Securities lending has continually innovated throughout its 200 year history, but most of this has been designed to meet the needs of borrowers. Isn’t it time for beneficial owners to have a turn at the table?
*This piece was originally published during the 2015 BBH Markets Symposium in London, April 2015.
The securities lending market has its roots in 19th century London, so it feels appropriate to be discussing the catalyst for the industry’s next innovation in the city where it all began. While the industry has seen innovations throughout its history, few have focused on how the beneficial owner can participate. That is changing, but before we discuss the present, let’s explore how we got here.
No one will dispute that the industry has come a long way from its humble beginnings when the City of London’s “jobbers” (the equivalent of modern day “market makers”) would physically exchange Gilts and collateral to settle client sales.
In the intervening 200 years, the daily appetite to borrow securities has soared to nearly $2 trillion, driven by the expansion of global trading, the creation of electronic settlement systems and derivative products, as well as the emergence of the hedge fund industry.
Innovation has played a key role in satisfying this demand, beginning in the 1960s through the new millennium. Investment banks, custodians, and third party specialists created agency lending and prime brokerage businesses to link beneficial owners with idle supply to the ultimate borrowers demanding the securities. New industry infrastructures, pricing vendors, and automated trading platforms also emerged as securities finance became an integral part of the broader financial ecosystem.
It hasn’t all been smooth sailing, however. The 2008 financial crisis had a huge and negative impact on the securities finance markets. Demand decreased as clients deleveraged and proprietary desks were shuttered. The regulatory response to the credit crisis was unprecedented, with legislation aimed at increasing the stability of banks, in particular impacting prime brokers, who are now having to adapt their business models to change the way they finance their businesses and capitalize their exposures.
These challenges in themselves present new opportunities for beneficial owners who can meet this increased need for longer term funding and high quality liquid assets. However, the opportunities for lenders resulting from the new regulatory environment are not restricted to merely meeting demand.
The 2008 credit crisis also caused pockets of lenders to suffer losses and impairment in cash reinvestment products. Understandably, many have yet to re-engage in the business. Moreover, the same capital pressures faced by prime brokers could also result in agent lenders reducing the indemnifications that have been traditionally offered against losses from borrower default. This would imply that in order to give beneficial owners enough confidence to continue lending their securities, far more transparency and control will need to be provided over how their securities are used and by whom.
This doesn’t mean just another online reporting module, but genuinely transformational approaches to how beneficial owners can participate in the business.
Wouldn’t it be fitting for that innovation to be introduced today, in the historic City of London, nearly 200 years after securities lending began?