CCP WORKSHOP: THE FUTURE OF SECURITIES FINANCE TRANSACTIONS

Transcription

1 CCP WORKSHOP: THE FUTURE OF SECURITIES FINANCE TRANSACTIONS TUESDAY, OCTOBER 14, 2014 Participants: Matthias Graulich, Chief Client Officer, Eurex Glenn Horner, Managing Director, State Street Christopher Kunkle, Managing Director, Wells Fargo Jonathan Lombardo, Head of Global Sales, Pirum Systems Susan O Flynn, Managing Director, Morgan Stanley Joseph Pellegrini, Vice President, OCC Dean Sakati, Managing Director, BNY Mellon JOIN. ENGAGE. LEAD.

2 SECURITIES LENDING A NEW STATUS QUO? Forthcoming regulations and associated impacts (SLR, RWAs, SCCL) mean broker dealers and agent lenders are increasingly focused around risk and resource efficiencies Status Quo will change what will the new market look like? Relationship Impact? Pricing? Volume? Market Share? CCPs and cleared securities lending may offer a partial solution to this challenge, and also raise some important considerations JOIN. ENGAGE. LEAD. Page 2

3 SECURITIES LENDING A NEW STATUS QUO? Benefits: Dealers Risk Facilitates bilateral counterparty risk management Capital Up to 10X counterparty risk weight reduction (assuming beneficial owner is 20% versus 2%) Leverage Product and potential cross-product netting opportunities Funding Portfolio margining JOIN. ENGAGE. LEAD. Page 3

4 SECURITIES LENDING A NEW STATUS QUO? Benefits (cont.): Agent Lenders Risk Facilitates bilateral counterparty risk management Capital Counterparty risk weight reduction, reduced Indemnification costs (or removal?) Opportunity - Increased business opportunity for beneficial owners JOIN. ENGAGE. LEAD. Page 4

5 COMPARING TRADITIONAL BILATERAL AND CURRENT CCP MODELS Traditional CCP Roles: Traditional Bilateral Lending Model Systemic Risk: CCPs reduce counterparty risk and improve operational efficiency Beneficial Owner Aggregated Supply Agent Lender Prime Broker (borrower) Hedge Funds Aggregated Demand Membership: Members intermediate the transaction on behalf of the CCP and assure the return of loaned securities as well as associated collateral Traditional Centrally Cleared Model Beneficial Owner Agent Lender Central Counterparty (CCP) Prime Broker (borrower) Hedge Funds Risk Management: CCPs deploy sophisticated risk management and require clearing members to put-up initial and variation margin. A guarantee fund is established for losses not covered by margin (margin will most likely be netted against the collateral transfer). The CCP looks through member s positions and transactions to mitigate risk Member Member JOIN. ENGAGE. LEAD. Page 5

6 FACTORS IN PLAY EMPOWERING CCP S Global regulators, post-crisis, are trying to reduce systemic risk in all OTC markets by demanding that clearing occur through Centrally Counterparties (CCPs) Central has not been specifically mandated for Securities Lending; however, regulations are creating incentives: Basel III- Increased capital charges can be reduced by having to take a 2% charge against exposure if trades are cleared though a qualified CCP Dodd Frank 165(e)- Constrains concentration of counter-party exposure. CCPs might reduce exposures by introducing another set of counterparties Supplemental Leverage Ratio (SLR)- With the SLR at 5% for US G-SIBs (3% in Europe) Banks and Dealers will need to reduce assets or increase capital. A qualified CCP might help facilitate accounting netting JOIN. ENGAGE. LEAD. Page 6

