creation of an Accelerated Settlement Taskforce in December 2022 to explore the potential for faster settlement of financial trades.
In the US, Lee comments that the SEC’s “aggressive agenda” has resulted in many proposed rules. Although primary regulatory developments are yet to be finalised, the sector can expect to face potential mandatory reporting regime for securities lending transactions, mandatory clearance of US Treasury securities and a transition to T+1 settlement, which is scheduled to take effect early in 2024.
State Street’s global head of agency lending Francesco Squillacioti expects that a significant regulatory change will come in the form of the Basel IV rules. Proposals for these rules are to be issued in 2023, with final rules likely to be implemented in 2025. A new standardised formula for securities finance transactions will have a large impact on the sector, says Squillacioti.
The new formula will take into account the benefits of correlation and diversification within netting sets of loans and collateral. This benefit will greatly reduce the risk-weighted assets (RWA) for entities that are bound by the standardised approach — generally US banks and broker-dealers, which have a 100 per cent floor.
Squillacioti also anticipates the SEC’s finalised proposal for Rule 10c-1, which is expected to be released in the first quarter of 2023 after a proposal and call for evidence was issued initially in December 2021. State Street worked closely with the Risk Management Association (RMA) and the Investment Company Institute (ICI) to respond to the suggested framework for this piece of legislation.
State Street's response to the SEC’s proposal indicates that the proposed T+15 minutes reporting requirement is “impractical” as the market recommends end-of-day reporting. Additionally, the firm suggests eliminating the requirement to report “lendable” shares, as State Street believes it may be “inaccurate and misleading”.
Subbu believes Basel IV will provide improved approaches to credit risk, operational risk and pricing of derivative instruments. “Preparation for these challenges will be the key, as market participants move toward cloud-based workflow providers to decrease collateral management costs, ensure settlement reliability and increase securities finance profits,” he concludes.
A global interest
A new year does not equate to a new agenda, it would appear. There remains a growing global interest by clients to promote sustainable environmental, social and governance (ESG) principles through securities lending programmes. For Lees, providing customers with the appropriate information to make informed decisions around ESG and securities lending remains a top priority.
In the summer of 2022, State Street’s Travis Whitmore, senior quantitative researcher and head of securities finance research, revealed that institutional owners were restricting lending of companies perceived as unsustainable. The International Capital Market Association (ICMA) has also indicated that repo is playing a more active role in sustainable finance, as firms continue to develop new sustainability-related products in the repo space to transition to a sustainable economy.
While global regulators are seeking to implement global standards in this ESG arena, says Lees, it remains that lenders employ a highly diversified approach to ESG and securities lending. BBH works alongside their clients to implement custom solutions in an effort to tackle the differing sustainable priorities between clients. This means adhering to each client’s governance requirements around restricting and recalling securities, while providing data around potential revenue that, along with governance policies, allows for optimal decision making.
Supporting this sentiment, Squillacioti adds that there is a lack of consistency across firms, with each client applying their own unique ESG criteria. This complexity requires bespoke ESG collateral schedules for each individual client. As a result they are not included in the omnibus pool — potentially, impacting their lending revenue potential.
Squillacioti remarks: “Work continues on several fronts to facilitate these differences among clients on internal non-cash collateral allocation methodologies, including with triparty banks to create flexible bespoke collateral schedules, and looking at industry ESG-scoring methodologies to attempt to create collateral sets that can gain wider client adoption.”
Transparency is critical to the evolution of the ESG landscape as well as the management of ESG risk and regulatory compliance, highlights BNY Mellon’s managing director and global head of securities finance Bill Kelly.
To help guide clients in operating ESG, BNY Mellon has released an ESG transparency dashboard which incorporates MSCI ESG ratings, assigning ESG scores to securities across environmental, social and governance. It can be applied to a client’s non-cash collateral and cash reinvestment, including outright purchases and repo collateral. The dashboard helps to enable clients to analyse how their portfolio, the collateral they receive and the investments they make align to their ESG principles and policies.
Big steps forward
Enhancing post-trade processes, supporting clearing of securities lending trades, and expanding electronic trading looks to be the largest advances relating to technology development for 2023.
Working within the sales team at HQLAX, Charlie Amesbury explains that a “big step forward” for development will be seen in the post-trade aspect of the securities finance industry, where firms will move from initial production trades into a full-scale volume on some of the market’s digital platforms. He adds: “After a number of years of building out the legal framework, digital representations of traditional assets are poised to enter mainstream use, allowing the frictionless exchange of ownership which will ease pain points in the industry.”
Similarly, enhancing post-trade processes will be a priority for State Street, who will continue to work with several vendors on this project for the next 24 months. Squillacioti explains that trade execution investment and technology has tended to garner the most attention in the past, but given the focus on transparency from a regulatory perspective, and efficiency from a commercial one, “it has pivoted the market to focus on the complete lifecycle of a trade holistically”.
Wematch’s co-founder and head of EMEA David Raccat says he has observed a huge need in post-trade and standardisation on the securities financing synthetic markets. The industry continues to push for advances in collateral management solutions, term sheet standardisation, workflow tools, and more efficient communication between sales and traders.
In general, securities finance continues to follow the direction of travel from other asset classes, explains Martin Walker, head of product, securities finance and collateral management at Broadridge. Over the last decade, the increased clearing of trades and electronic trading seen by the industry has massively reduced the number of post-trade exceptions and driven increased efficiency. However, the importance and volume of trade lifecycle events in securities finance does make it qualitatively different, Walker says.
