By Steve Swain, Co-founder & CEO, Lendingblock – the securities lending exchange for digital assets
Securities lending enables investment managers to generate additional sources of alpha. As such, it is an integral aspect of fund management and has become a mainstream investment management activity. In March 2018 for example, in excess of $20.2 trillion of assets were available for lending globally; on an average day $2.6 trillion of assets were on loan<1>. By increasing liquidity, securities lending not only facilitates transactions, but also helps mitigate price volatility and reduce transaction costs.
A commoditised and uniform product
All participants in the securitised lending market rely on the same Global Master Securities Lending Agreement, tri-party or bi-lateral agent structures and adhere to the market practices established by the International Securities Lending Association. But the risks which came to light in 2008, have persuaded beneficial owners to apply a greater degree of diligence to potential transactions.
Establishing a new and improved model
Despite advances over the last decade, there are still considerable inefficiencies within traditional securities lending. For example, the class action suit brought by a group of pension funds in the US against Goldman Sachs is indicative of the flaws in securities lending. And aspects of the activity can be nothing short of cumbersome. Over and above the borrower and the lender, the traditional securities lending arrangement involves a host of other parties. There is an agency member, who basically aggregates positions from other agency members, prime brokers who arrange deals with the agency members. And, to make things more opaque, it is not clear for participants the true prices struck by any of the parties.
When analysing the pros and cons of the traditional securities lending market for its participants, it is sensible to take those well-established and equitable trading principles and apply them to the borrowing and lending of digital assets. Automated matching, loan maintenance and servicing (e.g. real-time collateral management), and settlement of shorts should mirror that of conventional markets. Improvements to the model would significantly improve the experience of market participants; these include added features such as directly matching borrowers and lenders and the addition of an order book that provides a completely transparent ledger of open borrowing and lending requests on the platform.
The winds of change
Despite the events of 2008, securities lending continues to deliver for participants and contributes to the efficient functioning of the capital markets. Few, if any, investment vehicles—even those in the most transparent of markets—could make that claim. However, the profound regulatory changes in the European securities lending market leave firms with no alternative other than to review, reassess and streamline their operations.
Technology changes everything
It’s not just regulation that is forcing securities lending players to re-examine their practices—technology is also reshaping the industry. The largest of financial institutions, such as global investment banks are investing in technologies that encompass machine learning, artificial intelligence and blockchain. For reasons of technology, as well as regulatory necessity, the securities lending market will at some point begin to exhibit features common to other markets: spreads will be tighter, transparency will increase, and products will become more commoditised. The straight-through, front-to-back office processing provided by electronic platforms not only improves efficiency it also eliminates, or substantially reduces, human interaction. Digital trading also increases volumes and revenues. And as the technology gets smarter, the lending process, at both agent and beneficial owner level, will be further refined.
Lendingblock: the securities lending exchange for digital assets
Lending through a digital asset exchange results in a securities lending arrangement which is both leaner, completely transparent and far easier to understand. All parties in the arrangement, of which there are only three, can see the price that each participant has secured. Over and above transparency, transacting in crypto should, generally speaking, be. And thanks to the high degree of automation, deals will be friction-free.
To better match the needs of participants and more adequately reflect the digital age we live in, the opportunity to reinvent the traditional securities lending model could not be clearer.
<1> Source: IHS Markit, 1 March 2018 to 31 March 2018.