The securities lending sector is still adjusting to some of the realities of operating in a T+1 environment in the US, experts have highlighted during Global Custodian’s T+1 War Rooms initiatives.
Securities lending was one of the big areas of concern in the build-up to T+1, and despite the main takeaway being that it has also been a smooth transition – a genuine success, to put it succinctly – the practice hasn’t come through entirely unscathed.
Some of the worries prior to 28 May included participants not being able to meet reallocations/recall deadlines, and possibly exiting their lending programmes altogether. What we are seeing is some conservative inventory management, a slight uptick in fails and some issues with cut-offs and deadlines. No exits though.
Specifically, a lack of consensus on the new recall notification cut-off is causing some headaches. The RMA’s best practice of a 7pm ET came out late in the day and reportedly isn’t ideal because it precedes the affirmation cut-off for custody clients, creating a gap.
“Broadly speaking, borrowers still want the 3pm market close for T+1 settlement. However, they are working with lenders to ensure securities are returned in time to satisfy the sale, but a grey area does remain here,” Eusebio Sanchez, head of execution services, asia clusters, securities services, Citi, explained. This discrepancy has prompted Citi to engage in direct bilateral discussions with borrowers to ensure compliance with the new settlement timelines.
This was something echoed during our European webinar, where a participant said: “I think there still is this grey area where the borrower will broadly view it as 3pm ET as per what was historically in place. And the lending community is either adhering to something that aligns to what the RMA published as the best practise of 7pm ET, or even in the most extreme example using 11:59pm.
“That said – and we could all debate on what ultimately T should look like in terms of capturing that date – what we have seen is there’s broad-based willingness across the industry to accept and acknowledge the recall – regardless of your definition of T.”
Despite the success narrative of the initial weeks of T+1, some real tests for the securities lending space are nigh with major indices rebalances – notably Russell on 28 June. The discussion pointed to significant events like these rebalances reintroducing concerns about strains on securities lending programmes. This pressure has prompted some market participants to consider reducing their lending activities until the new processes proves stable.
The custodians discussed that rebalancing often strains securities lending operations due to the high volume of trades and recalls. Despite that, Sanchez noted, “Nothing really changes with how we manage passively managed tracking funds. We maintain some level of buffer for all index tracking names to account for intra-rebalancing reductions.”
Proactive strategies, such as restricting and recalling deletion names ahead of settlement dates, were discussed to minimise the impact on trade settlements and lending activities. Emphasis was placed on visibility and pre-emptive actions to handle index changes smoothly.
Sanchez added: “Heading into the rebalance date, we typically restrict and start recalling those deletion names ahead of settlement dates. Nothing really changed at all with our passively managed clients. Overall, the experience has been positive, and we consider this quite a success.”
Andrew Lawson, executive director of product management at JP Morgan, highlighted some other minor issues the custodian had seen: “From a custodial settlement perspective, we’ve noticed a slight uptick in overall settlement rates, which is positive.”
Another custodian observed that within their own business, as anticipated, they’ve seen an increase in both the number and value of lending fails. Despite this, these figures aren’t significant when considering the overall picture. Historically, lending recalls haven’t been the primary cause of settlement fails; issues like counterparties lacking stock or settlement instructions have been more prevalent,” they added.
Interestingly, addressing these other issues seems to have had a more substantial impact than the rise in loan recalls. So, despite the expected uptick in loan recall fails, the net effect on settlement rates remains positive.
Sanchez observed no significant change in lending volumes post-migration but noticed a shift in behaviour. Historically, most lending activity for US and other North American markets was handled from US desks. He said: “Now, we have observed an increase in T0 locates for US and North American Equities (Canada / Mexico) prior to those markets opening, around midday in EMEA. Consequently, we’ve enhanced our EMEA desk capabilities to accommodate this shift in demand. Overall lending activity remains stable, with only minor adjustments in behaviour patterns.”
Custodial challenges and borrower dynamics
JP Morgan’s Lawson raised a critical point about visibility into index changes and the proactive recalling of stocks. This proactive approach helped mitigate the impact on trade settlements. Citi confirmed this, noting its overall positive experience with the T+1 transition, despite some frustration over the industry’s late consensus on best practices.
Sanchez acknowledged the challenge of removing significant prime finance counterparts from its borrower list but emphasised ongoing conversations with significant beneficial owner clients, which are part of the Global Peer Financing Association (GPFA), to influence the borrowing community.
Sanchez added, “Our primary discussions have been bilaterally with each borrower. As mentioned, there’s a fringe area of exposure for beneficial owners and agent lenders currently, but we’re focusing on this fringe. The US equity market remains the most liquid securities lending market globally, with total assets available for lending comprising almost half of all lendable inventory. In practice, the vast majority of client sales do not require a recall as shares are not on loan or can be substituted within the agent lender’s own pool of assets.”
Influence and enforcement in securities lending
The conversation shifted towards enforcing new practices within the securities lending community. Sanchez noted that Citi is leveraging the influence of significant beneficial owner clients and the GPFA to encourage borrowers to adhere to the new cut-off times. Direct bilateral discussions with borrowers are ongoing, and while removing non-compliant borrowers from the list is challenging, there is a concerted effort to ensure broader compliance.
Despite the T+1 shift, Sanchez observed that lending volumes have remained stable. However, there has been a notable shift in behaviour, with increased demand for same-day settlement of US and North American instruments before midday in EMEA. This shift has led to enhanced capabilities on Citi’s EMEA desk to accommodate the new demand patterns.