When an operating environment rapidly becomes more challenging and technically complex an army of independent advisers and consultants often springs up in its wake. This is certainly the case in securities finance, where entities, predominantly on the buy-side, are seeking to ensure key functions are regulatory compliant and operationally efficient.

There are more solutions on offer to beneficial owners, asset managers, hedge funds, prime brokers, institutional investors, corporates and custodians than ever before. Consultants, outsiders offering a pragmatic perspective, are increasingly in demand due to their promise to expose critical flaws, identify areas of improvement or simply provide reassuring third-party verification. But what type of provider is best to turn to?

“That entirely depends upon the full purpose of the engagement but certainly one that can offer independent advice,” explains Steven Baker, director, securities finance consultancy and product management at IHS Markit. “For instance, if purely seeking a legal opinion then a law firm with appropriate expertise may suffice, if only investment advice, an agent lender.

“However, most engagements not only require securities finance and collateral market expertise, but also a broad range of accurate and detailed historical data. As the required data often crosses adjacent data sets such securities lending, repo, collateral pricing and liquidity metrics, a firm with both industry and data expertise seems best.”

IHS Markit has been providing securities lending data since 2012 when it acquired DataExplorers, which itself been around since 2002. SunGard and DataLend also provide data services, and each have different data sets and strengths in particular markets.

Holistic perspective

Oscar Huettner, managing principal of LGM Financial Consulting, agrees that market participants must look across all areas of a firm and recognise the common themes, which often revolve around deploying assets in the most efficient way possible.

“For example, getting everything correct on the repo desk, while giving away money margining derivatives contracts on an exchange is counterproductive. A front, middle and back office cross-product and has a global focus is required today. There would be limited appeal, therefore, if a consultant were to simply market him or herself in one area of expertise. A consultant has to offer front office advice and speak with authority to the back and middle office teams.”

Huettner’s latest project is with DTCC and Euroclear’s Global Collateral platform, which aims to create a global collateral management platform by mobilising DTCC and Fedwire securities on to the Euroclear Collateral Highway for use in secured financing transactions and to support OTC derivatives margining. 

The scope of his assignment includes operational design, legal/regulatory structure, sourcing of reference data and client integration. The former Barclays (Capital) director of repo trading and BondLend global product manager adds that consultants need a wide-ranging set of skills to operate in this market.

Earlier this year Broadridge acquired securities finance and collateral tech vendor 4sight for an undisclosed fee, extending the firm’s front-to-back office securities lending, repo processing, synthetic financing and collateral management capabilities.

Jerry Friedhoff, managing director of securities finance and collateral management at Broadridge, agrees that consultants must have global coverage and cover all products. He believes that the evolving environment offers tremendous potential for firms to build competitive advantage, perhaps aided by a consultant.

“By capitalising on the synergies between collateral management and securities financing, firms can focus on optimising collateral to reduce risk, improve liquidity and ultimately increase revenue,” he says. Friedhoff adds that the acquisition made strategic sense as 4sight was the only completely-integrated vendor covering equity, fixed income and derivative inventory in a holistic way.

“Regulators have placed collateral management and securities financing at the center of every firm’s treasury, trading, risk and operations activities,” he says. “Businesses are coming together more and more. Repo, securities lending and the associated collateral management are no longer siloed.

“It’s clear that the securities finance market is here to stay. There are significant funding needs and strong demand for tools and expertise to help navigate complexity. The addition of 4sight enables us to meet that demand.”

There has been a growing number of consultants appearing across the industry offering a range of services. However, this isn’t an entirely new trend says Ed Blount, executive director at the Center for the Study of Financial Market Evolution: “There have been periods of dramatic change across the securities finance industry that have prompted firms to seek independent advice and third-party solutions. The introduction of listed derivatives, for example, triggered another wave of consultants in the late 1980s.”

Blount, the founder of Astec Analytics, now part of FIS SunGard, adds: “I take exception when people say there is an ‘unprecedented demand’ for consultants. However, regulation and the threat of litigation following the crisis has undoubtedly created a strong need for solutions.”

Regulatory pressure

Regulation and compliance is likely to be the key concern for clients. Risk weighted capital levels must now factor in securities lending and obligations to indemnify client exposure.

Indeed, the required level of indemnification and its cost remains one of the substantial issues facing the industry.The liquidity coverage ratio (LCR), which requires banks to maintain a sufficient stock of high-quality liquid assets (HQLA) to meet their needs over a 30-day stress scenario, is putting pressure on the cash reinvestment side of lending programmes in relation to making longer term investments.

Additionally, as LCR is also drastically changing the value of different forms of collateral, driving lending fees higher for HQLA and cash re-investment repo rates higher for alternative collateral types. It is unclear how programmes can adapt to take advantage of this and its potential impact on performance and risk.

Basel III and EU directives are also having an impact. “The leverage ratio, which is constraining bank balance sheets and motivating lenders to accept alternative collateral types, is raising questions on how to price deals versus different forms of collateral and measure the associated collateral risks,” adds IHS Markit’s Baker.

"Solvency II is also driving greater needs for collateral reporting. And last, but certainly not least, MiFID II is placing more pressure on beneficial owners to demonstrate best execution. It is also driving the need for more frequent independent data and reviews of their security lending programme performance, risks, legal structures, operational processes and regulatory compliance.

“As a result, given their fiduciary responsibilities, we are seeing more activity on the beneficial owner side for benchmarking services, to assess programme performance and risks, to support their RFP process and opinions or surveys on fee splits – in particular, when considering changes to their level of indemnification.”

The combined effect of the many regulatory initiatives is transforming the industry and some participants may be struggling to keep up. “Our industry, our market, is mutating,” adds Sebastien Bietho, founder and chief executive of Alcognis, a Paris-based consultancy dedicated to securities finance. 

“There is an obvious need for securities finance consultants. Hence, newcomers are trying to penetrate the industry based on regulatory changes. “Demand is also being driven by business efficiency and profit generation. Margins are very low and market participants need to adapt to changes globally including trading, balance sheetoptimisation, collateral optimisation and management, systems, operations and new infrastructures such as CCPs.”

Formed in 2012, Alcognis offers front-to-back solutions including trading, operations, systems, regulation, legal, market infrastructure and market data. “We focus only on the securities finance industry and cover the full scope of the industry so that our clients can leverage on our expertise to build, restructure or reorganise an efficient and profitable securities finance business,” adds Bietho, who was previously Fortis Investments’ head of securities finance trading and head of the BNP Paribas agency lending desk in Paris.

“When we are taking securities finance we are touching the core of the financial industry functioning and liquidity. It is a core matter for the sell side and the buy side. For both, their securities finance business efficiency and profitability is fundamental in ensuring their global business to continue operating normally. 

"Because the securities finance and collateral management business is so fundamental, the sell side and the buy side need professionals that understand the market and consultants that have market and industry experience.”