Innovation the focus for stock lending business

Innovation the focus for stock lending business

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Investment funds are looking for new ways to boost income from their securities lending business as adverse regulatory effects continue to hit the practice nearly a decade on from the financial crisis.

Many of the largest asset owners in the world, including pension plans, foundations and asset managers, loan out securities that would otherwise sit idle, earning a fee in the process.

In most cases banks, known as agent lenders, manage the trades by dealing directly with borrowers such as prime brokers acting on behalf of hedge funds.

The industry suffered significantly in the wake of 2008’s financial crisis and has struggled to shake off negative perceptions since pockets of lenders experienced losses and impairment in cash reinvestment products.

Most funds have since re-engaged in the practice after improving their understanding of the business and strengthening their risk management teams. Despite struggles, IHS Markit statistics show asset owners and their agents generated over $8bn worth of revenues from lending securities in 2016 - the best result in four years.

However tax changes, attempts to increase transparency and efforts to curb shadow banking continue to put pressure on lenders and borrowers combined, impacting demand and forcing participants into a constant state of adaptation.

Leading figures from the US market (the industry's largest) will gather in Florida this week to discuss the outlook for the business. Tim Smollen, global head of Deutsche Bank’s agency lending business, believes innovation will be the main focus.

“There will certainly a lot of discussion around regulations and markets but interestingly we have been asked by a large number of beneficial owners to try to focus our panel discussions on ideas for innovating their programs,” Smollon told Global Investor/ISF.

“While regulations and money market reforms have resulted in many clients seeing their balances and revenues fall there are ways that beneficial owners can evolve their programs to continue to capture their share of revenues. 

“For example, for the first time in many years I think we will have a lot of discussion on cash collateral reinvestment options especially for clients that relied on money funds for many, many years. 

“In terms of regulations, clients clearly want to understand the impact that regulations will have on their program but again this conference is being asked to focus on ways to move forward.”

Lance Wargo, North American head of agency lending at BNP Paribas Securities Services, believes the securities finance industry will go through a “transformation process” in 2017.

“We expect the securities lending space continue to grow beyond an average $1.8trn of securities out on loan, but the winners and losers will be distinguished by clear, well-thought-out objectives in their securities lending programs,” Wargo told Global Investor/ISF.

“If the purpose is for incremental revenues with little to no risk, then a limited number of borrowers and a government securities-only cash reinvestment pool might be the best solution.

“If the objective is to beat a benchmark, then the lender may seek opportunities from both general collateral and special securities, as well as a more comprehensive reinvestment schedule.”

Jim, McDonald, senior managing director, global head of trading, agency lending at State Street, recently told Global Investor/ISF that returns should be good providing lenders figure out how to match off with demand. 

"That requires more flexibility around structures and counterparties. The business is evolving and each participant will need to evolve with it or risk becoming less productive," McDonald added.

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