On July 2, 2020, experts from the beneficial owner, agent lender and data provider community gathered to discuss some of the key issues influencing the European securities lending market. Here, we present some of the highlights from the roundtable discussion.

Chair: What key trends have shaped the European securities lending market in 2020?

DIMITRI ARLANDO: Looking at the beneficial owner breakdown in terms of the average lendable balances in 2020, collective investment vehicles accounted for 44% of the total lendable assets. Pension plans and government entities also contributed significantly to the lendable. However, when you look at the breakdown of loan balances you can see that collective investment vehicles account for only 22% of the actual amount on loan, with pension plans (34%) and government entities (29%) having more on loan in 2020. That’s not surprising because collective investment schemes tend to operate under much more conservative guidelines so you would expect to see this.

If we look at revenue now, global revenue is down 14% in the first half of 2020 compared to the first half of 2019, $3.89 billion is the total revenue so far this year. It’s important to highlight that this figure is based on loans from lenders to brokers and doesn’t include any revenue from broker to broker loans. This is a truer reflection of the actual value that beneficial owners are getting from securities lending.

In EMEA, revenue came in at $960 million, 33% lower than the same period in 2019. This was mainly driven by the impact of COVID-19 where we’ve seen declining market valuations, short-selling bans, dividend postponements and cancellations all contributing to that lower revenue number.

If we move on to look at the EMEA equity fees, you can see that this year on 25 March EMEA equities averaged 44 basis points, that was the lowest value at any point in the last three years. In calculating this, we remove the seasonal specials activity so we can better understand the impact of the current market conditions. From that low point in March fees have steadily risen, and that’s because of the temporary short-selling bans not being renewed and some COVID-related specials also coming into play over the last couple of months, but year-on-year clearly 2020 has seen less specials activity and lower fees compared to the same period in 2019.

Looking at EMEA fixed income, the fees are a lot lower than the equity market but again we’ve seen a rise in fees from March of this year, not surprising because the demand for high-quality liquid assets in times of market stress is always going to be higher and fees have increased as a result.

If we break the revenue numbers down further and look at the contribution from each of the different rate bands, looking at equities in EMEA first, both in 2019 and 2020, specials activity has been the largest contributor to revenue, in fact for both years over 40% of total revenue has come from trades with fees of over 500 basis points. If we look at fixed income, it’s almost the reverse where most of the activity comes from the GC market. Most activity is below 25 basis points, again not surprising given the way that the fixed income market trades.

Looking a little bit deeper at the top five securities for EMEA this year, Wirecard dominates, but then we also see some of the COVID related specials. Obviously the transport industry has struggled in recent months, so we can see that airlines, and in this case Lufthansa specifically, experiencing high demand. With oil prices being so low it’s not a surprise to see Total also experiencing high demand in the lending market.

Looking at Wirecard in a little bit more detail, there’s been a lot of interest in this particular security even before this year. You can see the utilisation through the early part of 2019 was high and then dropped as the year progressed. However, from October 2019 utilisation levels have risen dramatically again, and in more recent weeks fees have started to spike as well. This is a result of the company going into administration due to alleged fraudulent accounting, which has meant that short interest in the security has been high. Short sellers tend to get a lot of bad press, however in this case perhaps they should just get some praise for helping to unearth the wrongdoings at Wirecard. This might be a factor that ESG investors may want to take into account in the future, as in this case short selling Wirecard certainly does fall into the governance pillar for ESG.

Chair: Nick, do you want to talk to us about what you’ve seen from an agent lender perspective?

NICK DAVIS: From a European markets perspective, it’s been a split journey. At the start of the year, the hedge fund environment remained challenged, we saw continued outflows which impacted spreads, and this was followed by a slowdown in short activity and specials. When COVID 19 gathered pace in late January it fuelled a market sell-off globally. As the volatility increased we saw temporary short selling bans across EMEA and APAC, company dividends were either omitted or postponed. Some companies replaced their cash dividends with scrips, which helpedfuel demand.

March saw a divergence in Hedge Fund activity. Quant Funds were deleveraging due to market volatility, while Global Macro Funds fared better and that’s where we have seen the increase in balances. Specials started to increase in specific sectors such as Airlines and Travel. As we moved into the second quarter, short selling restrictions were lifted across EMEA and APAC for the majority of markets.

