A greater number of beneficial owners need to assess the benefits of indemnification against the costs and risks of their program.

That’s the view of Xavier Bouthors, senior portfolio manager at NN Investment Partners, formerly ING Investment Management.

“I believe if a lender has a conservative program and collateral profile (e.g. government bonds) the need for indemnification and cost can be challenged,” he told Global Investor/ISF.

For decades it has been common for lending agents (often custodial banks) to offer their lending clients indemnification against “borrower default" that is, if the borrower fails to return the securities that have been lent. 

This has given beneficial owners additional assurance as to the safety of their lending programs.

But the cost of providing indemnity is set to rise as a result of banks’ capital regulation.

Steve Kiely, head of securities finance new business development at BNY Mellon, said indemnification costs will be a “major theme for 2016” in a recent research note.

Although indemnification has become a ‘critical pre-requisite’ to stock lending for many risk-averse beneficial owners, Kiely reckons clients will see shifts in pricing from agent lenders and should adjust their approach accordingly.

Equity collateral

He also raised the theme of rising equity collateral volumes, something also witnessed by Bouthors who is responsible for securities lending and collateral optimization for NN Investment Partners’ funds.

“We have been seeing an increase in demand for equity collateral especially on term trades with significant pick up in spread,” Bouthors said.

“Equity collateral is also adding some value for GC balance on term loan, however we don’t see a real pick up in lending specials with equity collateral.”

In his recent outlook for securities lending market, BNY Mellon’s Kiely explained the reason for the rise.

“Although low interest rates and the very real possibility of downgrades for OECD government bonds have played their part, Basel III’s Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are the key reasons for this switch,” he said.

“These ratios encourage banks to hoard high-quality liquid assets (HQLAs) – largely government bonds, while other aspects of the Basel capital and liquidity framework (which is being rolled out by national regulators up to 2019) punish balance sheet holdings of equity securities.

“Moreover, lenders that are naturally long on equities can experience operational and cost efficiencies in accepting equities as collateral, even when lending out equities.”

Term trades

Like equity collateral, the trend toward term lending is already fairly well established and has similar drivers, notably the strain on sell-side balance sheets stemming from Basel III.

“Term trade is definitely a trend,” says Bouthors. “We see opportunities on 3 months and more from counterparties looking at borrowing HQLA (LCR) and for most posting equities but also corporates as collateral.

“Counterparties are asking for more flexibility in the equity indices they can post to extend to a wider range which could be a change for some lenders used to receive only main indices.”

Bouthors added that he is seeing increased opportunities when it comes to lending ETFs due to strong demand.