Don D’Eramo, Global Head of Securities Finance, RBC Investor & Treasury Services (RBC I&TS), talks volatility, technology and indemnification
What has recent market volatility meant for securities lending activity?
Historically, periods of elevated volatility--such as 2015 and 2016--were associated with increased demand for securities lending. However, this trend appears to be weakening. The most recent period of volatility at the end of 2018 and through to early 2019 has actually been characterised by a subdued securities lending market with low M&A activity. Lending volumes in North America and Europe continue to fall slowly, while those in Asia-Pacific, depending on the country, are between flat and slightly increasing. Amidst this changing context, the one constant is that clients are pro-actively searching for new opportunities. In this respect, discussions have gravitated towards lending assets that are less liquid, as well as emerging market assets. At the same time, an increasing market demand for HQLA assets continues.
Beneficial owners’ growing awareness of available lending opportunities has been facilitated by a steady process of education. This has continued in parallel with efforts by agent lenders to increase their knowledge of client portfolios and align securities lending programmes with the needs of clients.
How is technology increasing the visibility of opportunities to beneficial owners?
Beneficial owners are looking for timelier and more granular information to identify the precise nature and location of their liabilities. Here, technology has become a crucial tool. The diverse range of performance and visualisation metrics is encouraging internal discussion within clients. As beneficial owners increase the size and sophistication of the teams responsible for overseeing their securities lending programmes, more accessible, detailed and responsive information has become increasingly important to them.
Daily pricing on either side of the trade, supported by an enriched information set, means that beneficial owners are in a position to make decisions more quickly and increase their revenue generating opportunities. The potential revenue in such opportunities may be considered “latent revenue”: embedded in the portfolio but out of view. By leveraging technology to deliver data to clients, we are uncovering opportunities that were previously hidden, turning latent revenue into reality. Examples include the ability to provide information on the potential revenue gain from a particular voting decision, the removal of a restriction on a stock or part of the portfolio, and the inclusion of securities that are not yet contained within the securities lending programme.
Transforming latent revenue opportunities into real opportunities means extending the scope of the agent lender’s analytics across the client’s entire portfolio and mining data that is not held within the existing securities lending programme. This requires aggregating information in a way that beneficial owners can leverage and implementing processes to facilitate new opportunities when they are identified.
To put these elements into place, clients require technology connectivity and a next generation trading platform that supports a high level of straight-through-processing. This helps ensure that counterparts make RBC I&TS their first call for targeted availability and, when they do, we present a clear picture of what is available. RBC I&TS’ technology complements ongoing education initiatives and our longstanding experience, allowing clients to choose from revenue opportunities that best fit their performance and risk objectives. We support beneficial owners in an established lending mandate model, as well as those interested in an opportunistic transactional approach.
How is clients’ growing focus on risk management shaping what they expect of a securities lending programme?
As clients consider how they can empower their internal teams to seek out latent revenue in times of increasing pressure to generate additional alpha, they require the underlying reassurance that risk is being properly managed. A key tenet of the RBC I&TS approach is a robust and holistic risk management strategy. We look at the loan and collateral book through different lenses such as notional stress and credit limits with VaR.
Working with a lender to understand the impact of collateral decisions on the ability to generate revenue is an important role of the agent lender. Clients should have an open discussion on their acceptable collateral base and the related risks. For example, are they comfortable with the inherent risks of including triple B rated corporates?
What trends are you seeing regarding indemnification and why?
Clients are placing an increasing value on indemnification. The first thing to note here is that RBC I&TS is prudent in how we price indemnification for clients. We place significant emphasis on communication with our clients to understand what they expect and examine the range of options available to them. For those clients who consider indemnification particularly important, broadening the range of admissible collateral can be a valuable exercise since it extends the potential revenues available to them, making indemnification more affordable. This is another example of how communication and transparency can help shift a sub-optimal securities lending programme to an optimal one.
In future, what do you think will become increasingly important to beneficial owners?
Fixed income continues to be the asset class where demand is increasing at the fastest rate, and opportunities revealed by regulatory collateral requirements are expanding for clients with the appropriate profile. At the same time, regulators in North America and Europe are making the banking industry more robust: the increasing requirements around capital ratios have made a substantial difference, increasing demand for Level 1 or HQLA (including fixed income) assets compared to other securities, notably equities. Going forward, these pressures are likely to cause term lengths to extend beyond the current typical periods of between three and six months.
Emerging markets are also more likely to feature in future discussions. As we expand our presence into these markets, the contrasting settlement regimes have not hindered the development of a lending market. Nevertheless, there is plenty to stay on top of, if we are to continue to support our clients’ operations in these markets. For example, ensuring pre-notification of sales and a properly functioning settlement process are essential. High levels of performance in these areas mean that our clients are unlocking value with increasing speed. The volumes are still small, but they are growing.
The third area worth highlighting is the expansion of institutional clients into the alternatives space. Currently, we are mostly in the discussion phase and not calling it a trend. However, this is likely the early signal of a shift, spanning the more sophisticated institutions and a growing number of large public pensions, as well asset managers across the range of geographical regions that we serve. These conversations share an expressed desire to move beyond the traditional long-only lending paradigm into levered or 130/30 type strategies, which include a borrow component. For example, in Canada, which is at the forefront of this shift, many larger clients and prospects are looking for a combination of lending and borrowing. In addition, levered financing structures have traditionally been concentrated in the prime space but this is shifting. Our preferred solution is now more nuanced than the traditional prime approach.