Building blocks for an agency lending business

Building blocks for an agency lending business

By Frank Gambino, a securities finance specialist and former co-head of Deutsche Bank’s US agency lending business.

Years ago, a beneficial owner interested in lending securities to earn incremental income had to decide whether to outsource the program administration to their custodian, a third-party agent lender, or do it themselves.

As fee splits evolved and beneficial owners could outsource lending while still earning the majority of the earnings, the decision became based more on the capabilities of the custodian or agent and less on the additional earnings that might be captured if they performed the function themselves.

As more public entities entered the lending arena, the idea of indemnification in its many adaptations became a major component of the decision-making process.

With less beneficial owners opting to take the self-lending route, banks have an opportunity to provide agent lending to a larger audience of beneficial owners.

A bank looking to enter or enhance their agent lending program has many factors to evaluate to determine if it makes economic
sense to do so.

Fee splits aside, with increased transparency on rates and collateral that we see today with multiple vendors providing benchmarking data, the way to stand out amongst the stable of providers is based on operations and technology.

When building an agency securities lending (ASL) product, these two factors are paramount in importance and are the costliest.

Of course, there are other factors to consider when starting to build an ASL product. From the legal and compliance perspective, a bank
must determine if there is existing regulatory authority for it to provide the activity.

There are different rules for US bank, non-US banks, branches of foreign banks, etc. For example, booking location is a factor as there are rules overseeing a US entities ability to work with a non-US Bank.

If investing cash as agent for clients, there are trust powers that must be in place.

Agreements will need to be executed for both beneficial owners and other counterparties.

Once the legal and compliance hurdles are consumed, it is time to start thinking about the technology and operational resources needed to build and then support an ASL program.

There are basic functions that need to be present in any lending system. The main decision is to build or buy.

With all the vendors on the market, there is certain to be a solution that will fit every banks’ needs without having to build a system that will include all the pertinent links to outside entities like DTCC, Euroclear, Pirum, and EquiLend in addition to the benchmarking firms.

It is wiser to use resources to create value-added functionality such as real-time reporting or a user-friendly website.

Operations staff will need to be in place to manage reconciliations, maintain relationships with custodians, and process corporate actions to name a few functions.

There is a laundry list of functions that a mid-office and back-office staff will need to focus on but if the technology is utilized efficiently, staff can be held to a minimum and still maintain efficient controls.

While many beneficial owners focus on the indemnification as the primary risk in securities lending, it is important for a
provider to establish internal controls and risk parameters above and beyond the indemnification.

Investment risk, credit risk, asset and liability mismatch risk are just a few of the many risk factors that need to be monitored and controlled by providers and the ability to monitor and report these risks to the beneficial owners can set an agent apart from their peers.

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