Central Clearing: Next Move for Securities Lending?
The securities lending market could ultimately follow in the footsteps of other industry sectors and rely on central clearing, predicts a research firm.
Entitled "Top Trends in Securities Lending: The Road to Recovery and Evolution," a report just issued by Celent recommends that borrowers, lenders and lending agents prepare themselves operationally for the potential regulatory mandate for the "viable option" of central clearing of securities transactions. The U.S. market is more likely to apply the central clearing model than Europe with relies on multiple clearing and settlement agents.
"Now that Dodd-Frank; the European Market Infrastructure Regulation and MiFID II are pushing over-the-counter derivatives to be cleared centrally, the Financial Stability Board is exploring how to reduce systemic risk in securities lending, otherwise known to regulators as shadow banking," writes Medy Agami, an analyst at Celent, who authored the report. "The first question that comes to mind is can securities lending follow in the same steps as OTC derivatives and use a CCP model to increase liquidity and address counterparty risk factors."
Celent says yes, although there could be some resistance. In the event a central counterparty model is mandated and the market moves to full implementation, custodians will still play a major role in the securities lending space. It is highly unlikely beneficial owners would go directly to the marketplace, says Celent.
Agent lenders, prime brokers and custodians should consider applying to be general clearing members of clearinghouses. But to do so, they will need to beef up their data management systems to cover data not normally held by firms engaged in securities lending. Such data includes daily sourcing of loan data and complex gathering and data mapping at the legal entity collateral position level, as well as the counterparty position level to provide additional transparency to risk managers and regulators.
Among the three types of central counterparty models which could be implemented, the clearing utility model would be the most difficult even though it would reduce counterparty risk. The clearinghouse and its clearing members would need to invest in sophisticated technology and operational back office functions to manage post trade processes, such as collateral management, recalls, corporate actions, collection of fees and dividend payments. "This adds complexity and significant costs since there are six parties to the trade-- the lender; the lender's clearing member; the CCP; the borrower's clearing member; and the borrower. Each party would need to earn some return from what is relatively low margin business."
The easiest model to launch would be the central repository where market participants would simply report loan transactions and positions to CCPs. The middle-of-the-road approach involves a trading venue for market participants such as OCC or an alternative trading system such as Quadriserv's to connect to the clearing system. Under such a scenario, the borrower and lender can negotiate the stock loan terms and rebate; anonymous trading would also be facilitated.
Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)