Swiss market forum
Ueli von Burg, Zürcher Kantonalbank Well, it definitely has changed. Otherwise we wouldn't be sitting here today. Zurcher Kantonalbank (ZKB) started its programme in 1993 as a lending agent. We saw in 1999, after a written business case, that it's important to act as a principal and to offer the service to an expanded range of clients, and we moved into the trading area at ZKB. Collateral Trading became more and more of a benefit for the banking oversight with its support on the risk, equity capital and liquidity management side. It also helped the growth of internal trading areas.
Because of this tactical view of our desk, we're now at a stage where we have to move forward for our clients our counterparties and our bank. That's why we have introduced a new strategy – we will turn our Collateral Trading desk into a Prime Finance Desk. We're going to massively increase the existing products, while also offering the synthetic finance side. Acting as a central Prime Finance Desk we will be able to quickly react to complete customized solutions for our clients and counterparties out of one desk.
Roger Widmer, Bank Julius Baer From Julius Baer's perspective, from the outset securities lending has always been a respected business, and I'm quite confident that it will gain in importance in the near future. We now have the green light from the board for a software upgrade and this should give the desk a further boost.
Patrick Keller, Clariden Leu Clariden Leu introduced securities lending in 1990. I think the market was perhaps not aware that the smaller Swiss banks had secured this lending and borrowing business, because of the vast size of both UBS and Credit Suisse. But as you can see here, we are five private banks including Eurex offering securities lending and borrowing (SLB) to the market. We are very much in the market and are offering it to the whole market as principals. And all Swiss private banks offering SLB in Switzerland are increasing their securities lending business. At Clariden Leu we are further strengthening the SLB business. And I understand that the other private banks have the same ambitions.
Jong Frochaux, Bank Vontobel Vontobel, with its Investment Banking unit has a strong focus in fixed income and equity derivative structured products. Therefore with its business model we have an important role to play and are actively involved in the trading process. On the whole the bank is managing CHF112 billion ($100.4 billion) AUM.
Chair Switzerland has always been a very asset-rich market and a big lender's market. Is it still a lender's market today?
Widmer Yes, I would say that it is. Swiss banks have got about $3,800 billion in assets under management, so from that perspective the chances of it being a lender's market are great. But I wouldn't say that there is an abundance of assets in general, we have witnessed shortages in various segments – even in Swiss government bonds.
von Burg I definitely think Switzerland is predominantly a lender's market. If you look at ZKB, bottom line we are a lender, even though things have changed during the last couple of years. Over the last five years we were able to increase fourfold the lending amount that we have outstanding with our counterparts. Our internal demand also grew strongly. Our prop-trading has increased sharply and we weren't able to cover the demand with our internal lending pool. So we have acted more and more as a borrower in the market. That is why we've advanced – especially on the bond side - to become a big borrower and hence an end-user. Speaking in numbers, we increased fivefold the external borrowing volumes.
Widmer I can agree that there has been this move towards borrowing in Switzerland. We have also seen domestic borrowing activities increasing, mainly generated by structured products, by quantitative trading or by hedge funds that have been freshly established in Switzerland. So, the demand is definitely growing in Switzerland as well as supply.
Keller It really depends on what you're looking at. On the equity side, yes we are a lender. But when it comes down to bonds, especially government bonds, and liquidity, we end up as a borrower from the market.
Frochaux I fully agree with the view that in general you have to treat securities lending in Switzerland as a lender's market, but every bank has a different set up and a different need with this business. We cover for our internal trading strategies either with in-house or external supply. In other words there is to a certain extent a borrowing market in Switzerland which could be further established amongst the local players.
Chair With Switzerland being such an asset-rich market, is there an oversupply in securities lending?
Keller I don't think so, because UK borrowers are still the predominant borrowers for Swiss lenders – especially with the demand they have for European equities. They often say 'your size is my size'. So, an oversupply coming out of Switzerland? It really depends to a degree on what particular security you're looking at. But the borrowers have such a huge demand for borrowing the stocks out of this country. I really don't think you can talk about an oversupply in the Swiss market. Oversupply might however be an issue for Swiss equities.
Frochaux In general for Switzerland, I still see further potential for growing this business. We are certainly not at a still see further potential for growing this business. We are certainly not at a standstill. Many Swiss pension funds and asset managers are today still reluctant to participate in any lending programme. I would say that one of the main reasons for this is that there is still a lack of understanding about the full scale of this lending business, and what its impact could be for their company and for the market.
Chair How involved do beneficial owners get in securities lending in Switzerland?
Keller Actually, once the private client has signed his lending contract, he becomes part of our lending pool. So all he sees is that we have borrowed an asset from him or have returned one to him, and the fee by the end of the year. But the private client does not have anything to do with the securities lending and borrowing himself, as we act as principal in the interest of the client and we are the principal against the market.
