Rob Sackett, head of Securities Lending at Wells Fargo Securities, explains how all sides in securities lending stand to benefit from progress in automation and discusses why the early life cycle of the firm’s business is good news for clients.
What can technology offer the sector currently?
Automation is a theme that is top of mind with participants in the securities lending market. Both borrowers and lenders are cognizant that current platforms are not appropriately optimized to allow them to achieve both operational cost efficiencies as well as provide the tools necessary to identify potential trading opportunities. While automation is critical to the success of both the lending and borrowing participants, it may not be suitable for all aspects of trading. For example, some participants may want to maintain human oversight around trading Hard To Borrow (HTB) stocks as there are multiple variables to consider including stability of borrow, counterparty allocation and other factors that may not be easy to quantify into an algorithmic solution. Recently there is a growing consensus that automated trading solutions may be extended to cover warm stocks and that firms that continue to manage via high touch means could be missing out on achieving lower operational costs and increased trading efficiencies.
The efficiency benefits that accrue to both agents and prime brokers borrowing and lending of warm names through a more automated system can be significant. Automated interfaces provide scalability, reduce the risk of operational/trading errors and allows borrowers/lenders to focus on more value add services that they can provide. Some participants have automated a significant portion of this life-cycle process but still overlay with manual oversight.
This of course needs to be balanced with implementation and ongoing maintenance costs, as well as supervision of testing systems.
The ultimate goal for all participants is to utilise technology to lower costs, increase scalability, reduce operational losses and provide data to make more informed decisions. Algorithms can provide securities lending participants with tools that were not available five or 10 years ago, and their value is achieved through the ability to take in multiple variables that are critical to making a trading decision. Key inputs such as rate trends, availability, stock movements, corporate actions and other key inputs can now be coded into a trading model.
How widespread is the adoption of greater automation?
Automation is critical to the success of all the participants in the securities lending market. As more data has become available this has led to greater transparency within the marketplace. This has provided counterparts an opportunity to incorporate this data into their process flows, which has a direct impact on trading decisions. The industry is demanding that participants become more efficient, and central treasury groups are demanding a wider array of analytics to understand profitability. In addition, as machine learning, big data and artificial intelligence (AI) have become more commonplace, it has led to the advance of black box or high frequency trading strategies that cannot be serviced in legacy high touch business models. Counterparts that can’t keep up with the pace of automation may not be able to participate fully in the new norms.
In order to achieve the maximum benefit of automation both lender and borrowers need to understand their counterpart’s data models and how to integrate into their workflow. Another component that is often overlooked is normalizing metadata across counterparts and ensuring the integrity of the data to ensure an optimized outcome. The ability of counterparts to connect among themselves is critical to the success and growth of the securities lending market and it is through achieving these factors can the market truly be optimized.
How important have CCPs become in smoothing the trade process?
The role of CCP’s has grown considerably post the financial crisis as counterparts continue to look to optimize their firms’ financial resources such as capital, balance sheet, RWA’s and RoE. CCP’s provide a conduit for eligible market participants (broker –dealers) to conduct business in a more capital efficient manner with their trading partners. The biggest hurdle to overcome in achieving a more optimized operating model would be to extend the eligible participants to include banks/agent lenders.
This restriction on counterpart eligibility has necessitated considerable amount of trading occurring outside of CCP’s between agent banks and borrowers. Given these considerations, a number of smaller to medium sized firms may choose not to actively participate in non CCP securities lending activity given the increased capital required to conduct business. One of the advantages of Wells Fargo is the strength of our balance sheet, which allows us to participate in this segment of the market. This has allowed us to build relationships across a considerable amount of counterparties.
The strength of Wells Fargo’s balance sheet has allowed us to be more flexible in taking on clients with various strategies and this flexibility has been critical to the success and growth of our prime brokerage platform. We have the ability to take on and service asymmetrical portfolios and are not managing to a daily client optimization model. This has allowed us to build our business organically and achieve efficiencies through client acquisitions while not limiting our clients with daily targets they need to adhere to. Increasingly prime brokers are having discussions with their clients around the definition of a ‘good client’ which requires them to maintain portfolio compositions that align to the dealer’s key measurements: return on equity (RoE), return on assets (RoA), and risk weighted assets (RWA) and capital utilization. For some participant these ‘neutral’ portfolios are not feasible given their trading strategies and a prime broker that can service these asymmetrical portfolios is a valued partner.
Given Wells Fargo continued investment in its Prime Brokerage business, we are able to assimilate client assets into our portfolio more seamlessly. It allows our desk to have the flexibility to borrow and lend a wider array of assets as we organically build out the portfolio efficiencies. We realize that in order to achieve portfolio optimization by building a balanced book over the long-term is the willingness and flexibility to take in a wide array of assets while building out our client franchise. The ability to finance longs, shorts and the gamut of credit, from investment grade to high yield are valued with our client segment. This capability allows our clients to focus on trading their strategies to optimize returns rather than focusing on building a portfolio that is efficient to their financing provider. We view this as a partnership with our clients and our ability to fund portfolios of all shapes will allow us to develop a strong relationship with our customers as we build towards the long term.
What other concerns are pre-occupying your clients?
Pricing is still top of mind with clients. Given that clients tend to have multiple financing counterparts, they are able to leverage these relationships to get better transparency. Larger counterparts may also require some term commitment to allow them the liquidity to trade their strategy. Finding the right balance between term and asset composition is essential given the incremental costs associated with term financing. Post the financial crisis, Prime Brokers are now focused on aligning the weighted average maturity (WAM) of their asset / liability structures.
Another trend we have seen recently is a growing appetite for less liquid assets such as high yield instruments, master limited partnerships (MLP) and convertible assets. The challenge that clients need to understand is if current pricing levels are sustainable for the longer term or are just due to a liquidity rich environment.
What are clients expecting you to do with data?
With the question of regulation now moving out of the foreground, clients are particularly focused on data. One of the biggest changes in the securities lending markets over the past decade has been the increasing level of transparency with the advent of third-party data providers. Clients are now looking to their prime brokers to make the best use of this data while overlaying with the broker’s proprietary research and market data to provide traders with differentiated market views. This must be shaped into usable real-time solutions through a smooth-functioning client portal that can provide near real time reporting, risk and data analytics.
Clients also expect data to be supplied in ever-more granular detail. Corporate actions are a particular focus for clients currently, in part owing to the current push around proxy voting. A firm’s ability to differentiate themselves in this segment is critical to clients. The ability to get accurate data in a timely fashion can give confidence to your clients to place more balances with your firm.
Client’s want improved transparency in general and as their providers develop their data models and strategy this will become an increasing point of interaction. Types of data that is being asked for can include securities being re-hypothecated; a precise and timely account of dividend dates and information on special dividends and a clear read out of where their assets are – are they unencumbered, are they overseas, are they in tri-party? The more information the parties can share allows for a long term mutual beneficial relationship.
To learn more about what Wells Fargo Securities can do for you, please contact Rob Sackett: