From the desk of John Arnesen,
Consulting Lead, Pierpoint
Four years ago this month, I made my annual pilgrimage to the RMA Securities Lending conference in Boca Raton, Florida. Attending allowed me to hear first-hand the latest challenges facing the US industry, catch up with colleagues and peers, and something that I always looked for, the extraterritoriality of either US or European-based regulation on both regions and how to deal with them. The opening evening event had me in total awe when I grabbed a plate to eat. The picture above is the first thing I noticed, and I can categorically state with some confidence, we simply do not breed cows this large in the UK!
Fast forward to today, and the balmy climes of Florida are replaced with a virtual summit set-up due to the pandemic. As a result, the event was free to attend and in theory, could reach many more people. I have to commend the sponsors who stepped up to the plate for a conference held in a very different format. My blog this week will not rehash the panels verbatim but give my observations and comments from each that I found of interest and hopefully, so will you, especially if you missed it. To avoid misquoting someone, I will not refer to individuals by name.
The summit kicked off with an update from the RMA Council, and a few things caught my attention. It was encouraging to hear that due to the extraterritoriality (right up my street) of some regulation, that has slowed in the US but still has teeth in Europe, cooperation and collaboration between the RMA and ISLA has been far more coordinated. The impact of MiFID II, Shareholder Rights Directive II (SRD II) and Central Securities Depositories Regulation (CSDR) has made this a necessity and long may it last. It strikes me that there is a wealth of knowledge and resources in several trade bodies but not about all subjects and not all the time. Should the time come for associations to see the benefits of combining into a more extensive or new entity, you will find no objection from me. The panel referred to the Directive on Administration Cooperation Amendment 6 (DAC6) which came into legislation in July 2020. At its core is the mandate that cross-border transactions should treat taxation with fairness and transparency and, more importantly for securities finance, that tax advantage is not the driver of the transaction. ISLA has written extensively on this subject which you can read on its website. The consensus view that securities finance transactions (SFT) are exempt from reporting isn't held comprehensively. The German Investment Funds Association believes that they are subject to reporting and a Norwegian entity has raised similar views. This regulation, even if not applicable to SFT needs to be understood and monitored as if we know anything about taxation, it's always subject to interpretation and change.
The second panel, Securities Lending and ESG started with a survey of attendants. 38% were 'other' 28.6% agent lenders, 17.5% borrowers and 12.2% investment managers. I was somewhat surprised more borrowers were not dialled in, they certainly make up a high proportion of attendees in Florida. What was more telling to me was a question as to how many participants have an ESG policy? Encouragingly, 57% said yes, 16% are planning, but a shocking 25% responded no. It is almost inconceivable that an investment manager or agent lender can operate without one in today's market and I wondered if there is a different pace between the US and Europe on this topic? It wouldn't appear so to hear that ESG factors now apply to 90% of 4.7tn of assets under management by 27 leading pension and sovereign wealth funds according to a survey from BNY Mellon.
Further, the RMA conducted a survey on whether securities lending and ESG principles can coexist with a whopping 95% confirming it could. That sits somewhat at odds with only 18% stating that they apply their ESG policy to securities lending. I wonder why that figure is so low, especially when contrasted with the approach in Europe where asset managers are far more likely to expect their lending programmes to reflect the ESG policy.
The panel made a great point about voting and recalling. Of the Russell 3000 companies, when reviewed for corporate actions, revealed that 90% of votes are related to directors' compensation and appointments. Of that, only 30% are actually voted. If investment managers don't feel compelled to vote on these issues, the more likely it is they won't recall for voting purposes. Couple this with the average utilisation of US equities at 10% and the case is made stronger. I fear, however, that as the pressure for corporate governance is felt more acutely, the tendency to vote on everything at all opportunities will also increase. Should this happen, it will lead to a recallable market if the argument above falls on deaf ears. There are already funds in Europe that have adopted 'vote on all' as policy.
The Cash and Changing Landscape of Collateral panel began with references to the global credit crisis and whether there are any similarities to be drawn to 2020. While the period of high volatility in the equity markets felt like it was 2008 again, the action taken is different.
The Fed's swift rate cuts, which benefitted agent lenders' spreads from fixed-rate reinvestments soon smoothed out over time, but it is the sheer scale of fiscal action that is most noticeably different. The panel agreed that the Fed has no tolerance for any funding market stress and will do anything and everything to avoid a repetition of the liquidity squeeze of September 2019. The operating framework that allows for a flexible inflation target means that the zero rate environment will continue for longer, even if inflation picks up. Of course, with all this liquidity, growing available collateral, almost no volatility and flat balance sheets, it's harder to generate any meaningful revenue. Sponsored repo, which reduces balance sheet consumption was suggested as a vehicle to generate activity efficiently but with the reality of the Fed intervening so extensively, there is little spread in anything. Even the 'turn' of the year repo rate is only 21 basis points, and the panel expects no volatility pick up over this period. The observation was made that banks service clients to access liquidity and in doing so, have to hold sufficient liquidity via borrowing HQLA. The liquidity of those securities is continuously assessed and done so assuming the Fed won't be there forever. The question posed at this point was that with participants in search of yield for the foreseeable future, will it lead to a change in risk tolerance? Agent lenders when reinvesting tend to all chase the same instruments and are doing so in a low-interest rate, highly liquid market so will they extend duration and increase risk? The response was a resounding no. If anything changes, it will be a focus on operating costs and how to cut them. The final subject debated was where is the market with the use of CCPs, and why is it still a discussion, 12 years on?
There is no question as to the efficiency they bring in terms of liquidity, netting and stability and its clear they play a vital role in the derivatives market. Despite this, agent lenders continue to be slow on the uptake, but no one was prepared to spell out why. The mutualisation of risk was mentioned and that you have to provision liquidity against that, so there are costs involved. However, the panel agreed that, on balance, the positives outweigh the negatives. One day, I'll write a blog about an agent lender that has mobilised significant volume via a CCP. I just can't say when.
In my next blog, I will cover the final panel of day one and share my thoughts on the content of day two.