The controversial topic of indemnification kicked off the IMN’s Annual Beneficial Owners conference in Arizona on Wednesday.

Essentially insurance for beneficial owners, agent lenders provide indemnification that is triggered when counterparties default on a loan and insufficient collateral is in place.

A hot topic for some time, due to rules within Basel III that require custodians to increase the regulatory capital they set aside for securities lending deals.

The regulation will, in many cases, either ramp up the cost of indemnification or simply reduce indemnification passed on by custodians.

Led by David Martocci, Citi’s global head of agency lending, the first panel at this year’s IMN event was focused on this theme.

“There’s no doubt that Basel III puts a strain on the securities lending business,” said Mark Skowron, senior vice president, head of US trading, Northern Trust.

“Returns are being squeezed and the biggest challenge is how best to address pricing strategies.”

For lenders of securities, often large pension funds and asset managers, this is enough to make them consider replacing their current bilateral mode of doing business by trading through a central clearing counterparty (CPP).

The panellists, including others from State Street and EquiLend, agreed that the indemnification debate boils down to a change in the way securities lending transactions will be priced.

Clearly, the idea of a central counterparty cleared segment of the market gaining traction as the focus on capital costs increases.

In short, it forces borrowers and agent lenders to focus on counterparty exposure and the resulting impact on balance sheets.

It also takes care of the issue of indemnity, but widespread adoption is still a way off, according to Skowron.

“The perfect CCP model hasn’t been designed yet, and the benefit to beneficial owners remains unclear,” he said.

A panel, including members of CCP securities lending specialists Eurex Clearing, will discuss the model on Day 2, Thursday.

Global Investor/ISF is reporting live from the event.