From the desk of John Arnesen
Consulting Lead, Pierpoint Financial
As many will know, Pierpoint holds a LinkedIn live event on most Wednesdays at 10 am UK time. We believe we pick a subject matter that will be either informative, thought-provoking or educational. Ideally, it will be all three. Recently Roy Zimmerhansl and I discussed potential upcoming topics we could discuss, and I mentioned client onboarding. The idea didn't exactly floor Roy until I elaborated on why I think it is a crucial topic as it is a frictional pain point for a new client or those transitioning into a new service provider. New clients, however, are not always clear on what is involved.
The Legal Issue
You have spent the better part of a year in meetings, presentations, correspondence and a host of ancillary tasks to win a new securities lending client. And you do, to the delight of your colleagues, the client, and of course, yourself. It's a great feeling which many of you have experienced, and it endorses your programme capabilities over and above those provided by others. All parties involved are keen to begin the work required to bring the client on board. If this is part of a new custody mandate, there are multiple moving parts in which the securities lending team is not involved, but nevertheless, remains a vital cog in the project team.
You send the client your standard Securities Lending Agreement or Authority (SLA), wait a few weeks and then hear from the client’s legal counsel. At best, they have several clauses they wish to negotiate. At worst, you hear, 'We will never sign an agreement like this.' The latter is pretty devastating as, despite the likelihood that they have seen a version of the agreement during the past year, no one would dedicate quality time reviewing it until the deal was closed, and now, you have a new client raising an eyebrow over what your organisation considers to be reasonable. Such a situation occurs when an overzealous in-house legal department draws up their version of the agreement without seeking external counsel from a firm specialising in securities finance or because there is a lack of solicitors that have gained experience at other service providers with how they construct their agreements. Naturally, an organisation will mitigate its risks as much as possible or mutualise them with the new client, but when these risk issues are pushed too far in favour of the agent lender, it becomes transparent to the client and tends to irritate them. Two things will then happen. A protracted and lengthy debate over the unacceptable wording with the agent lenders legal department standing their ground, making your life harder, and then acquiescence to all the problem clauses favouring the client. In thirty years, I have yet to hear of a failure to sign the lending authority (few would admit to this), but I have heard of this process and haggling going on for more than a year. The irony is that several beneficial owners produce their own securities finance agreement, as they have multiple providers, and every one of those providers signs them with little to no negotiation. The terms of these will not be in the agent banks favour, but they get signed regardless.
There is a case one could make for the industry to produce a standard version similar to the Global Master Securities Lending Agreement (GMSLA) that is used between lenders and borrowers, but unfortunately, at the moment, this is wishful thinking. It would end up so customised that most providers would reject it, but I think there is mileage in exploring this. The core content of these agreements does not differ that much from one provider to another.
The Approval Issue
While the legal contract negotiations are bubbling away, you need to seek approval of the new client from each of your borrowers. This is a necessary process from the borrowers perspective as, via margining, they have real credit exposure to your new client. Now you have to collect the most recent financial statements from the client and distribute them to all of your borrowers. At this point, you have no control over how long the process will take. Your borrower typically has stretched resources assigned to this task, and you aren't the only agent lender in town. In an attempt to get a jump on this process, you ask the new client if you may release their identity to borrowers before the lending authority is signed. If the answer is no, you wait, but if allowed, you now have the opportunity to get the client approved early, so the gap between being ready to lend and making your first loans is reduced. Except it isn't. The borrower wants evidence that the client has the 'authority and capacity' to enter loans and will accept the SLA's front or last page signatures as evidence. Painful, isn't it? It gets worse. A few years ago, a new client that appoints multiple agent lenders became a client. In discussing with several borrowers the good news, I assumed the approval of the name would be automatic given that they already approved the client from other providers. I couldn't have been more wrong. They had to go through the approval process despite having already gone through the process for the same legal entity. If that is frustrating, this is more so. A few years ago, a new borrower in continental Europe was working through our entire lending client base and reconciling the financial statements we had provided. They mentioned the gaps, to which I replied, "those are central banks, so obviously no financials are available." The response stunned me, 'Sorry, John, we are mandated to review financial statements for each relationship.' And they meant it too. The result of this was that they couldn't access the very asset class held by these central banks, which motivated me to seek them as a borrower in the first place.
If you are an agent lender or borrower, this will be very familiar to you but are beneficial owners aware of this clunky, inefficient process? I believe they ought to be informed as delays in borrower approval has a direct impact on revenue. If you didn't receive permission to release their name before signing the SLA, managing their expectations at this juncture is vitally important. There is nothing worse than a disappointed client before the relationship has even begun.
It strikes me that a motivated Fintech could blast through these frictional events and develop a creative process as a third-party clearing house' to speed up disseminating information and making it easier for credit officers to approve new legal entities. There would be no shortage of interested customers.
The Recall Issue
It's finally happened. You have won an RFP and have been appointed custodian and agent lender for a large asset manager that is already lending. The client has a high on-loan balance with the incumbent agent lender, and at some point, you are going to ask them to recall all securities on loan in preparation for the transition into your custody. Given everything I have described above, the effect of this is to destroy about one year of revenue. Does it have to be this way? No, it doesn't. It requires effort and some legal input, but you could novate the outstanding loans made by the incumbent to various borrowers and take them over. Most custodians are reluctant to do this, however, and admittedly, it isn't the cleanest way to begin a new relationship, but in putting the client first, effort should be made to find a way. Central to the issue is the high level of Straight-Through-Processing (STP) utilised by most agent lenders.
The lending system and custody platform are intrinsically linked, whereby the loan record has unique identifiers in the custody system to track which loan is which and allows for returns to match the original loan record, even in circumstances of partial returns. This is a highly automated process, but it breaks down entirely when novating loans. The outstanding loan records will need creating manually or by a script in the lending system, and depending on in-house capabilities, perhaps manually in the custody system, all with the suppression of outgoing Swift messaging. Assuming that goes well, returning, novated loans from the borrower will ideally have an element of STP and allow the messaging back to the lending system, but this is by no means a given. If it sounds hairy, it is, but with a careful assessment of the requirements, a well-developed protocol centred on risk mitigation, it can be done. I know because I've experienced this on more than one occasion, which was many years ago, as I'm sure some of those reading this have also done.
Summary
Growth in securities finance supply is a lengthy process from initial pitch to the signing of contracts. Onboarding begins at the point where client enthusiasm is likely at its highest, and yet it's a process rife with friction and ultimately delays in generating revenue which can severely dampen that enthusiasm. I've highlighted just three issues that occur in the onboarding process. There are undoubtedly more.In a market that debates its evolution into the next iteration using common domain models, machine learning and distributed ledger technology with vigour, applying that technology to finding better solutions to this cumbersome but necessary task would equally be more than welcome.