BBH has seen a “significant” rise in trading automation across all fee spaces in 2022. This comes as a result of increased quantitative trading, reduced industry fail tolerance due to CSDR, and strict regulation in markets such as Korea. Lees expects this trend towards automated loan execution in higher fee loans to continue, in addition to the emergence of an increased number of automated routes to market.
Consequently, BBH indicates that investment in automated execution capability will be a key component of its investment strategy in 2023. Lees explains: “As loan execution becomes increasingly automated, the migration of complex trading strategies to code has become a key source of competitive advantage. Increased trading model complexity has yielded impressive results and BBH plans further investments in trading models, including the potential application of artificial intelligence in 2023.”
During 2023, HQLAX will continue to develop its agency securities lending delivery-versus-delivery (DVD) product, which aims to eliminate the intraday credit exposure inherent in this trade flow, bringing efficiencies for the borrowers, while allowing the lenders to offer post-trade technology solutions.
HQLAX will also collaborate with industry members to introduce an intraday delivery-versus-payment repo capability through cross-blockchain execution between the firm and partnering digital platforms. “Our clients would have the ability to monetise their digital collateral records versus tokenised cash,” says Amesbury. “This allows the borrowers more control over their intra-day liquidity, while lenders benefit from a new market in which to monetise their excess cash.”
Following the launch of the Automated Trading Locates Allocation System (ATLAS), Clear Street plans to roll out ATLAS to European Markets in 2023. The system allocates stock loan inventory to incoming customer requests. Additionally, Clear Street is introducing a multi-asset and multi-market inventory and contract management system in the first half of 2023 that looks to improve the efficiency of the firm’s securities finance desk. “It is all part of our plan to modernise the market infrastructure across capital markets, and improve market access for all participants,” concludes Subbu.
The good and the bad
Raccat indicates that not only will the securities finance market need to adjust to an environment of higher interest rates, but also reduced central bank involvement in funding markets in 2023. He suggests that this will encourage the need to diversify funding sources and optimise balance sheet efficiencies, as funding costs increase.
Speaking to SFT on his predictions for loan supply and borrower demand, Squillacioti warns that RWA will remain a binding constraint for many borrowers and lenders across the market. He continues: “In 2022 we saw a noticeable increase in lendable supply with minimum spreads assigned, and can only assume that trend continues to grow next year.”
This is expected to make it increasingly difficult for prime brokers to maintain legacy GC pricing, or, at a minimum, participants will see the count of securities available at GC decrease. He concludes: “In one form or another, this will likely result in higher borrow fees for prime brokers and ultimately for the end user.”
According to Walker, the Basel III and Basel IV rules regarding unrated parties could lead to a significant reduction of supply for a number of years as countries adopt the standards. Increased RWA charges are expected to cause a larger impact in the general collateral (GC) market — where trades with unrated lenders are likely to become uneconomic.
“We have to remember that the long-term trend over a decade has been forever more supply of stock to be made available,” suggests Walker. “Supply that the securities finance market has not been able to make full use of. The reduction in excess supply, particularly in the GC [market], would take some of the edge off the potential liquidity squeeze.”
Despite these concerns, it is not all doom and gloom. Subbu predicts that central clearing models will unlock significant liquidity in 2023 and beyond. The Depository Trust & Clearing Corporation’s (DTCC’s) securities financing transaction (SFT) initiative, in particular, is expected to contribute to this, he says. The service aims to support the central clearing of SFTs between National Securities Clearing Corporation (NSCC) full-service members, as well as the central clearing of clients’ SFTs intermediated by sponsoring members or agent clearing members.
Transaction costs are coming down, thanks to the advent of central clearing and the continued commodification of the lending process, Subbu highlights. As a result, an increasing number of beneficial owners are willing to participate in securities lending, thereby increasing supply.
Bringing to bear
As the industry takes its first steps into the new year, expansion seems to be a common theme for market participants who spoke to SFT.
Regulatory change is still a main focus and a major part of Broadridge’s work. However, now post-SFTR and post-CSDR, the firm anticipates working with its user base on revenue generation and efficiency focused system enhancements.
Likewise, HQLAX will continue to prioritise launching scalable solutions that will service their clients, as well as expanding their customer base. Amesbury indicates: “The collaborative work we are doing with other digital registries and technology providers remains a key focus, with the goal of creating an interoperable network in which the ownership of different asset classes located around the world can be exchanged seamlessly and efficiently.”
Summarising State Streets’ key focus for 2023, Squillacioti says the firm is looking to expand the business and client footprint in an “accretive and efficient manner”, across all State Street businesses, while bringing to bear for each client the full suite of services that its financing solutions group offers.
Speaking to SFT, Subbu explains: “In May 2022, Clear Street raised US$165 million in our Series B funding round to further our mission to create a single-source platform to serve all investor types, across all asset classes, globally. Next year, we’ll continue that work.” Clear Street will focus on further expanding into Europe. In addition to building out its securities lending platform, the firm will focus on expanding and diversifying the securities lending supply so it can improve access to liquidity for customers.
The priority for the industry should be to continue to attract diverse talent to help drive innovation to meet the challenges and opportunities ahead, says Lees. He states that the Women in Securities Finance community has been “tremendously successful” in supporting diversity, equity and inclusion in the industry and BBH is committed to its further growth.
More specifically to BBH, the firm continues to focus on preserving its differentiated offering in the marketplace by investing in technology and client service. Lees concludes: “Securities lending is increasingly relevant for investors globally, and we are seeing the need for further customisation coupled with a desire from asset lenders to enhance transparency, optimisation and control.”
