Bill Kelly, Global Head of Agency Securities Finance at BNY Mellon Markets, explains how a challenging year for securities lending has seen the company focus its energies into creating new distribution channels while improving operational efficiencies for clients.
How has the last 12 months been for the securities finance market?
Securities lending has generally underperformed in 2019 due to a number of factors. These include falling interest rates which have made the investment landscape tougher for investors looking for yield, while lower spreads have made for a very challenging environment. Demand for securities with high intrinsic value has been dramatically depressed, probably to historic lows, coupled with an increase in supply as managers expand their lending participation in order to seek alpha.
This downturn follows 2018, which, despite being probably the strongest year for securities lending since the financial crisis, proved to be a tale of two halves. The first six months of the year were particularly strong in fixed income, but the second half was characterized by lower spreads, contributing to poorer earnings, setting the scene for 2019 which has continued on this lower trajectory.
Two green shoots this year have come in the form of lucrative exchange trades in the securities of Eli Lilly, the US American pharmaceutical company and Coty, the beauty and cosmetics business. In addition, activity has been buoyed by a strong pipeline of IPOs during the second quarter, which has included Beyond Meat, Lyft, Uber and new listings in the healthcare sector. But these have been isolated examples and have been unable to buck the trend of a poor year so far.
While volatility has ticked up somewhat in recent weeks, three things preoccupy markets currently. The first is Brexit, with most participants impatient for things to be concluded as quickly as possible. The second is the continuing ebb and flow of the current trade war between the US and China. The third is the beginning of a return to more accommodative monetary policy from central banks, which in the midterm should support risk assets and allow markets to climb a little higher, providing some volatility along the way. Currently, however, demand remains muted due to a lack of conviction in the deployment of capital.
What new routes to market have repo participants seen in the last year?
Two new clearing initiatives have become available to beneficial owners recently, providing new distribution channels and the potential for improved trade economics for both beneficial owners and borrowers.
The first is sponsored cleared repo at FICC, the central counterparty. Recently introduced regulations have reduced the availability of dealer balance sheets, driving up costs for bilateral repos and constraining overall capacity in the marketplace.
We have focused considerable efforts, therefore, to facilitate the most efficient use of what are increasingly limited financial resources for both borrowers and lenders.
Centrally clearing repo trades at FICC has been a valuable avenue to ameliorate these constraints, helping to increase capacity in the repo market.
The benefit of this initiative has been amply demonstrated by steadily climbing cleared balances this year, as clients have embraced cleared repo through BNY Mellon’s Sponsored Repo program. The swift uptake is unsurprising, given that the program improves the management of a scarce resource, by bringing together those with high quality collateral on the one hand and those with cash on the other, in a highly efficient fashion.
The popularity of the new program represents the strongest indication yet that cleared repo transactions are a practical and appealing solution for participants on both sides of the trade.
Have there been developments in central clearing for securities lending transactions?
Yes. The market has been seeking a cleared securities lending model that works for the buy side for some time – especially one that allows buy-side firms to clear trades through their agent lender.
In June, BNY Mellon became the first agent lender to centrally clear a securities lending transaction on behalf of a buy-side client through Eurex Clearing’s Lending CCP platform. The trade originally faced Morgan Stanley as counterparty, and ultimately cleared with Eurex.
This is a major new distribution channel for clients, offering operational efficiencies and potentially improved trade pricing. We are the first to bring such a solution to market and it means that our clients can now capitalize on growing market demand to undertake securities finance within a centrally cleared environment, without the obligations and responsibilities they would face with traditional clearing house membership.
With this solution borrowers are becoming increasingly focused on the capital treatment of lending clients. Clearing provides benefits to clients who may be disadvantaged by their capital treatment.
It is an important precedent and it has created a groundswell of interest from both borrowers and asset owners. If the solution is to grow quickly, however, we need to ease the path to its wider adoption by clients and agents, which, as an example, means focusing on making the documentation more streamlined. Devoting time and effort to this area will be crucial if the industry is to harvest the full benefits in terms of scale and liquidity. But with the precedent now set, this is an exciting development.
What progress is your company and the industry more widely making in applying technology to securities lending?
Both BNY Mellon and the industry have focused their efforts in recent years on improving the technology underpinning both the repo and securities finance markets. The industry is ripe for the full application of technology: as the largest agent lender we see this potential clearly and have made a considerable move this year with the purchase of the agency securities finance software and associated intellectual property of Trading Apps.
While we’ve been a multi-year user of this technology which has allowed our agency lending program to achieve better pricing by feeding multiple sources of price inputs and other market information into a smart algorithm, providing the speed and responsiveness needed to handle high volumes of activity, and allowing prices to adjust more quickly to changes in demand in the market for securities, we look forward to the opportunity to accelerate our continued advancement in this area.
It has also provided us with an exclusive advantage to build on a vendor relationship that will ease our engagement with borrowers. In addition, it’s our expectation that asset owners will benefit from our growing market share in terms of lending, which increases their lending opportunities.
What future progress in this area can participants expect?
I anticipate that the industry will see greater automation across the lifecycle of securities finance in the coming years as machine learning and smart automation – sophisticated technologies whose potential is still hard to evaluate – are increasingly brought to bear.
There remain huge inefficiencies in this process, including around reconciliation, dividends, interest and corporate actions. Progress leveraging new automation, alternative channels and new conventions will reduce expense, minimize operational risk and, in turn, mitigate financial risk. The willingness on the part of the industry is certainly now in place: by and large we all understand the importance of moving forward from what has been a voice-brokered and email mediated OTC market to better keep pace with the progress seen in other sectors. Clearly the more you automate, the more you release traders from dealing with lower volume, lower value cases to concentrate on exceptions and higher value cases.