At the same time, the expectations of wider society are that investors have to invest responsibly by excluding certain sectors from their portfolios and taking their stewardship duties seriously.
Securities lending fights back
It is often a simple fact that the solutions to market challenges can simultaneously pull in opposing directions. Investors in particular, regularly face this tug-of-war. With muted performance and challenges from passive and algorithmic strategies, every little bit of alpha must be captured. Investors also have to factor capital considerations into their investing activities in a way they have never had to do before.
Sitting right in the middle of this complex set of expectations is the securities lending industry. Recent years have seen the industry suffer declining volumes and be forced into intense preparations for the 2020 rollout of the Securities Financing Transaction Regulation (SFTR). Moreover, some large asset owners have begun to adhere to the arguments that securities lending cannot be aligned with their wider Environmental, Social and Governance (ESG) commitments and have stopped their securities lending activities altogether.
But the industry is fighting back. Securities lending can not only help the buyside to improve its performance, but it is also a solution to help them meet their liquidity and collateral objectives. And with new data gathering and technology emerging within the securities lending arena delivering new levels of transparency, beneficial owners will be able to meet their ESG expectations.
“The buyside cannot ignore the increased alpha that securities lending can generate at a time when every basis point matters,” says Harpreet Bains, Global Product Head of Agency Securities Lending at J.P. Morgan in London. “However, it’s no longer just a source of incremental income. The role of securities lending is evolving to become a primary part of a firmwide liquidity management process as clients increasingly search for financing solutions that will enable them to run their business as efficiently as possible, whether it be seeking new liquidity, transforming their assets into eligible collateral or seeking ways to enhance yields on excess cash.”
Asset managers and asset owners, like their banking brethren are taking a very close look at how they manage their balance sheets, especially with increasing concerns around buyside liquidity. But borrowers of securities also have collateral needs and balance sheet concerns for which securities lending is a solution. It is not just for short sellers. “From a borrower’s perspective, securities lending is a very important tool as it helps with their balance sheet optimisation and allows them to access a wider pool of collateral,” says Amanda Butavand, Head of Secured Funding and Repo Sales, UK, at Credit Agricole CIB in London.
Central clearing counterparties also play a role in allowing lenders to maximise the benefits of securities lending. According to Efthimia Kefalea, Senior Vice President, Clearing Design at Eurex Clearing AG in Germany, beneficial owners increasingly want their agent lenders to put their portfolios into CCPs as it helps enhance these securities’ collateral eligibility and offers useful netting opportunities. “Collateral optimisation is a fundamental need for both borrowers and beneficial owners,” she says. “CCPs are now central to this process.”
One active lender is the European Central Bank, which lends out of two separate portfolios, the EUR 21 billion it manages on its own behalf and also their share of the holdings under the EUR 2,5 trillion of securities that the Eurosystem has built up in its APP. “For the APP, our motivation is to make these bonds available back to the market to support bond and repo market liquidity and thereby ensure a smooth programme implementation,” says Monika Znidar, Principal Portfolio Management Expert at the European Central Bank in Frankfurt. While the volume of the PSPP securities the Eurosystem lends out has been gradually declining in recent years, Znidar is unconcerned. “We are fine with that as the APP securities lending has been set up as a backstop and our motivation is to ensure smooth market functioning.”
The two specific ESG concerns that beneficial owners have with securities lending are that firstly it can be seen as an abrogation of their stewardship duties, especially around voting. There are also concerns that some securities, which are excluded from investment portfolios, could nevertheless end up being posted as collateral. There is also the age-old discussion over the optics of short-selling in general.
“Shareholder engagement is an important pillar of most ESG approaches and ability to recall over key dates is fully supported within our programme” says Bains at J.P.Morgan. “It’s important for the agent lender to engage in ongoing dialogue with clients to understand their specific ESG goals and develop solutions to enable the optimisation of portfolio returns whilst achieving the ESG goals set by the lender. We are also seeing a similar focus on what is deemed to be appropriate collateral, with lenders wanting to limit collateral to securities that match their wider investment strategies.”
Integrating ESG concerns into securities lending will take time, even if it is one of the fastest areas of growth in the primary markets. “The ECB has been very involved in various green finance initiatives, but as regards our securities lending we are at early stages,” says Znidar.
The solution to effectively integrate securities lending into the broader push for responsible investing lies in data and technology. Securities lending is widely seen to be behind other areas of the market in these facets, largely due to its bilateral nature and plethora of details. “Securities lending has lots of special characteristics. We have been consistently investing in our IT systems in order to build a straight through processing own platform for this market. Automation and standardisation of processes is key for a clearing house.” says Kefalea at Eurex.
The data that will allow for this will come through the introduction of SFTR. “We believe the introduction of SFTR will be a catalyst for repo and securities lending to converge - the repo market is further ahead than securities lending in terms of technology,” says Butavand. “But SFTR will push the securities lending market to collect more data and improve STP which will benefit the market overall. Better mastering our data will then allow us to decide how best to use it and solve a wide variety of these challenges.”
With new data and new technology, beneficial owners will be able to have a much more granular control of the securities they lend out, which should allow them to simultaneously meet their responsible investing duties. “Data is very important for us and we have devoted quite some time and resources to improve our databases and IT tools,” says Znidar. “We are now in a much better position to spot any significant changes at an early stage (in securities lending activity) and can do more detailed analysis. All this also allows us to have better discussions with our agent lender and our counterparties.”
After a period of being caught in various market crosswinds, 2020 seems to be the year that securities lending will come fighting back, proving an effective tool for capital and collateral optimization, and even for responsible investing.