Finally, Fixed Income saw an increased demand in US Treasuries due to Money Market Fund demand and overall dislocations due to volatility and increased specials in Emerging Markets, Sovereigns and the corporate space.

Chair: Dongyi, can you give us some insight from a beneficial owner perspective and how you’ve been tackling this pandemic?

DONGYI YIN: As Dimitri mentioned earlier, the lending revenues have dropped during the COVID crisis; we can say that short selling bans have also intensified the downwards impact on lending revenues. However, in our case we have a lot of exclusive agreements with our borrowers on a yearly basis so we have some protection from the COVID crisis, but it also takes the upside of the market volatility. In the end we have chosen exclusive agreements since we want to have guaranteed revenues for our clients, and that has protected us quite well from this crisis. In the end we can see recovery in the market, and we also see it in our lending revenues. We see that the market volatility in our portfolios is becoming a bit less, and we also see that since the short selling bans were lifted that it has some positive impact on our equity portfolios.

NICK DAVIS: Just to add, from an Agent Lender and Beneficial Owner perspective, the main focus from both parties were risk; Operational, settlement and collateral. Clients wanted assurance that there was no collateral exposure during this period of volatility, and that the settlement rate remained high to reduce any fails despite the increase in volume that Agent Lenders were experiencing.  This was a priority for J.P Morgan and managed accordingly to ensure that the program ran without issue. 

Technology remains a focus, and because of the continued investment over the years, J.P Morgan’s Agent Lending & Collateral Management platform allowed us to service our clients through this period of extreme volatility, that we, and the rest of the market were experiencing.  As the market started to normalise and the level of risk to some extent subsided, the desk and client teams  focused on alpha generation such as collateral expansion, term and the alternative finance space to help clients who were either long or short cash. 

MATTHEW CHESSUM: I think that’s one of the big positives that anybody can take from this recent crisis, it appears that the mind set of beneficial owners remained vastly unchanged. During previous crises there has been beneficial owner movement, whether they’ve pulled out the market completely, whether they’ve sat on the side-lines and waited or whether they changed their guidelines. Most beneficial owners are probably more experienced now in comparison to before; they’re likely to have stronger controls in place and I think that many would argue that nothing much really changed for them. The only real topics of conversations regarding the recent COVID volatility was that the indemnity still holds value as it still provides a level of comfort and whether margin calls need to be done more frequently. Both the possibility of this and whether the market needs to move to more intraday pricing of both collateral and on loan positions remains an active conversation.

I believe that the industry’s proved itself to be very robust. If you look at securities finance in general, it fared a lot better than the repo market, and I think that’s because we’ve learnt our lessons from the past. There’s more protection in place, along with more robust procedures.  The level of risk mitigation that is in place surrounding  any securities lending transaction in comparison to many other market instruments was noticeable. I think that we were very well prepared.

It was a different type of crisis as well – it wasn’t a credit crisis – there wasn’t any fear about any participants going bankrupt and the associated contagion, which is probably one of the main drivers for a lot of beneficial owners pulling back previously. Here, it was more about ensuring that market sales completed in a timely manner and that both recalls and collateral settled on time. It proves  the robustness of the procedural operations that everybody now has in place, whether that’s agent lenders, whether it’s on the broker dealer side or whether it’s indeed on the beneficial owner’s side, along with the improvements in programme oversight that all of the above continued to function well throughout.

DONGYI YIN: That’s indeed true that as beneficial owners we have more confidence in our agent lenders than 12 years ago. We know that our agent lenders are healthy with a strong balance sheet, and we have very clear communication and we can have very clear conversations, honest conversations, so we know that we can tackle the whole crisis together.

STEVE KIELY: I just want to pick up on something Matt said, comparing the current conditions to the financial crisis of 12-13 years ago. This is different and whatever your view on the last crisis, whatever your political colour, etc., people generally accept there were issues within financial systems. Currently, the financial systems are reacting to external stimulus and I think, as we’ve heard from the beneficial owners so far, there’s a lot more confidence in the agent lenders and the market in general.