Frochaux This is more a question of how you act legally – whether your status is of principal or agent in nature – and it doesn't differ much in Switzerland to other countries. In certain aspects, with both a principal and an agent, the beneficial owners have to be involved in the business. But from an operational point of view, dealing with an agent would require a bit more involvement from the beneficial owner, such as the active involvement of the underlying client with agreements, credit limits, risk management processes, etc.
With the current rather nervous markets we are witnessing, a lot of noise has been created from the investors. And the problem here, when we come down to it, is education. We need to involve them even more in order to increase the investor's confidence in its investment decision with securities lending.
von Burg With regards to how involved Swiss beneficial owners are. We aim for closer contact with our bigger clients. We communicate more, get them detailed reportings, we find solutions for and with them for example on new products and we also go by to visit and address market updates. Unfortunately, we don't have the same approach with smaller clients. Besides providing transparent and traceable reporting we look to take everything away from them and get the processes as smooth as possible, so that they only need to sign the contract and receive the earnings.
Widmer What we have experienced, is that institutional clients in particular have become more prudent in the wake of the credit crisis. One has to consider that for an institutional investor, for a bond portfolio it normally means a deterioration of the risk profile. With all the collateral upgrades that are out there, these clients actually move down on the credit quality curve and they are now paying more attention to that risk reward ratio. For these reasons, a few clients have actually cut down their lending size or even cancelled agreements.
von Burg That is quite an interesting point as that is why market spreads have moved up so fast. You've not only had clients cancelling their securities lending agreements, you've also had the risk appetite of lenders drop in the market, the collateral schedules have tightened, and on the other hand you Gonzalez As I said before, the users of Eurex SecLend decide how far they want to go with their level of transparency. For example, a bank decides what and to whom to expose the bank's lending and borrowing demand, so you don't show everything to the entire market at once. We have incorporated that model, because we know that that's the way the market works. Of course, whether a bank changes the work flow or not, this is an internal matter and the way traders work may also change processes. By balancing the tradeoffs and benefits against each other and then deciding.
A trade may be made very quickly over the phone, but the post trade process is then a time consuming, manual process with many complex steps involved. This is certainly not the trader's problem; it's more of an overall banks issue, or a back office issue. Generally speaking, I think it would free up traders' time for market screening and opportunity allocation rather then answering back office phone calls for clarification of processing issues.
von Burg It's a good point from Jong, but we need more than just price transparency for adequate overall transparency. The whole reporting side, the education and a traceable view is also very important and will mean transparency for the beneficial owner. Also, you need to have a good platform which is representative of the market. I don't think that Switzerland is big enough to display a representative market in all kinds of asset allocation. That's why it's good that you have the strategy to go outside of Switzerland and also get the big brokers/borrowers on the platform.
Gonzalez Let's come back to fact that the data's actually provided through the extras in the market. It's the actor; the bank or the prime broker. They are providing this data to these data providers. This is good, so traders know where the prices are in the market. But on the other hand, I think it's not yet a consolidated view, it's not like a market feed for the exchange, as an example. It's still quite far from that kind of standardisation.
von Burg I think there are many more parameters that go with the price. It's the risk appetite/counterparty risk; it's the question of how is the counterparty working? How is their mid-office working? How is their back office working? Have we had other problems in the past? What is the special/GC ratio? How is the overall relationship?
And as was mentioned, it's a GC market that surely can be automated and put on a platform. But there is the special market as well – both are related to each other.
Gonzalez Yes. So if you have standardisation, 50% of the problems go away. If you have an integrated solution, 99% of problems, including back office problems, go away. But this is a view for the future. That is the bigger view and the question is – is the market ready to adopt this with this outcome, in the end?
von Burg I think it's not just about the beneficial owners, it's also about your credit risk people, and if you do it in a standardised form then you can maybe someday get the settlement risk out of the way – that would improve the market in a big way on the supply side.
Widmer I would like to add something about transparency. What does it mean exactly? Price transparency doesn't necessarily mean a whole lot, since we live in such a multi-faceted environment and as Ueli said, there are a lot of parameters that have to be considered with this. And who wants transparency? What kind of transparency is there and who offers it? These are delicate questions. On the equity cash trading side we have price transparency, but even there with new platforms such as Turquoise and Chi-X having started, we see transparency disappearing through the establishment of so called 'dark pools'. I am not sure if increased transparency would improve trading and market volumes. To reach transparency in our business goes far beyond price transparency.
von Burg It's a big word.
Chair With trading specials. What would be lost by going onto a platform and doing things in a more transparent way?
Keller With everybody on a platform SLB wouldn't be a people's business anymore because you could deal every trade through this platform. But in the SLB market people still want to talk to each other, the direct and personal contact with colleagues and partners is very important. If you deal purely on a platform you wouldn't lose a trade but you would lose the personal contacts. It wouldn't result in any big difference in the results of the business – like with the balance sheets, the prices, etc. As we heard before, it's not purely the price the business is about. It's all that comes with it.
Widmer Regarding the standardisation and automation that we're talking about – securities lending is a people's business, but that doesn't necessarily mean that we cannot trade on electronic platforms. In my opinion, it all eventually comes down to efficiency. And standardisation as well as automation enhances efficiency.
