Agency Securities Lending

Transcription

1 IMN Beneficial Owners International Securities Lending & Collateral Management Conference Recap Deutsche Bank s Agency Securities Lending team had the pleasure of attending IMN s 22nd Annual Beneficial Owners International Securities Lending & Collateral Management Conference in Phoenix, Arizona (February 3-5). We are a perennial, high profile sponsor of the event with thirteen professionals in attendance, representing Agency Securities Lending, Deutsche Asset Management, and Global Prime Finance. We had speakers on three panels and we ran one beneficial owners-only workshop. While the conference was both informative and productive, it was our distinct pleasure to spend time with nearly a dozen of our valued securities lending clients in attendance. The conference kicked off with The Pricing of Securities Finance Transactions: Change is Coming. A panel of our competitors discussed the effect of regulatory change on the pricing of loans, lending strategies, and the potential impacts to beneficial owners. Lending general collateral ( GC ) was discussed in light of rising cost for indemnification. Custodian panelists suggested that lending GC (fees<=20bps) may require beneficial owners to consider changes, e.g., forego indemnification, widen GC spreads via a more aggressive reinvestment strategy, or adjust trading based on counterparty risk weighting. Queuing was discussed insofar as might it impede the ability to bring together borrowers and beneficial owners with lower / more desirable counterparty risk weightings? Some banks suggested redacting or re-pricing indemnification for some or all activity. The panel ran a series of real-time polls to gauge audience reaction to various topics. For example, 61.9% of beneficial owners in the audience responded that they would not lend securities without indemnification. [Deutsche Bank's view: Deutsche Bank, with its sustainable intrinsic value business model, has considered its costs when entering into client relationships and does not feel the need to re-price or redact indemnification.] The next panel, A Conversation with the

2 Regulators & an Update on Key Regulation and Market Developments Impacting Securities Lending & Repo in 2016, included representatives from the SEC and the Federal Reserve Bank ( Fed ). The panel covered priorities for 2016, including: Dodd-Frank/Volcker Rule interpretations Basel III Financial Stability Board/Shadow Banking ESMA (CSDR/EMIR/TS2) Financial Transaction Tax (FTT) Repo Clearing SEC Rules Affecting Lending by Mutual Funds The Resolution Stay Protocol The Fed will focus on development of central counterparties, mitigating fire sale risk and balance sheet netting (to increase capacities). The SEC s comments centered on enhanced data collection required under the Dodd-Frank Act and new rule makings affecting mutual funds (transactions, reporting and disclosure). The FSB is nearing completion of data collection requirements globally, but more work needs to be done to standardize across regimes. Debevoise & Plimpton, attorneys for the Risk Management Association, provided an overview of Resolution Stay Protocols, which are under development, and designed to enhance the resolution of large failing financial institutions. This is a major effort that will soon affect agents and beneficial owners. The panel included audience polls to address beneficial owners concerns. The vast majority of beneficial owners are looking for additional transparency in understanding the risks associated with securities lending. On the morning of day #2, Deutsche Bank ran a beneficial owner workshop on, Timeline and Process of an Equity Short, Borrow, & Securities Loan Transaction. Anthony Toscano, Co-Head of Deutsche Bank s US Agency Lending team, and James Lailey, Head of North American Securities Lending within Deutsche Bank s Global Prime Finance, provided rare insights into the process of lending and borrowing stocks to cover shorts, including rules and practices. [Deutsche Bank's view: While Deutsche Bank s agency program maintains to a strict confidentiality regime, we leverage the Bank s collective expertise

3 and capabilities relative to capital markets, prime brokerage and repo.] The first session, International Securities Lending Market Update & State of the Industry Address 2016, was presented by Tim D Arcy, Senior Vice President FIS ASTEC Analytics (formerly known as Sungard). The presentation draws from FIS data repository covering the vast majority of securities lending trades globally, i.e., >90%. A few important takeaways: General Collateral (fees <=20 bps) still dominates loan volume. Across all markets, GC makes up 70% of loan volume; meanwhile, 90% of loan revenues emanate from the remaining 30% of volume, which consists of specials, with deep specials (>=500 bps) making up about 40% of all loan revenues. Similarly, in the US, GC makes up 80% of loan volume; meanwhile, 87% of loan revenues emanates from specials, with deep specials (>=500 bps) making up 45% of all loan revenues. [Deutsche Bank s view: the above statistics illustrate the importance of having an effective intrinsic value trading process focusing on securities in greatest demand, which is the hallmark of our trading and risk process.] The percentage of revenues emanating from fixed income lending activity has grown slightly over the past few years but still only represents about 10% of overall securities lending revenues (all markets). In Europe and Asia, non-cash loans account for just over 80% of loan volume. In the US, non-cash loans account for 39% of loan volume; however, about 90% of all revenues emanate from loans collateralized by cash. On a world-wide basis, loans made versus cash collateral make up about one-half of volume and garner about 75% of loan revenues. This is due to the fact that most of the deep specials are lent against cash. So in the deep specials world, cash is still king. [Deutsche Bank's view: In the US, cash is the preferred collateral type. Many beneficial owners are not aware that non-cash collateral is subject to an automatic stay in the event of bankruptcy by a SIPC registered US broker-dealer.] The next panel, The Practical Implications of Global Regulation for Securities Lending, Repo, Collateral Management & Cash Reinvestment Programs, built upon previous panels by looking at the practical approach of changing regulations. The panel covered how programs and beneficial owners are being impacted with respect to indemnification, borrower demand, and liquidity. Sonelius Kendrick- Smith, Senior Portfolio Manager - Deutsche Asset Management was on the panel. Rule changes relative to Single Counterparty Credit Limits ( SCCL ) may result in capacity issues for large custodian agents (the banks are still pressing for relief). If no relief is granted, it may be necessary for clients to agree to enact measures to mitigate risk weighted asset charges ( rwa ) such as: further diversify counterparties, use counterparties that attract lower capital charges, agree to collateral flexibility, consider term lending, match currencies, and consider using central counterparties. Panelists stressed that it benefits clients to be cognizant of the amount of capital (cost) their program guidelines attract, i.e., capital charges and risk weightings are in effect and agents are managing trades according to rwa relative to beneficial owner type (public fund, pension, insurer, central bank, etc.) and borrower. Borrowers are becoming increasingly sensitive to balance sheet costs relative to beneficial owners. To illustrate, borrowers are beginning to evaluate and classify beneficial owners based on counterparty risk weightings, and rejecting some as a potential lender. Borrower demand is affected by leverage, capital and liquidity requirements. This is evidenced by more loan

4 transactions being moved offshore, or transacted on a term basis or a non-cash basis, all of which provide balance sheet relief for the broker-dealer. The next panel, Cash Collateral Reinvestment: Responding to Money Market Changes - Fund Consolidation; Conversion; Repurposing; & Closing focused on reinvestment strategies and new money market fund regulations (floating NAV), use of separate accounts, and liquidity. Several audience polls provided insights into beneficial owner concerns and their preferences: The next panel, CCP Model Adoption: Stakeholder Case Studies, covered the different Central Counterparty (CCP) models being proposed and the main challenges. There was recognition that none of the CCP models are far enough along in development to be used by beneficial owners. Agents and beneficial owners should continue to educate themselves on potential benefits and possible solutions. Again, audience polls revealed sentiments on CCPs: Anthony Toscano Co-Head of Deutsche Bank s US Agency Lending team, was a panelist on the next session entitled, Liquidity Drivers: Self-Financing Your Liquidity Needs.

5 Self-financing, including controlling the cash collateral yourself, was a key theme. In terms of financing trends, tri-party repo volumes are down from 2007 peeks of $2.5 trillion to $1.5 trillion, and have leveled out. The Fed s reverse repo facility is only a temporary measure. During this session, Anthony asserted that successful agent lenders need to assess their counterparty s ultimate motivation for borrowing, and highlighted ideas surrounding new routes to market (non-standard counterparties). This is likely to be important going forward. Panelists discussed centralization of the collateral management function, i.e., optimizing financing / collateral within a given organization, across sub entities and portfolios. Once again, audience polls revealed interesting insights into the views to beneficial owners. [In Deutsche Bank s view: The rapid pace of regulatory change is a call for beneficial owners to take a broader view on securities lending, to include securities financing, collateral management, and non-standard counterparties. This will ultimately garner new revenue opportunities, enhanced liquidity, and attractive sources of financing.] The final panel on day #2 was, Doing Business Today - Liquidity Crunch; Global Turmoil; Rising Interest Rates; Evolving Regulatory Environment: The Beneficial Owner Perspective. Perhaps the most interesting themes were from beneficial owners who expressed such points as: A self-lender noted difficulty placing money with repo counterparties.

6 Indemnification (legal terms and conditions can) vary widely across agents. Some are much more favorable to beneficial owners. Concern over impending change globally relative to bankruptcy treatment (stay protocols). One panelist, an intrinsic value selflender with a very conservative reinvestment strategy, expressed no interest in changing its risk profile. On day #3, the first panel, Critical Issues Heading Beneficial Owners Agendas: The Agent Lender/Borrower Response, covered themes suggested by beneficial owners. Key comments: A beneficial owner expressed the importance of indemnification as a means of aligning interests between the agent and beneficial owner. One agent commented they do not envision material changes to indemnification other than pricing, and perhaps terms (e.g., trade types / activity covered). Increasingly, it will be a matter of capacity and price, negotiated with individual clients. Two agents indicated that using a prime money fund with gates and fees requires careful thought (the client may need to provide cash if a fund is gated). Similarly, one agent indicated, in the event of borrower default, they might not purchase replacement securities if the cash is invested in a money fund that is gated. A beneficial owner questioned whether agents might treat clients differently based on whether they are indemnified. A key theme throughout the conference showcased beneficial owners being proactive and strategically positioning for the greatest changes to have ever come about in the business. They seem to appreciate the impact of change and the importance of flexibility/adaptability.

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