Chair: Steve, as agent lenders, what have you been doing to maintain and uphold those relationships with beneficial owners?

STEVE KIELY: The level of communication we’ve had with clients has been greater in the last four months than it has been in the last four years; because of the volatility we’ve had to have that extra communication and it’s influenced by the fact that nearly everyone’s working from home. I think for existing clients, the relationship has gotten deeper. As was mentioned just now, I think there’s even more trust between beneficial owners and their agent lenders than there was four or five months ago. You’ve got to look for the positives, and I think that is one of the real positives to come out of this.

CATHRINE POULTON: We’re very much seeing the same, the engagement with our clients throughout the crisis has been fantastic, we’ve had extensive feedback from them, extensive meetings with them, lots of information flow. What’s stuck for me throughout the crisis is that they are very confident with the programme despite seeing this level of volatility, the markets have been relatively stable, we’ve been able to deliver on what we needed to deliver, we’ve managed in a risk averse manner. I think as well, taking it more to the human dynamic, a lot of those relationships we have with our beneficial owners have become much more humanised – we’re on video calls with them in their home with their families and I think that has really added value to our beneficial owner relationships. I think there are definite positives that are coming out of us almost having to go into this crisis scenario. I think underlying all of that, what’s very clear to everyone is the most important thing is that everyone is safe and healthy.

DIMITRI ARLANDO: Just to add from a data perspective, I think that’s really helped both sides – beneficial owners and agent lenders. We’ve certainly seen a thirst for data over the last few months. We release daily market updates, and the feedback from that has been extremely positive and appreciative as well, but more so the requests for different cuts of the data that we’re getting from both beneficial owners and agent lenders has increased significantly.

Interestingly, some of the beneficial owner community have come to us and asked to see different types of screens than they would normally look at, and I’m talking about the screens that we typically see trading desks using. To me that says the beneficial owner community are really engaged in their programmes, and want to really understand the drivers behind the performance in the current environment.

FUAD AHMED: One of the big drivers is an increased interest from senior management, where six months ago perhaps they weren’t so interested in securities lending, but I think given recent events there’s been a lot of focus around collateral exposures, counterparty exposures and the like and making sure that we’re on top of it and able to communicate upwards quite clearly what that risk profile looks like.

STEVE KIELY: Catherine, to your point you made earlier on, I’ve got no empirical evidence – it’s just anecdotal – but I think there has been a far greater willingness to pick up the phone and speak to people than just send emails since we’ve all been at home and since we’ve all been in this environment. Amen to that, long may that continue.

MATTHEW CHESSUM: This all comes down to engagement and that’s one of the good things that came out of the last financial crisis, participants are more engaged, beneficial owners are more engaged, as well as, I dare to say, agent lenders are now more engaged with their beneficial owners as well. This enhanced level of engagement will help to develop market activity going into the rest of the year. It takes longer to put risk on than it does to take risk off, which is why revenues might fall within the next few months. Moving forward however there is likely to be more corporate activity, it’s true that there may be fewer dividends but there will most likely also be more rights issues and more mergers and acquisitions opportunities. All of those are likely to create chances for beneficial owners in the second half of the year to add important incremental returns to their underlying investors.

NICK DAVIS: Collateral and settlement risk remain a key factor, with the majority of agent lenders having operational and trading platforms across the globe, with many working from home, and with settlement volumes up 100%, hearing the rest of the panel, I agree that it is a real testament of how the Securities Lending business has managed through this period.

DONGYI YIN: I also agree with deeper relationships between agent lenders and the beneficial owners. I don’t think that applies to all agent lenders, because in times of crisis it’s an opportunity for agent lenders to prove their abilities, and if an agent lender really supports the beneficial owners to control their risk and to keep their programme ongoing, we are gaining more trust, and we can also justify towards our senior managers or our board we have a really good agent lender who can also keep our programme ongoing during the crisis.

We are also getting questions from our clients, especially during the crisis or equivalent situation. We want to make sure that our clients will be fully, timely and correctly informed. The first thing I am going to do is call my agent lenders to make sure that we have all relevant information for comprehensive responses. If the agent lender is supporting us, as a real agent lender has to, then we are gaining more trust in them, we are having more confidence and we are building our relationship to a higher level.

