Constant change in prime brokerage shines the spotlight on proven, trusted partners

In the midst of ongoing change in the prime brokerage industry, participants face a wide range of issues, from fluctuating financial resource availability to rising cost pressures. Paul McGuigan, Scotiabank’s European Head of Securities Lending, describes how the Canadian bank’s Prime Services business has continued to grow and differentiate itself, despite the trends impacting the industry.

Over a decade on from the Global Financial Crisis, the ongoing impact of regulation on the industry can still be felt. Whilst some Prime Brokers have rebased their businesses to operate more efficiently in light of the limitations banks have imposed on financial resource consumption, others have reached a point where exiting from the market was the ultimate conclusion. The number of committed participants continues to evolve and as such, hedge funds give thought to what makes a suitable long-term partner.

Across the industry, we have observed softer funding markets, revenue shortfalls across prime brokers and lenders, and a focus on cost reduction and regulatory compliance, as well as growing interest in Environmental and Social Governance (ESG) matters. All of this, alongside tightening spreads in the financing markets, Brexit uncertainty and global trade wars, have created a muted European deal space and a difficult year for many prime brokerage participants, prompting some to scale back their services.

A Canadian view of dynamic global markets

I have been fortunate to observe this activity from the vantage point of Scotiabank, Canada’s international bank and a leading financial services provider in the Americas. Scotiabank has been offering prime brokerage services for more than 15 years, initially in Canada and later launching a global offering. In that time, the prime brokerage industry has undergone much change, yet Scotiabank’s commitment to servicing clients has been unwavering. Scotiabank has continued to invest in people and technology, with the goal of improving the client experience. The result: a multi-product, cross asset platform with a global team of vast experience. Our European prime services team, for example, has an average of 15 years market experience. Most of our team members joined Scotiabank from larger prime brokers, bringing invaluable expertise that enables us to apply best practices, while offering a high-touch service and better execution for our clients. This was highlighted in the recent global custodian prime brokerage report where one client commented on Scotiabank: ‘excellent improvements made in automation and tech in the stock loan space.’

Through our Global Banking and Markets division, we offer international prime services, with regional desks providing local expertise and coverage in Toronto, New York, London and Singapore. Over the last five years, we have greatly expanded our European and Asian offering and while our team’s core aim has been to service our Americas clients globally, we also offer access to European and Asian clients and provide local expertise on a regional basis. Scotiabank’s Prime Services international growth has been driven by leveraging our strength in the Americas where we are one of the leading wholesale banks.

The strength and diverse experience of the team has been advantageous when onboarding clients and integrating systems. As the regulatory landscape changes and client needs evolve, Scotiabank built a scalable offering from the outset, rather than solving for silos or having to re-engineer outdated systems and processes. For example, in Europe we recently launched our low-touch equity execution product, which significantly expands the breadth of clients we can service. Our disciplined institutional culture has enabled Scotiabank to grow in a sustainable and measured manner. We believe that our clients take comfort in the fact that they can depend on Scotiabank to service their needs long into the future.

The Bank’s ongoing commitment has also enabled us to expand our offerings. For example, we have focused on improving our securities lending capabilities within Europe, enhancing our local client offering while introducing new supply avenues and new trading opportunities for the global desks and our clients.

Scotiabank’s strong credit rating allows us to gain access to supply from beneficial owners who only wish to have exposure to highly-rated Canadian banks. This is a notable differentiator for our international business. Additionally, we have successfully opened pockets of un-utilised European beneficial owner supply for the Americas and Asia, with significant success in the Canadian and Latin American markets. This has led to a material improvement in the breadth, size and stability of our supply and we continue to improve globally relative to the largest prime brokers.

In tandem, we have significantly improved our collateral management and operational efficiencies to ensure we provide a low touch, seamless and competitive execution for clients. We have upgraded our internal systems to manage inventory and risk and adopted external vendor solutions for client service optimization and efficiency. Scotiabank has partnered with several leading FinTech providers and is committed to improving our architecture and implementing new technologies to boost efficiency, enhance service delivery and ensure client scalability.

An eye on securities lending market trends

We see several trends in the securities lending market that merit close attention:

Reduced agency lending revenue: It is well reported that revenues for many agency lending programs are down. Consequently, we are fielding more requests to add balances and trade flow. This can be difficult without significant improvement in levels, optimal risk weighting, beneficial collateral profiles or improved stability for our underlying clients. At the same time, we have seen increased rate pressure on securities trading special. As agency lending programs seek to extract more and more value from their underlying securities, they face the danger of having a negative longer-term impact. Some clients have already moved away from trading securities with small or concentrated lending pools due to the increased risk of recalls or aggressive rate movements. Increasingly, clients need comfort when securing a loan that it will be stable in size and rate.

Bottom line costs drive efficiency programs: The recent revenue pressures have been industry-wide and led many firms to improve and streamline operational flows with the aim of reducing bottom line costs. As a result, we have seen an increase in the adoption of vendor solutions for straight through processing, a move away from bilateral collateralisation, firms exploring omnibus structures and a reduction in the facilitation of lower notional trade flows.

Collateral expansion evident: This continues to be a significant differentiator for beneficial owners and agency lending programs. We have witnessed further moves to non-cash collateral, and exploratory moves down the collateral curve. Those who moved have benefited from additional trade flow and revenue capture. As global lendable assets continue to grow, and competition increases with transparency, beneficial owners who differentiate themselves via their collateral will be well placed. In addition, with the ongoing roll out of the Standard Initial Margin Model; Phase V (September 2020) and Phase VI (September 2020), creating a further drain on resources, broad collateral acceptance and the ability to mobilise assets will be of greater importance. Consequently, the available tools and capabilities of a tri-party agent are paramount. The ability to be versatile, nimble and quick to implement will be essential and critical to the market’s well-being.

Continued regulatory demands: Although the pending implementation of the Securities Financing Transaction Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) results operational changes and technology investments, these regulations will greatly benefit the industry. Over time, they will ensure best practice, increased levels of standardization, improvements in market settlement and behaviour and, ultimately, improve the experience for all participants.

ESG gains momentum: ESG criteria are gaining influence within Prime Brokerage. We have seen an increased number of ESG funds come to market, additional restrictions on securities lending, and related amendments to collateral profiles. Scotiabank is supportive of this movement and recently boosted its sustainability commitment by closing our inaugural Green Bond issuance in Canada. In addition, Scotiabank London has implemented an ESG initiative, focused on delivering on clients’ increasing focus in this space. We have an ESG-themed week planned in December 2019 which will incorporate a buy-side roundtable.

Consolidation drives clients to elite providers: Finally, as the securities lending market continues to evolve, automation improves, and transparency increases, there will likely be further amalgamation of businesses, operations and trading teams across the industry.

While these changes can be unsettling, significant upside remains. The flexibility and fluidity that securities lending offers will ensure that committed providers who have the support and capacity will continue to develop and broaden their businesses. Scotiabank continues to demonstrate commitment to the securities lending market, in recognition of the value it brings to our clients and shar eholders. We continue to deepen our client relationships by applying our securities lending platform to deliver effective and innovative client solutions.

With this commitment, an exceptional team and a thoughtful and measured approach to growth, Scotiabank Prime Services is a solid, trusted partner in an ever-changing landscape.