Tougher capital rules placed on big custodian banks are
leading to a misalignment of client interests when it comes to
lending securities, according to a Boston-based lending
Speaking at the Investment Company Institute’s
(ICI) annual event in Washington D.C, eSecLending chief Craig
Starble said regulatory change is resulting in the most
profitable clients of some custodian banks getting the
"lion’s share" of new loans.
"The concept of fairness is being called into question in
the securities lending market," said Starble, who previously
ran State Street’s agency lending business.
"Custodians can’t do certain transactions
anymore, so the most profitable clients take precedent.
It’s not malicious, it’s just the
reality of what regulation is forcing them to do."
In a securities lending trade, securities are transferred
temporarily from one party, the lender, to another party, the
borrower, for a fee.
The borrower collateralizes the loan and is obliged to
return them either on demand or at the end of the agreed term.
Indemnification – an added layer of protection
underpinning lending programs – is also present.
However, certain trades such as general collateral,
depending on fee splits, are no longer economically viable for
agent lenders due to added costs from Basel III and Dodd
Moreover, providing the indemnity, the insurance which often
sits on the custodian bank’s balance sheet, is
"It’s a problem for our industry which has
traditionally always been aligned with client interests, but I
would argue large custodians aren’t as aligned as
they used to be," Starble added.
Speaking to Global Investor/ISF, one custodian bank
disagreed and argued that there is in fact a greater alignment
of interests occurring.
"I really can’t comment on other programs but I
say that if anything with the avalanche of potential
regulations hitting our business, we are seeing our clients
getting more and more engaged with their programs," said Tim
Smollen, global head of agency securities lending at Deutsche
"Clients want to understand the regulations, the impact on
their programs and if necessary what changes they can make to
adapt their lending strategies. Clients want to talk about and
understand things like capital costs and
"Our job is to ensure that our interests are always aligned
and in most cases we are viewed as a direct extension of our
eSeclending is independently owned and, with around 100
staff, classes itself as a boutique.
That differentiates it from custodians, such as Deutsche
Bank, providing similar lending services – i.e
globally systemically important banks that are subject to the
stricter capital rules.
Ultimately, according to eSecLending, there will be
consequences for investors choosing to lend out
The first could be a trend set by some agent lenders to
change their fee splits as certain trades become
"Custodians will be asking themselves 'how much money am I
making on the total client relationship? How much expense am I
creating? Then, what’s my return?'" Starble added.
"Securities lending is going to be impacted by that."