STEVE KIELY: But that’s a psychological phenomenon, adversity bonds people like success never can. I wouldn’t profess to go into it any more than that, but it’s a fact, adversity bonds people.

FUAD AHMED: I also think what has been helpful in the virtual environment is being able to bring my boss into the room for a half-hour catch up with the agent lender. Whereas, in the past, it would have been quite difficult to get time in his diary, get people in the right place, etc., it has been a lot easier to have conversations at a senior level. I think that’s helped with this kind of crisis; I don’t know if we would have been able to do that if we were back in the office for example.

CATHRINE POULTON: I think we really are in business-as-usual (BAU) again now, even though we have everyone working remotely, we are truly BAU; we’re functioning as if we were in the office in the old days, and I’m not sure that we will return to what used to be the norm.

I think there were two things that came out of Covid that have rung true for many years, and that presents opportunities for some of our beneficial owners if they are comfortable with their programmes or if the regulations allow. One of those is obviously around term – term trades remain in demand – and the other is around collateral. For those clients that have expansive collateral sets and have flexibility within them, throughout the crisis we have managed to get them into profitable trades. JGBs would be one that I would name, there has been some volatility around the basis there, for those clients that allow it we’ve managed to make some revenue for them by placing them into those trades.

So, I think for me there are two things – term and collateral – that we always talk to our beneficial owners around, and we always talk about the importance of the flexibility, but I think when markets are in turmoil or volatility and our brokers are demanding different types of trades from us, the more flexible you can be and the more trust you have in your agent lender to manage those exposures, obviously the most we can get from your portfolio.

FUAD AHMED: We are already in the term lending space, and with equity collateral as well. I think what has been helpful through the crisis has been flexibility on both sides. We’ve had to rebalance several portfolios given market movement, so that’s involved recalling some of those term lines and being creative and finding solutions for those relationships in order to be able to manage those positions.

CHAIR: Does this culture have longevity?

FUAD AHMED: I think things are getting back to normal, and we are constantly looking for new opportunities. Just because we are not in the office, does not mean things have to pause on that side. Things have settled down a little bit in the market, so we are happy to look at new opportunities.

STEVE KIELY: I am slightly concerned with one thing, and that is if I take my relationship management hat off where, as I have said, those relationships have deepened, and then I put a sales hat on, I think this virtual world makes forming new relationships more difficult. It is not impossible but I think it is more difficult. So, whilst we’re okay for now, if, worst case scenario, there are further lockdowns across the world, there are second or third waves of the Coronavirus and we’re having this same discussion this way in a year’s time, things might be a bit different.

CHAIR: We have witnessed a tremendous push towards peer-to-peer lending from various beneficial owners in the Americas, and they have recently formed a new association, which they are hoping to grow globally. Could a similar model be applied in Europe?

CATHRINE POULTON: I think peer-to-peer will be increasingly used in the next few years. Ultimately, peer-to-peer is around additional distribution away from the traditional banks and broker dealers that agent lenders have typically used. I think there’s a particularly interesting ESG angle to peer-to-peer, as we’ll go on to talk around ESG, one of the factors is around beneficial owners wanting to understand what their securities are being used for and potentially who’s borrowing them. One solution to that is to enter a peer-to-peer platform – you know where your securities are going, you know who’s borrowing them, and you effectively know what their ESG stance is. We deal with some large hedge fund clients within our Enhanced Custody business and our Direct Access Lending product links our Enhanced Custody product with our Agency Lending product, and some of those clients are very ESG conscious.

I think the reason why peer-to-peer hasn’t exploded is because of the infrastructure. If you don’t have those pipes already in-house, I think it’s very challenging for firms to stand up a platform that is efficient and effective. Ultimately, our hedge fund clients don’t want to take on additional operational duties, they want to deal with us in the same way that they always deal with us and hence we offer a managed platform for them. They are the challenges around peer-to-peer, but I do think in terms of distribution, in terms of financial resource management, in terms of ESG, I think that they’re great products. If people are comfortable with the risk appetite, again from a beneficial owner perspective, certainly within the State Street Direct Access Lending programme, our indemnity still stands, so from a beneficial owner perspective it’s additional distribution still with a highly-rated indemnity stood behind it.