7 Basel III Advanced Approach RBC ESMA Basel III guidelines for Standardized UCITS Approach RBC (October 2014) AIFMD (July 2014) FATCA (July 2014) CDOT (July 2014) LCR (Liquidity Coverage Ratio) CSDR EU Money Market Reform CRS Regulatory Timeline DFA 165(e) Single Counterparty Concentration Limits (May be pushed out) SEC Money Market Reform (Q4 2016) UCITS V and VI (March 2016) CBI UCITS rulebook (2015) CBI UCITS and ETF guidelines (2015) SLR (Supplementary Leverage Ratio) (January 2018) June 2014 November 2014 January 2015 July 2015 October 2015 Rules likely to be pushed out beyond and beyond FSB Shadow banking proposals Volker Rule Compliance EU FTT (Financial Transaction Tax) -8 NSFR (Net Stable Funding Ratio) (January 2018) DFA 984(b) (SEC regulation around transparency original compliance Transparency Directive 7/12) (TBA) BEPS (2015-6) Portugese FTT (TBA) Solvency II (January 2016) Spanish FTT (TBA) EU Regulation of SFT s (2016) US FTT (TBA) MiFiD II (January 2017) OECD paper on beneficial ownership (TBA) OLA FSB Shadow banking (minimum haircuts, cash reinvestment and transparency) JOIN. ENGAGE. LEAD. Page 7

8 RWA AND CAPITAL RATIOS EXPLAINED JOIN. ENGAGE. LEAD.

9 TIER 1 COMMON RATIO IS THE MOST PROMINENT CAPITAL RATIO Securities Lending Indemnification does not impact the leverage ratios. The most significant impact is to the capital ratios, specifically the Tier 1 Common Ratio which is the ratio the Fed focused on in its stress tests. Indemnified Securities Lending Loans impact the Tier 1 Common Ratio through the denominator (RWA) RWA Formula: Adjusted Exposure = E* = max {0, [ ( E - C ) + ( Es * Hs ) + ( EFX + HFX ) ] } e.g. (Loan Notional Amount Collateral Amount) + (Exposures * Haircuts) +(Exposure * FX Mismatch Haircuts) JOIN. ENGAGE. LEAD. Page 9

10 TIER 1 COMMON RATIO IS THE MOST PROMINENT CAPITAL RATIO Factors affecting the RWA calculation: - Haircut is reduced for repo style transactions, (70.7%) - Mismatched Currency Transactions attract an additional haircut e.g. when loan and collateral are in different currencies - Collateral amount and quality will reduce the capital charge - Maturity and country risk classification affect sovereign haircuts - Counterparty Type: Bank (20% charge subject to CRC rating) versus Broker Dealer (100% charge) and CCPs (2% charge) The hurdle rate required to cover changes in required capital is affected by: Fee Split with lenders, Banks targeted Tier 1 Capital Ratio, Banks desired return on capital JOIN. ENGAGE. LEAD. Page 10

11 FINANCIAL IMPLICATION OF REGULATORY CHANGE ON CAPITAL JOIN. ENGAGE. LEAD. Page 11

12 RELATIVE STRENGTH OF INSTITUTIONS- TIER 1 COMMON RATIO Results from the Fed s Dodd-Frank Act Stress Test May 2013: Supervisory Stress Test Methodology and Results The FED tested 18 of the most systemically important financial institutions. Median Tier 1 Common Ratio is 11.1 JOIN. ENGAGE. LEAD. Page 12

13 SLR DISCUSSION JOIN. ENGAGE. LEAD.

14 SUPPLEMENTAL LEVERAGE RATIO Historically Leverage Ratio applied in U.S., but not Globally Basel III introduces Leverage Ratio for all Globally active banks SLR= Tier 1 Capital Assets + Off Balance Sheet Exposures (e.g. OTC derivatives, cleared derivatives, repo style transactions and other off balance sheet exposures) Basel Assets include certain off-balance sheet exposures, agency SF is de minimis U.S. historically required a 3% minimum ratio, but off balance sheet exposures not included Under Basel Global Standard will be 3%, but U.S. Globally Systemically Important Banks (G- SIBs) will have a 5% requirement at Bank Holding Company level and 6% at Depository Institution level FIN 41 type netting will be permissible for repo and SFT exposures, this was a modification from the original proposal JOIN. ENGAGE. LEAD. Page 14

