From the desk of John Arnesen
Consulting lead, Pierpoint Financial Consulting
When I think back to the early 2000s, it reminds me just how much the securities lending market has changed. The sheer volume of business moving between market participants was clearly a fundamental motivation for the creation of EquiLend to solve for a more structured and automated way to deal with this volume, particularly for equities. That development was timely, when one considers the volume that the platform has seen since 2001 and coupled with its post trade services, EquiLend has become an essential part of the fabric of the market.
The relationship between lender and borrower is one of the changes that has been an interesting observation for me. Back in the day, borrowers bent over backwards for agents when sourcing supply. While rebate or fee was a negotiation, (let’s call it “price”) it was just one consideration in the transaction and hardly ever the cause for a loan to collapse. This could be considered odd in any other market where price dictates all.
An agent lender, on behalf of its underlying beneficial owner clients was mandated to extract the greatest intrinsic value for the loans it made while the borrower had the exact opposite task in mind, making the interests of the parties diametrically opposed to each other. The agent was somewhat disadvantaged. In an over-the-counter market with no available reference source, the value of the loan could only really be determined by demand for the same security from other sources and the price they were willing to pay. This was less true for fixed income lending which at least had a benchmark reference rate from which to base a price when lending against cash collateral and also for certain equity trades that had specific structures but for the most part, the borrower had the advantage.
However, price wasn’t the only element in the transaction and in fact individual trades were not considered in isolation. The relationship had to be viewed with respect to all of its moving parts. Agents sat on a huge supply of less lucrative assets but borrowers were willing to combine a portion of those assets referred to as “general collateral” into a loan if they could access the more valuable or “special” assets. The ratio of these trades differed from one borrower to another but the value to the agent was that it contributed to overall performance for their beneficial owner clients. On occasion, an agent committing to lend a large amount of special stocks would discover a significant sale by a client missed through some internal breakdown of procedure after the trade was agreed and booked that severely impacted the borrower. The reaction rarely resulted in raised voices or a heated argument. Manufactured payment claims for periods during heavy dividend pay dates would rarely be paid on the due date and could build into sizeable liabilities for the agents. It wasn’t welcomed but it was also treated as quite normal. These are a few examples of how a typical bilateral relationship coexisted to the mutual benefits of both parties.
The global credit crisis changed a lot of the way relationships were conducted from then onwards. Capital constraints in the form of LCR, NSFR and the leverage ratio have become a daily consideration for borrowers, not to mention their internal hurdle rate to access balance sheet. Exposure to counterparties is a carefully managed process and borrowers are no longer inclined to leave excess collateral with any counterparty. Agents, spooked by the failure of Lehman Brothers have taken equal measures to manage and maintain margins. I had occasion to insist on collateralising a very large non receipt of manufactured dividend payments with one borrower that objected, claiming they had paid. That did lead to raised voices with some heat. It turned out they had paid but in such a manner that it was impossible to reconcile.
The appetite to include general collateral with a special loan had diminished or came with a more aggressive price as borrowers were not able to house this collateral without some significant cost to themselves. In short, relationships have changed to one based far more on their commercial aspects.
I know from my experience as an agent lender that Agents are taking a holistic view to their borrowers. Statistical information regarding duration of loans, the number and frequency of fails, the age of overdue payments, the efficiency of operational staff and the type and structure of a borrower’s demand are scrutinised in far more detail and I’m sure the same scrutiny is conducted by borrowers.
Does this make for a bad relationship?
Not at all, it has more than likely fine-tuned each party’s approach to all of their relationships to know which ones are the most optimal. Not every agent has the supply a borrower is looking for or, if they do, they can’t lend it the way a borrower needs it. Or, perhaps the collateral required is too restrictive or expensive to provide. For agents, borrowers with a high frequency of returns or that otherwise causes excessive operational burden may see less business. Bear in mind, while agent lenders are subject to providing best execution to their clients, it isn’t only about price.
Why am I raising this?
One really good reason. SFTR. The closer we get to “go live” the clearer it becomes to everyone that the efficiency of getting the data right between agent and borrower is of paramount importance if this is going to go well. Ensuring the static data is accurate, that communication to changes is timely and actioned, that trade entry, subsequent rate changes and reallocations are booked correctly is going to take on new importance. The downstream effect of error will no longer be an irritation to a trader, it will become a regulatory imperative. Relationships where both parties understand this will thrive in the spirit of mutual cooperation and become deeper. SFTR is an industry- wide event and the cooperation and effort in preparing for this has been truly remarkable. Come April, that cooperation will need to extend to bilateral relationships on a daily, ongoing basis. Group hug anyone?