From a social point of view, private clubs, private beaches and private pools are meant to allow like-minded individuals to partake in certain activities without intrusion. Advocates of this exclusivity argue that keeping out the different-minded or different-opined masses is a way to keep things stable, controlled and at least from their vantage point, transparent.
A recent white paper by Andrew Howieson and Roy Zimmerhansl published by New York-based Automated Equity Markets Finance Inc. (AQS) entitled “Good, Bad or Inevitable” (click here to download the PDF version of the report) puts the introduction and progress of counterparty clearing services, or CPPs, in much the same context. Securities lending has long been the exclusive domain of a select group of pensions, mutual funds and hedge funds. But the introduction of CCPs is meant to swing open the doors and level the playing field by bringing securities lending abilities to the masses.
Introduced in 2009 in both Europe and the U.S., CCPs are a way to broaden both access and liquidity to securities lending practices, as well as open up access to securities lent out by pensions, mutual funds, brokers, and hedge funds to a broader array of clients. CCPs are linked to electronic trading platform initiatives, which an increasing number of buy-side players are utilizing. The illustration below shows how the mechanism for borrowing securities changes with CCPs.
In practice, however, the adoption of CCPs has been slow. Despite being in what the author describes as “close alignment” with the drivers of change in the industry – increased attention to counterparty risk, tougher regulatory requirements in terms of capital allocation and balance sheet usage, new awareness of the costs to end users inherent in securities lending and regulatory concern over systemic risk and market supervision – there is still significant hesitation.
Indeed, opponents say that CCPs open the playing field to a much wider group of participants, reducing visibility to some degree, since it’s not as clear who the actual securities belong to. Unfortunately for them, CCPs reduce profits, since someone can now theoretically find the same securities for cheaper terms somewhere else – and with post-trade anonymity.
Of course, the entire securities lending model in of itself has come into question in recent years, particularly after the fall of Lehman and ensuing financial crisis. Some argue that “Sec” lending should be much more controlled and much less open to so many different market participants. Those who disagree argue that the securities get put to good use, and that the increase in overall market liquidity is a big positive.
“The broad adoption of CCPs in securities lending is not only inevitable but provides a major opportunity to reduce systemic risk, increase participant earnings and reduce the industry’s cost structure, while providing a foundation for sustained growth,” the paper says. “Broad adoption of CCPs will contribute to growth in both electronic trading platform business and in bilateral OTC securities lending as the business will become less resource intensive allowing both to flourish in a growing marketplace.”
While considerable uncertainty remains around the specifics of CCP adoption in securities lending, the introduction of CCPs presents an opportunity for competitive advantage, particularly to Agent Lenders and Principal Borrowers able to work with Beneficial Owners and End Borrowers to optimize their participation and to transfer significant lending volumes from a bilateral to a centrally cleared environment.
CCPs can complement bilateral business, however, allowing the overall market volume to grow without placing unnecessary burdens on firm resources.
The conclusion? That the securities lending industry as a whole needs to be proactive in determining the optimal CCP configuration and working with CCP providers to achieve broad implementation, namely because the locked gates are going to be forced open no matter what. In other words, embrace change and open up the doors before the masses knock them down anyway.