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Lending CCP: View from the lenders

Release date: 23 Jun 2017 | Eurex Clearing

Lending CCP: View from the lenders

Mark Dugdale talks to executives from BNY Mellon, BlackRock and Deutsche Bank ASL to discuss their utilisation of a CCP for their securities lending business

Eurex Clearing’s Securities Lending Central Counterparty (CCP) service continues to establish itself as an innovative and strategically important infrastructure provider to the securities lending marketplace.

This year, a number of new participants are joining the Lending CCP, while additional service extensions and enhancements of the service are being implemented. Mike Landolfi of BNY Mellon, Tim McLeod of BlackRock and Jay Schreyer of Deutsche Bank ASL explain how they have utilised central clearing for their securities lending businesses.


As committed clients to Eurex Clearing’s Lending CCP, what are the key business drivers that influenced your decision to use the Lending CCP?

Mike Landolfi: The use of CCPs for securities finance transactions (SFTs) is one of the critical ways forward for our lending clients to preserve and potentially expand their on-loan balances, pricing and distribution channels. Eurex’s Lending CCP retains some key components of the bilateral model while introducing CCP-specific benefits such as favourable capital treatments and expanded counterparties.

Tim McLeod: The new regulatory framework has increased the capital cost of securities loans against bilateral counterparties, but decreases the cost when the counterparty is a qualified CCP. Consequently, many of our counterparties have asked agents to explore the feasibility of moving certain parts of their book to clearing. From the lender’s angle, the CCP would enhance counterparty credit quality and in theory lower default risk, making central clearing attractive. Furthermore, as a central repository of data on every participant’s outstanding positions and collateral, a CCP—together with financial market regulators—should be in the best position to quickly ascertain exposures in a member default scenario, and conduct an orderly wind-down via position netting and standardised default management procedures. Finally, a CCP acts as the central transactional hub for the lifecycle of the loan. We see potential value, therefore, in the CCP providing a standardised operating platform for the securities lending industry, which should result in operational efficiencies for participants, lower fail rates and reduced post-trade ‘noise’.

Jay Schreyer: Key drivers for Deutsche Bank Agency Securities Lending (ASL) has been the development of the Lending CCP platform and the importance this has to some of our borrower community. The ability to enter the market via the Eurex platform allows Deutsche Bank ASL to position itself to a wider audience in a way that allows underlying clients to have peace of mind in the knowledge that they are facing a strong financial organisation whose structure looks to minimise risk at all levels. In addition, the ability to have a CCP structure that takes much strain away from the operations teams is a very attractive proposition indeed.

Why has the market been reluctant to prioritise and implement central clearing into their business?

Landolfi: The clearing of SFTs has been discussed for some time, but it’s only in the past two years that workable clearing models have been developed and gained approval from regulators. That said, the documentation required for beneficial owners to become buy-side CCP members remains more onerous than the paperwork required for similar bilateral agent lending relationships. Nonetheless, it’s expected that these additional requirements should be more than offset by the improved balances, pricing and diversification that cleared SFTs can provide beneficial owners and agent lenders.

McLeod: It’s arguably taken a long time for the CCPs to fully understand the agency lending business and to develop a model that’s appropriate for the potential beneficial owner participants— for example, identifying a suitable collateral model, ensuring that we achieve the operational scale and efficiency the CCP should deliver, and understanding the regulatory hurdles that large parts of the market will face when looking to connect. At the time of writing, we’re still not in a position to say that the CCP models available work for the majority of lending markets for the majority of potential clients—and that may deter some market participants from devoting project resources to what is a significant implementation effort.

Schreyer: It is difficult for us to comment on the priorities of the market as a whole. We can say that we have had to prioritise Eurex delivery against many other needs such as regulatory requirements, internal business strategy initiative and as always ongoing run-thebank (RTB) and change-the-bank (CTB) deliveries, which all have an impact on the wallet size. In addition, market participants might see the need to add key markets to the platform as a driver for more demand, such as the US, Japan and the Middle East, to name a few. Finally, the overall set-up process, while very much supported by Eurex in terms of the onboarding, is both detailed and complex from legal reviews to connectivity deliveries and internal drivers such as new product approval sign-off.