Gonzalez It integrates risk, operational risk at least.
Widmer So I think that the way clearly leads us towards automation, standardisation and, yes, eventually probably fully integrated trading platforms. That doesn't prevent us from having a people's business or a good relationship.
Keller You wouldn't lose any business when you deal through a platform. You just have to get this into the heads of the traders. A lot of traders prefer personal contacts, they want to talk and trade.... At the end of the day they wouldn't lose any deals. It comes down to efficiency, as Roger said. You will simply be able to enter the trade and the deal is done.
Gonzalez But again, it's education, it's culture. People want to continue the way they have done things in the past, with no change at all. We create a change ultimately – like everything changes in life. But we are not saying that it's the only way or the only route to such a market. There are many routes, many different strategies, options, and ways to go and trade, to reach counterparties. This is certainly one and it's an interesting one. The market has to be clear at what scale it can be used and what is beneficial for the market, and that's what we aim to provide; of course – a benefit to the market.
Chair Could a central counterparty (CCP) be introduced in Switzerland to securities lending?
Frochaux With all the efforts and improvements put into systems such as data providing, electronic trading, and reporting, etc – this is the forerunner for a CCP. On the bottom line a CCP will minimize business processes for better controlling and maximizing of efficiency in trading.
Gonzalez Yes, and then really with a CCP you've lost everything bilateral and everything has to be standardised to a high degree.
Widmer I find that from a standardisation point of view it's definitely a good thing. From collateral management and risk management point of view it could also be a plus.
Gonzalez There are some benefits, like you said Roger, but the question is whether the market would embrace such a solution. At present it is unlikely, but maybe in five years or so. It will be a huge step. If you talk about automation and standardisation or transparency, that is one thing, but a CCP is another story.
Widmer I would say that for every bank from an operational point of view, they could benefit as well. Billing, collateral management, risk management – all that could be outsourced and be provided by a CCP.
Gonzalez If you went ahead with a CCP, then basically the entire industry would benefit and all sorts of financial institutions could actually join this CCP market. You wouldn't know who the other side is that you're trading with. It could be any type of institution, including a hedge fund of pension fund or whatever. It is a really large step in the sense of not knowing the counterparty in this anonymous model. Yes there are legal issues, but we are thinking along these lines for the future, working on future solutions and market models also for securities lending. One has to think years before it could happen – how these future solutions could be structured.
Chair Now, we've already touched on this a few times. But what specifically has been the impact of the subprime crisis on the Swiss market?
Frochaux The subprime crisis has proven one more time that good collateral quality with liquidity including cash is essential these days. In the past few months the demand for this has been tremendous. On the one hand we as a lender have been able to take advantage of the higher fees paid for bond and cash transactions. On the other hand for the borrowers, financing costs have heavily increased. For us it is important to know with whom we do business – our business partner's profile, history, rating, financials, and reputation, etc.
von Burg I can state the same for our desk. As a triple-A bank we received cash. On the other hand we have also seen that the consolidation of the financial market participants, with the regulatory environment, in the area of equity capital and risk, led to a decline in the uncovered money market, which was very good for the bilateral repo/repo side.
Widmer As mentioned before, as a result of the crisis we have seen clients, private clients as well as institutional clients, becoming more interested in the mechanism of securities lending and the entire credit play. They have become much more aware of what could happen and are asking many more questions.
von Burg This is not just on the client side; it's also on the risk management side. They are really looking closely at what's in our collection mix and what really shouldn't be in there. The biggest benefit from the crisis that I have found, is that good quality Swiss bonds and government bonds in general are finally getting a fair price – they were traded way below a fair price over the last couple of years against equities, for example.
Keller Yes, that is what we have seen as well, especially on the US treasury side. Spreads and the lending rates went up. They have recently come down a little bit, but they're still on a high level. Also, with Swiss government bonds, securities lending fees at least came to levels with which we can deal, and it's not just a service for the market. That's the main impact that we saw during the crisis – spreads and levels just went up.
von Burg Which is important for the market and it should stay that way. You said that it recently came down a little bit. I think it will be higher for the future, not just because of a higher demand, but also because people are starting to realise; 'If I give away a good qualified bond and I take into account an equity and the market is going down because of a counterparty default, I can't just walk away with a black zero. I would lose money and maybe more money than I made during the whole year'. This is not just in the heads of risk managers but also in the heads of traders.
Widmer We saw a level of utilisation of our assets that we have never seen before. A further impact is that the risk managers are really going through the eligibility criteria. They are tightening the collateral schedules and that's something that the borrowers apparently don't like. Credit officers will be watching the market very closely in the future and this scrutiny will continue.
Frochaux Let's face it, no one really knows whether the subprime crisis has reached its peak or how tense the aftermath reaction in the market will be. But if we keep our collateral schedule tied within our risk parameters, we are optimistic that we will see further growth in this business.