15 SECURITIES LENDING IMPACT TO PARTICIPANTS? Regulatory Impact of Collateralized Securities Lending Transactions SLR Risk-Based Capital Large Exposures Current Mkt Cleared Mkt Current Mkt Cleared Mkt Current Mkt Cleared Mkt Broker Dealer (Borrower) Balance Sheet intensive (exc. E4E) Potential Balance Sheet netting (provided CCP Rulebook allow it) 20%-100% risk weight in bilateral 2% risk weight (cpty + default fund charge) Smaller exposures to underlying beneficial owners - QCCP currently excluded from large exposures regulations - Potential for less punitive final rule on exposure calculation Bank Custodian (Agent Lender) No SLR exposure if AL receives excess collateral Limited benefits from transacting via CCP 20%-100% risk weight in bilateral 2% risk weight (cpty + default fund charge) Concentrated lending exposures to large prime dealers: significant risk of limit breaching - QCCP currently excluded from large exposures regulations - Potential for less punitive final rule on exposure calculation G-SIB Requirement Minimum 5% Tier1 equity to total assets and exposures, including off balance sheet Minimum 7% Tier1 common equity to RWAs + expected G-SIB add-on of 1-2% Maximum 15% firm wide exposure as percentage of Tier1 equity vs. another G-SIB High level of importance Moderate level of importance Low level of importance JOIN. ENGAGE. LEAD. Page 15

16 SECURITIES LENDING MARKET FUTURE STATUS QUO? Market Impact: When? What? How? Timeline: Basel rules steadily phase in between now and 2019, creating strong incentives to begin adapting now Pricing: How are increased costs properly allocated along the transaction continuum? Fee splits and borrow rates: Beneficial Owner Agent Lender Prime Dealer End User Future state: No one-size-fits-all approach; emergence of multiple venues driven by need for resource efficiency CCPs: Attractive potential for resource efficiencies under new regulatory regime Bilateral securities lending still plays a role depending on portfolio characteristics Beneficial owner comfort level with CCPs and trade-off between indemnities and fee levels JOIN. ENGAGE. LEAD. Page 16

17 Broad Strategic Considerations for Securities Lending Market CCP Models in Securities Lending and Flow Providers Explained 17

18 OCC Stock Loan Program Bi-lateral Model BO BO AL BO BO Lending CM Bi-laterally negotiated trade Borrow CM Hedge Fund BO BO AL DTC Lending CM OCC Borrow CM 18 MTM payments through OCC

19 OCC Stock Loan Program Loan Market Model BO BO AL Trade negotiated through approved Stock Loan Market BO BO Lending CM Loan Market Borrow CM Hedge Fund BO AL BO OCC DTC Lending CM Borrow CM 19 MTM payments through OCC

20 Eurex s CCP service for securities lending Lending CCP serves the key elements of the securities lending market Transactions Bilateral transactions (OTC) Electronic markets Markets Bonds European corporate & government bonds Equities coverage of key European markets Exchange Traded Funds (ETFs) Collateral Loans against cash collateral Loans against non-cash collateral - bonds & equities Tri-party collateral agents Clearstream Banking Luxembourg Euroclear Bank Post-trade functionality Loan Deliveries, Mark-to-Marks, Re-rates, Recalls, Returns, Buy-ins Corporate Actions, Dividend payments Automated billing (lending fees & rebates)

21 Eurex s CCP service for securities lending Lending CCP incorporates STP trade-flow for your securities lending activity Lender Loan negotiation Borrower Trading Lender Loan information Flow Provider* Real-time trade validation Loan information Broker- Dealer Data transmission Member Membership Eurex Validation Novation Confirmation Loan life-cycle management Membership Member Principal Collateral Loan securities Settlement Cash Non-cash Equities Bonds Payment bank Tri-party agent CSD ICSD *Flow Provider used as the entry channel from market participants to Eurex e.g. for New loan transactions, Re-rates, Recalls, Returns etc.