Where do you see opportunity for more effective pricing and revenue for your business and your clients by using the Lending CCP?

Landolfi: Global regulatory reform is placing greater emphasis on the capital impact of transactions. As cleared SFTs are efficient from both a capital and balance sheet perspective, demand for cleared securities finance balances has been increasing. As early adopters

sign up to cleared SFT solutions, a supply/demand imbalance will emerge favouring beneficial owners as collateral suppliers. One of the ways this inequity may manifest itself is through increased utilisation of CCPs and potentially premium pricing for cleared SFTs.

McLeod: While lenders have not focused greatly on pricing (yet), it’s reasonable to expect a two-tier model to develop, with cleared trades attracting a higher lending fee where a portion of the capital and balance sheet savings may be passed on through improved economics for the lender. In terms of operating costs, however, agent lenders and broker-dealers alike are assessing the (modest) incremental transaction and vendor charges that will arise.

Schreyer: It’s difficult to see at this moment in time. One area that may provide better pricing will be the ability for the borrowers to net and therefore reduce balance sheet exposure which means clearing through a CCP may provide better pricing structures for certain transactions. In addition, the ability to face Eurex in the transaction will as suggested above, also potentially open up the market for us to new borrowers whom in the past we have been unable to transact with or had any relationship.

The market has adapted to new conditions imposed by policymakers. What are the main regulatory topics that are leading the market towards greater use of CCPs for securities lending?

Landolfi: Regulatory reform is incentivising the clearing of SFTs and repos. Basel III capital charges can be reduced from a 20 percent-100 percent bilateral risk weight to just a 2 percent risk weight if trades are cleared though a CCP. Cleared repo and SFTs can also lessen the impact from supplemental leverage ratio calculations for balance sheet netting of transactions while trades facing a CCP can also be exempted from the single counterparty credit limit rules.

McLeod: The Basel III framework and the prudential capital requirements imposed are changing the dynamics of the lending market. CCPs may offer both netting opportunities and a lower riskweighted asset counterparty, which will improve the return on capital for the sell side and reduce balance sheet usage. For buy-side participants, there is no regulatory requirement leading the market to clear, however, we would encourage policymakers to look at how the clearing models fit into the current regulatory text, to help where possible forge a level playing field for beneficial owners— for example, UCITS funds must potentially be allowed to avail of nontitle transfer collateral arrangements to become members of any of the CCPs. It’s also worth noting that while many market participants do support central clearing for derivatives and other products, it’s important to recognise that further regulatory work is required on CCP resilience and recovery and resolution planning, recognising that CCPs have become systemically relevant entities.

Schreyer: For our business, the demand is not so much on the imposed regulation but more on the opportunities transacting via a CCP provides. A key driver is the ability to net balance sheet as well as operate in a more risk-averse environment. In addition, the importance and focus on the ability to offer liquidity to the market both short and medium term, through existing products and new ones as they are developed, lends themselves well to the CCP model.

What should CCPs focus on for the medium to long term so that they can assist the market further?

Landolfi: CCPs need to continue to focus on the development of the SFT and repo clearing models that maximise the regulatory benefits for participants, reduce risk to the industry, and facilitate the adoption and utilisation of clearing by the broad array of buy-side institutions currently active in the bilateral SFT marketplace.

McLeod: We would encourage CCPs to continue to balance their time across risk management and expansion. Broadening lendable markets, eligible client domiciles and collateral options (such as a more complete range of collateral agents and eligible asset types, or a cash collateral solution) will be key over the next couple of years. Equally important will be an ongoing strengthening of the risk management tools and operating models to ensure that CCPs can withstand the impact of significant lending balances—for example, developing a higher level of automation for voluntary corporate action processing. Finally, CCPs should continue to work with industry bodies and policymakers, consistently articulating the valueproposition where the existing regulatory framework is preventing buy-side clients (such as UCITS) from participating.

Schreyer: Long term, I feel the ability to provide connectivity to the CCP by different means and by market standard messaging should be considered. The continued development of the securities lending platform through evolution with the industry should and needs to continue, an area that Eurex has been excellent in to date. The expansion of the securities lending market profile is a key factor for continued growth. Finally, a simpler legal structure will be important if more counterparties are to join the platform with a more reasonable lead time.