MATTHEW CHESSUM: I think it’s always quite peculiar, when you look at asset managers in general, some have funds of funds and they manage and look at the credit quality of the underlying hedge funds for this business. However, when you ask them to look at peer-to-peer transactions through a securities lending lens they seem to find that very difficult to quantify as it seems to be a different computer system with a different risk modeller and everything else. It still seems to be quite a different world and the two haven’t really collided as yet.

The second point that I would make about the organisation in the US, is that these pension funds involved are of meaningful size, and the number of individual funds of similar critical mass are far fewer in Europe. I would therefore predict that the membership of that group in Europe will be less sought after. I can completely understand  why those participants have connected because if you look at the costs involved and the infrastructure required, it’s worth their while to engage in peer-to-peer activity to save costs. In Europe as beneficial owners tend to be  smaller, I think that the trade specific infrastructure through an agent or bank needs to be put in front of us for us to be able to engage fully, and we also need a bit more hand-holding.

STEVE KIELY: There are some big North American pension funds that are borrowers in a number of agent lender programmes, which you don’t really see outside of that area, so I absolutely agree with Matt there.

I think the peer-to-peer platforms that emerged a couple of years ago were trying to solve an issue, which was liquidity driven, where broker dealers were constrained, and there was an attempt to unlock that by almost disintermediating them and going peer-to-peer; that’s largely gone away now. Issues arising from the current situation are driven by volatility as opposed to credit or liquidity, but I still think there’s that hurdle to get over of the credit intermediation that is provided by the BNY Mellon or the State Street or the JP Morgan indemnification. I still think in Europe peers may be nervous of the risk of other peers, but I’ll be corrected by our beneficial owners.

FUAD AHMED: We have a very high bar to get something like this over the line, predominantly driven by regulatory requirements but also our own risk appetite. Generally, we take a very conservative approach and we wouldn’t really go into securities lending arrangements where we’re reliant on the indemnity. Our approach is very much to structure it so that the counterparty risk we’re comfortable with, the collateral exposure we’re going to be comfortable with, and the indemnity is there as a sort of backstop.

What kind of peer are we talking about? If it’s a hedge fund then that’s probably not likely to be approved by the board. If we can get over some of those hurdles there might be scope there to do something. Are the returns worth it? That’s the other side of the equation, so it all has to be weighed up in that way to decide if it’s worth prioritising.

DONGYI YIN: To be honest, I think there might be some opportunities for peer-to-peer, because in our case we are a pension fund and we are quite safe, and other pension funds have the same risk model, so I don’t really see a big counterparty risk if we are having peer-to-peer with other pension funds. However, we have to analyse the risk even when we have the same risk profiles, which is quite low. Most of our peers don’t have any credit rating, so that is something that we have to review and also have to discuss with our risk department.

If we are going to do peer-to-peer, I don’t believe that we are going to move our whole programme to peer-to-peer, however, it provides another option in an ever-evolving industry. I think that some of my colleagues are looking to the peer-to-peer part because it sounds quite interesting, and if we are looking at the fees, we are directly lending to our end users. This means we don’t have a borrower who is lending to our end user, so in the end we have a fee that we don’t have to share with a lot of other participants.

NICK DAVIS: As a business, we continue to develop and expand peer-to-peer through our Agency Prime model. In parallel with the peer-to-peer expansion we have also been focusing in the Alternative Financing space, and exploring liquidity solutions for our clients.

STEVE KIELY: My view would be, if it is going to gain traction the way that CCP gained traction then it’s more likely to be a platform which is backed by a big organisation, because what they can offer there is peer-to-peer and also do some of the heavy lifting, the operational work, etc., so that can be outsourced to an extent. But, as I said before, I think the credit and risk intermediation is still a hurdle that we haven’t properly got over to really move forward with this at speed.

