Clearstream GSF Summit: Panelists Sound Cautiously Optimistic Note For Securities Lending

An audience poll at the Clearstream Global Securities Finance Summit this week revealed mixed feelings about revenues in securities lending for the future: 29.2% believed they would increase over a three year time frame; 17.6% believed they would decrease over the next three years; 21.8% believed that there are too many uncertainties to know; 15.3% said they would remain flat for the medium term; 9.3% said they would increase over a one year time frame and 6.9% said they would decrease over next year then increase.

The summit, which took place in Luxembourg this week, had over 850 delegates in attendance.

Taking stock of the securities lending market, a panel of practitioners discussed trends in the market, particularly regulation. Kick-starting the panel, moderator Ed Oliver of eSecLending, asked participants to respond to the results of the poll.

David Raccat from BNP Paribas Securities Services said the market “will probably change in terms of structure, and the fact that it might get more competitive over the next two or three years might explain the fact that in terms of pricing the market is slightly underpriced at the moment, so revenues might actually increase.”

Michael Evan from Blackrock Advisors indicated that growth in lendable assets in the last seven years is a good measure of further growth: “With hedge funds decreasing and picking back up you had less risk, there was cash collateral reinvestment securities lending, the regulatory environment has changed, balance sheets are shrinking, some lenders are in specials only, there are all sorts of things happening over the past five years and the line is just incredibly flat. Its reasonable to suggest we may get a point of equilibrium on the supply and demand side in that the securities lenders have found a point where they’re willing to lend and willing not to lend.”

On the supply side, Oliver pointed out that in general, the average returns on equity portfolios have been consistent at around 5 or 6 bps of the portfolio and 2 bps of the portfolio for fixed income. “These are not massive numbers but there are incremental returns being made there and the return comes from two themes: it comes from the level of the fee you’re charging on the loan and how much of the asset you can get out. Its quite interesting how the equity fees have increased over the last two or three years of 50, 75 or 80 bps on average and of course the fixed income fees are much lower at 10 or 12 bps and again very constituent over that five year period. At the moment fixed income fees are on average about 10-12 bps. Fixed income utilization is much higher than equity utilization, which is at a seven year low. Fixed income utilization held steady at 15 – 20.

“Hedge funds are raising capital and there again there is more opportunity to do more on the short side. That’s an indication of perhaps where trends lie.”

Adding to Oliver’s comments on hedge fund trends, Barclays Capital’s Michael Manna pointed to a recent survey by Barclays of hedge funds investors, including sovereign wealth funds, pension funds and family offices. “One of the questions about where the allocation is coming in the New Year is not just the asset class but what was the biggest gripe with their performance and about 54% of them the response was they didn’t take enough risk. That’s quite interesting looking on a forward basis at what are the opportunities in 2014. With hedge funds taking more risk that usually equates to leverage either on the short or long side so there’s always going to be mixed messages. Leverage is down and has been down over the last couple of years, so not a lot of people are using it but this could be where we see some demand for supply and demand for financing. Over 50% of that allocation went to long short equities so for anyone with a long lendable equities portfolios, it could be a very good thing in 2014 for you.”

Debating the importance of incremental revenue to pension funds, panelists were again cautiously optimistic. “Securities lending can be very attractive for pension funds,” said Raccat. “It’s a growing business, it’s a growing market, however it will be interesting to look at what is going to happen with EMIR and collateral awareness. These funds might need to allocate collateral to other needs like for EMIR so it could be an issue on what portion of the assets could be lent which will have an impact on the revenues generated.”

On the lending side, where revenues have flat lined over the last few years, Zurcher Kantonalbank has looked at collateral to achieve higher revenues from clients. “We are showing flexible collateral schedules…risk mitigation and we are working with our clients to be more flexible on the collateral schedule. We’re trying to keep that dialogue going on an ongoing basis with our client base.”

“Some clients like central banks and sovereign wealth funds are globally seeing an increase in their balance sheet and on the assets they manage and there is much interest in securities lending here because lenders are still able to flood the market with HQAs (high quality assets) which the market is looking for at the moment,” added Raccat.

Gerard Denham of Eurex Clearing said: “We believe there’s an opportunity for pension funds and other institutional lenders to broaden the collateral they can take if they come via the CCP model because it’s a structure designed for them and one that gives them additional opportunities.

“Clients can maintain their existing schedules or operate new schedules that take advantage of the opportunity they have.”

The audience was then asked which type of regulation would have the most impact on their business over the next three years: 43.2% said Dodd-Frank and Basel III – impact on capital and provision of indemnification, 41.3% said EMIR and Dodd-Frank –the impact on collateral as a result of OTC derivatives and moving to central clearing, 11.7% said ESMA and AIFMD – impact on UCITS. And 3.8% said MiFID I and II would have an impact.

Commenting on these regulations, Manna said certain regulations are becoming more complicated given their multi-tiered approach: “You have the Basel committee doing the macro stuff and then some work streams doing Dodd Frank, the Volker Rule, the ring fencing, all of those bring about the unintended consequences. Will it lead to more volatility? I think so. If the markets are fine then there’s no tail risk, and everything will be fine. But looking what happened in July last year when the Fed just mentioned tapering and the reaction to that now…so yes that could be one of the unintended consequences in that all of a sudden the markets become a bit less predictable. Regulation is a tax. It’s a tax on activities to the point of extinction or for the appropriate pricing of financial resource.”