22 Eurex s CCP service for securities lending Lending CCP offers multiple collateralization options for your securities lending activity Lender CCP Borrower Cash lnon-cash Pledge Transfer of Title Transfer of Title Member Member Member Loan securities Cash Principal Collateral Margin Collateral Loan securities Non-cash Principal Collateral Margin Collateral Loan securities Non-cash Principal Collateral Eurex Eurex Eurex Loan securities Cash Principal Collateral Margin Collateral Loan securities Non-cash Principal Collateral Margin Collateral Loan securities Non-cash Principal Collateral Margin Collateral Member Member Member Key: Pledge to Lender Pledge to the CCP Transfer of Title

23 Eurex s CCP service for securities lending Lending CCP s Specific Lender License supports the Beneficial Owner s role and Agent Lender relationship Agent Lender Loan negotiation Borrower Beneficial Owner Specific Lender License Loan securities Non-cash Principal Collateral Eurex Loan securities Non-cash Principal Collateral Margin Collateral Member Key: Pledge to Lender Pledge to the CCP Transfer of Title Beneficial Owner maintains business relationship with Agent Lender Agent Lender continues to arrange loans for CCP eligible transactions Operational links with flow provider and CCP maintained by Agent Lender Agent Lender reports loans and collateral through existing reporting set Beneficial Owner uses an approved Specific Lender License with a distinctive CCP membership No requirement to clear through a General Member No requirement to pay margin No default fund contribution Dedicated requirements for Specific Lender License Supervised financial sector entity located within the EU, Switzerland, USA and other selected countries Permission to perform securities lending business Pre-requisite is collateral pledge model with Tri-party Collateral Agent

24 JOIN. ENGAGE. LEAD. Enterprise Risk Credit Risk Market Risk Operational Risk Regulatory Compliance Securities Lending

25 CCP S CONSIDERATIONS JOIN. ENGAGE. LEAD.

26 CONSIDERATIONS IN REVIEWING THE ADOPTION OF CCP S IN THE SECURITIES LENDING SPACE? Will trades through CCPs continue to be indemnified by agent lenders? In some models, will lenders be willing to place excess collateral for initial and variation margin? Today the lender is always the receiver of excess collateral and some may be required to be under statute or policy Leverage constraint concerns for agent lenders if they indemnify or use a principal model. For many agent lenders Basel III/DFA leverage constraints will be more binding than RBC constraints Single Counterparty Credit Limits Under SFA 165(e) CCPs are not exempt, so the potential volume that each lender could flow through a single CCP would be significantly restricted Single Allocation vs. Multi-Allocation models, under a single allocation model loan stability and operational issues are of concern. Markets and clients covered by existing CCPs are limited in scope, so there would be limits in volume. JOIN. ENGAGE. LEAD. Page 26

27 OPTIMAL CCP FOR SECURITIES LENDING CLEARING Broker-dealers Selected cross product netting Selected cross product margin netting Common Principles Preservation of existing execution model and relationship Risk and resource efficiencies Well regulated and capitalized, sufficient skin in the game Well defined default and non default waterfall Credible, transparent IM and guarantee fund calculations Scalable (i.e., accommodate sec lending and repo) CCP stress testing overseen by regulators Separate SFT silo no risk mutualisation Tiered Membership categories Defined Recovery and Resolution Plan Agent Lenders Ability to use cash collateral for reinvestment Mandatory submission only if two or more CCPs clear SFTs JOIN. ENGAGE. LEAD. Page 27

28 BROAD STRATEGIC CONSIDERATIONS FOR SECURITIES CONCLUSIONS AND Q & A LENDING MARKET Conclusions Q & A JOIN. ENGAGE. LEAD. Page 28