Date: 29 March 2023
Time: 3pm – 4.30pm | M&G Plc, 10 Fenchurch Avenue, London EC3M 5AG.
Item 1 – Recent market trends
The Committee firstly noted that markets have coped well with the volatility seen over the last few weeks, which is beginning to calm down.
The Committee then discussed recent market trends and conditions. It was noted the market feels “full,” with many at capacity with increased demand from hedge fund clients. This environment was noted as predating the volatility caused by the collapse of SVB. RWA consumption remains the biggest driving factor behind the constraints, with the rolling impact of Basel IV beginning to be felt more widely. It was suggested that there was limited available capital to accommodate each side of the chain, with banks disincentivised to take risk. However, the Edinburgh reforms could mean a softening of the regulatory position in the UK in the future.
Members agreed that RWAs may remain an issue going forward, with fewer firms able to lend securities in Europe. The market is not broken, but could get more expensive and difficult going forward. One area that had seen more interest was in delivering total return swaps, as these can be more RWA efficient. These swaps are not operationally easy, but lenders have to do what they can to get lending done. The industry continues to find new ways to market. Other solutions such as wider use of central clearing were considered to be expensive and very time consuming to introduce. Increased use of pledge was considered by some members to be a likely route to reduce the RWA impact.
Basel Counterparty credit and capital charges
The Committee then turned to Basel 4 and counterparty and capital charges. CCR3 is currently being finalised by the European Council, with the PRA consultation due at the end of March. The Committee welcomed the decision from both the EU and UK to refrain from implementing minimum haircuts, which would have been particularly penal on non-Government instruments. It was thought that some agent lenders will benefit as banks and broker dealers will be treated equally.
For some members the implementation of the output floor remains the key issue. This standardises rules for RWA treatment, with a floor set at 72.5% by 2027. This will capture a large number of rated and unrated corporates and allow no recognition of the lower risk on short dated transactions. In many cases, internal modelled risk weights if 10-20% will be increased to 65-100% risk weights. While this begins in 2025, this is expected to become binding in 2029. ISLA highlighted that they are asking for a carve-out for some SFT transactions, though acknowledging this is a more difficult conversation after recent events.
In the US there is good engagement on the implementation of T+1 settlement, there has been much less discussion elsewhere – particularly where firms are not trading in US dollars. Views on the overall effect on the securities lending industry are quite polarised. The US market is often already operating on a T+0 basis, but elsewhere generally settlement is at T+2. There are likely to be issues around settling recalls, with accelerated recall timeframes. Some members suggested that this might drive a bifurcated market where some lenders cannot get recall notices to borrowers until the settlement date. If the change is pushed too quickly it will only drive up the level of fails. There could also be issues where there are settlement mismatches between markets. Specials will pose a particular problem. One alternative option would be to use tokenisation which might be quicker, and apply less strain to the market.
Item 2 – Diversity and Inclusion
The Committee then turned to a discussion on diversity & inclusion in the securities lending industry. It was agreed it is important to have diversity at the start, and the end, of the career ladder; people need to be able to see people like themselves at the top of a company. Diversity led recruitment drives are crucial, and it was felt strongly that operating at a range of different universities is important. Recruitment from outside of universities – school leavers and career returners (for example) - can create some of the most committed employees. School leavers in particular can be more diverse and stay in the industry for longer. The Committee also noted that it could do a better job of selling and socialising itself. One barrier to diversity in securities lending is that many trading desks do not support flexible working, and often those that do, do not have the proper infrastructure around it. Some Committee members noted the importance working flexibility had had in their careers.
Item 3 – ESG
The Committee then discussed how much focus ESG issues had been getting in securities lending recently. It was noted that previously clients were talking about ESG regularly, but at the moment there is less discussion. Clients do use recalls and proxy voting, but collateral schedules are rarely affected. Repos and other transactions with underlying green collateral have had limited interest. Green assets can be used in repo transactions, but it is much harder to raise repo cash to specifically identified green usage. ESG was felt by several members to have been deprioritised as other global events (e.g. Ukraine) have taken up more attention.
Item 4 – indemnities
The Committee finally held a discussion on the use of indemnities in securities lending. It was pointed out that agent lenders have to hold capital to account for the risks inherent in securities lending around the provision of indemnities – the cost of this is typically around 10-13bp, but this cost has historically not been recognised and fully compensated for in pricing. Given the returns on securities lending are relatively low, the bulk of lending will struggle to be profitable to the agent if indemnified. For this to be at more realistically profitable levels, it was suggested that agent lenders will need to alter their pricing, or lenders may have to forfeit indemnification. However, indemnities are very important to many clients, to ensure that low income lending is risk free. It was emphasised that agent lenders can still offer a service in the event of defaults. But, if the current paradigm continues, members felt that market liquidity will reduce.
The Committee noted that in recent events it was the spike in CDS levels that caused more issues than the wider volatility from SVB. Whilst the effects were fairly modest, it has brought a lot more focus onto indemnities. The Committee agreed to discuss this topic again at the next meeting.
Ina Budh-Raja, Bank of New York Mellon
Devi Aujeet, Barclays
Tim McLeod, Blackrock
Andy Krangel, Citi
Habib Motani , Clifford Chance
Tanja Hauenstein, Credit Suisse
Johanne Armita, Goldman Sachs
Jamie Anderson, HSBC
Anant Gajar, HSBC
Godfried de Vidts, ICMA
Andrew Dyson, ISLA
Tim Smollen, MUFG
Simon Dunderdale, M&G Plc
Sunil Daswani, Standard Chartered
Matt Emerson, Citadel
Morten Gevoll, Norges Bank IM
Matthew Neville, State Street Agendy Lending EMEA
Adam Jacobs-Dean, AIMA
Harpreet Bains, JP Morgan
Krishan Chada, Morgan Stanley
Cassie Jones, State Street Global Markets