Although two key planks of the post-crisis regulatory reform agenda encourage greater use of equities for collateral purposes, other incoming rules are having a negative impact on suppliers.
A major threat to both the upgrade trade and the supply of securities into the lending market are new guidelines issued by the European Securities and Markets Authority on the securities lending activities of mutual funds (regulated as UCITS in Europe), which currently account for roughly half of lendable securities globally. There are two key issues from the new rules, which are designed to reduce risks carried by UCITS. First, the rules mean UCITS cannot enter into lending transactions lasting more than seven days; second, they can only receive collateral by title transfer, not by pledge, which rules them out of activity facilitated by CCPs. ISLA is concerned that both of these measures limit supply from UCITS to the securities lending market, thus acting against a key aim of the European Commission’s Capital Market Union initiative. “A deep and vibrant secondary market for equities is dependent at least in part on a robust securities lending market,” says ISLA CEO, Andrew Dyson. “The commission needs to think holistically about market liquidity.”
A further risk to supply is represented by the reporting requirements of the EU Securities Financing Transactions Regulation (SFTR), which will oblige agent lenders to provide more details on out-of-scope securities lenders than at present. This includes Middle East Sovereign Wealth Funds (SWFs) and US pension funds that currently represent as much as 60% of supply, but may be less keen to comply with the additional administrative efforts required by SFTR, thus reducing supply.
Although mutual funds account for around 46% of the lendable security universe, according to ISLA’s latest figures, they only represent 14% of actual loans. There has been a steady decline in balances in response to post-crisis regulatory change, says Dyson. In contrast, SWFs represent 6% of total supply but 11% of loan balances. He suggests that banks increasingly find SWFs easier to deal with, both generally and in terms of handling collateral, but also notes the deterrent effect of high RWA costs of borrowing from many SWFs.
These supply challenges have coincided with a rise in inter-dealer borrowing. While SWF borrowing has not increased over the past six months, according to ISLA, lending between banks and broker-dealers grew from 15% of global on-loan value in June 2016 to 19% in December 2016 to 29% in June 2017 – almost doubling in 12 months.