20 February 2020
- OP-ED by José Manuel Tassara de León, Securities Finance, Cecabank
Homer wrote in the Odyssey about the punishment given out to Sisyphus, which consisted of pushing a huge boulder up a mountain which, just before reaching the top and completing the task, would slip from his hands and return to its initial position. An endless task that was repeated over and over again. Differences aside, I cannot think of a better example to describe the history of CII securities lending in Spain.
It is worth recalling how in early 2008 the Spanish investment funds industry expected to see the end of one of its main local disadvantages compared to its peers in the rest of Europe: the inability to lend its assets in order to add extra return to its investments for the benefit of its shareholders. However, the earthquake caused by the bankruptcy of Lehman Brothers in September of that same year prevented the completion of work related to the regulatory development of CII securities lending.
Closer in time was the last attempt, in May 2018, which involved a public consultation by the Secretariat-General of the Treasury and Financial Policy, and which left us feeling moderately optimistic. Once again, however, this attempt fell by the wayside. Thus, to date, no progress has been made.
For all the above reasons, the CII securities lending industry in Spain has lagged behind a market in constant transformation. While in the rest of Europe the first blockchain asset exchanges are starting to take place, and the commitment to digitalisation is growing, in Spain regulation is still lagging far behind in this regard. Globally, the level of sophistication of these transactions is increasing. The use of triparty agents simplifies all collateral assessment, billing and control processes. Furthermore, the use of CCPs (Central Counterparty Clearing Houses) contributes to increasing the security and confidence in this product, securities lending.
If we can draw one lesson from the collapse of Lehman, it is the importance of proper collateral management, the control of credit risk and sufficient diversification of counterparties. The very definition of securities lending, seen as the 'temporary assignment of assets that takes the form of an exchange of collateral (either cash or other assets) that protects the lender from a potential default by the borrower', has allowed this industry to be one of the sectors that best weathered the impacts of the crisis. An example of integrity, protection and resilience in the new post-Lehman environment.
Since then, the importance of global securities lending has been increasing. Now in the past is the unfortunate notion that reduced it to a transaction intended exclusively to hedge short positions in shares. The potential underlying this instrument has therefore proven to be a tool with enormous adaptive power, which has become a fundamental element of the current financial system.
The European Central Bank itself has created a securities lending programme to correct the impact of the asset repurchase programme (PSPP) on market liquidity, which has facilitated the proper functioning of the market. Likewise, the Federal Reserve has a similar tool to prevent market distortions, and central securities depositories, such as Iberclear, have resorted to securities lending to cushion the impact that defaults could have on the smooth functioning of settlement cycles prior to the entry into force of TARGET2-Securities.
This reuse of assets not only provides liquidity to the market allowing it to function properly, in the context of tightening money markets (credit crunch) it has also proven to be a powerful tool for obtaining financing. In view of the above, and the regulatory pressure that banks are under with the implementation of Basel III requirements, securities lending has become a very recurrent transaction at present, where transactions related to high quality assets (HQLA, according to financial terminology) are the most sought after.
Regulation that seeks transparency has had a direct impact on these transactions, on the eve of the introduction of the transaction reporting obligation (SFTR), which will provide a great deal of information to regulators concerning trades entered into. In the same manner that EMIR and the segregation of Initial Margins for OTC derivatives will require agile collateral management, and to this end securities lending will be a key element. The implementation of the Central Securities Depositories Regulation (CSDR) will also mean an even greater need for stocks and shares for the correct functioning of the market.
To get an idea of what this market represents, we must take a look at the data provided by ISLA (International Securities Lending Association) in the third quarter of 2019, where it estimates that the total value of assets available worldwide for loans stood at around €20.6 billion, with close to €2.3 billion in use. These data include shares, government bonds, private bonds, ETFs, and ADRs. If we carry out a more detailed analysis of these data we can observe that the market has a clear preference for using other assets as collateral (67% of transactions) as opposed to the traditional use of cash as collateral. This is a consequence of the impact of cash outflows on short-term liquidity ratios (LCR) and the European Central Bank's negative interest rate monetary policies.
Of the approximately €9 billion per year that this industry generates for stakeholders, the Spanish market is not able to capture anything, despite having a volume of equity in CIIs of €492,759 million and around €112 billion in pension funds (according to the data provided by Inverco as at November 2019). To give us an idea of the magnitude, it represents almost 50% of Spanish GDP in 2018.
The possibility of an additional return to shareholders, in an environment of negative interest rates, increases the need for a standardisation of securities lending in Spain. The fact that the volume of assets available for lending is at near record highs, shows the market's confidence in this business model and the need to generate an extra return.
In short, we can summarise in three key points what is fundamental for the correct functioning of this form of trading:
- Credit risk management.
- Collateral management.
- Diversification of counterparties.
In this regard, the depositary bank is the key player, as it plays a fundamental role as guarantor, guardian and agent for its customers. This is the institution on which they should rely when initiating this activity, taking advantage of their expertise. Depositories in Spain are undoubtedly perfectly prepared to assume these responsibilities.
The creation of a monitoring panel where the main stakeholders and associations can make their commitment clear and where concerns can be discussed and shared, could perhaps be a point of reference for the regulator.
The market and shareholders need to continue to move towards consolidating a stronger and more autonomous capital market in the EU. This is not only a matter of returns, but also about making the CII industry even more attractive in order to increase the channelling of private savings within a standardised framework of security and regulatory homogeneity, to attract more cross-border investment. This would entail a further step towards the stability, resilience and competitiveness of the European Union's financial system.