MATTHEW CHESSUM: I would predict that this will probably come in stages. Beneficial owners would look at whether it was a possible source of either liquidity or counterparty diversification and what the associated risk requirements were. Additional repo counterparties, to take emphasis away from having 100% banks or additional cheaper and or stable sources of liquidity seem to be the main drivers for this activity. After this, I see securities lending as a secondary step where we’re comfortable with the transactions that we’re doing elsewhere within the organisation that actually bring us some strong tangible benefits, where we’re now comfortable with any ‘new’ sources of risk  so we are therefore comfortable entering it into the securities lending arena as well.

STEVE KIELY: It could be seasonal. It could be something where, the extra distribution at quarter end/year end comes into play a bit more to open up that extra channel, or it could be that beneficial owners will say, ‘When I want to earn money, where it’s an alpha driver, I’m going to lend through my agent, but where I want to do collateral transformation per se then maybe I’ll try that peer-to-peer.’

CATHRINE POULTON: I think different trades fit different structures, and I think ultimately with peer-to-peer you’re probably looking at volume-based GC. If you’re looking at specials trades, you want those to be handheld and you want your value maximised effectively, and effectively that’s what you’re using an agent for, so I think there is a time and a place for peer-to-peer. I think the only thing I would add around our peer-to-peer solutions are they are margined differently to typical agency business, so depending on who the counterparty is, the collateral margins and collateral itself, and obviously the way that we take that is aligned to the peer-to-peer structure, so that does work slightly differently to an agency programme.

CHAIR: Is securities lending compatible with environmental, social and governance investing?

MATTHEW CHESSUM: Yes, and absolutely this is what we set out to prove from the outset to be honest. There were many concerns circulating in different/various regions of the world saying that securities lending was not fully aligned with any kind of ESG strategy, but all of the beneficial owners that I spoke to were firmly in disagreement with that statement. That is how the ICSF came about; a number of beneficial owners came together and decided to create the principles for sustainable securities lending under the leadership of Radek Stech, who’s a senior law professor at the University of Exeter; he does a lot of work with sustainable finance and he was prepared to drive this project forward. So, after going through the process of forming these principles that we believed were the main areas of any ESG concerns in regards to lending securities, we came together and we published those principles, and then we formed the Council for Sustainable Finance to implement those principles within the market.

What the council has achieved so far I think is already quite powerful. We put those together 12 months ago, and to remain aligned with ESG developments the principles will continue to be updated. The conversation around ESG is very fluid and it’s a conversation that’s forever progressing. Everybody has a slightly different view on ESG; whether we all arrive at the same point or of the same opinion at some point in the future, I very much doubt it. I think it’s a very personal viewpoint within every organisation, I think every organisation views it slightly differently and puts the different amounts of emphasis on either the E, the S or the G.

The council has done a lot of work in regards to the G, the governance part of securities lending. What we’re looking to do in the near future is to add to that and look at the E and the S as well. Diversity and inclusion is obviously something that’s missing from the principles at this point in time and that’s something that will be addressed following the partnership with the London chapter of Women in Securities Finance.

CHAIR: Dimitri, what have you witnessed at DataLend?

DIMITRI ARLANDO: I think from a data perspective around ESG it’s a difficult one in terms of performance measurement because actually there are so many different elements of ESG it’s difficult to get a consistent framework in place. That’s why the work that Matt’s doing with ICSF, who we have partnered with as well, is vital. Without that consistency and a framework in place it is difficult to measure performance from a data perspective.

The important thing though is that it would appear clients with an ESG wrapper are in fact continuing to lend.

From a data perspective, we can help beneficial owners who want to see how they are performing against a universe of other clients or the industry in general. We can also help identify the true cost, in securities lending terms, of ESG, which I think is important because that then allows you to say, at a very high level, ‘If I weren’t an ESG investor maybe I would have earned X, but I’m okay with that because I have decided that ESG is more important to me than the additional revenue.’

DONGYI YIN: For us ESG awareness is becoming more relevant, and I think overall it’s becoming more important for the beneficial owners. We want to get more engaged in impact investing. We have created some ESG customised benchmarks for our portfolios, because we believe that we have to engage more with ESG-proof securities and parties, and this leads to a natural flow into the market of more ESG-proof securities in the lending markets.

We really want to support industry-wide methods of how we should do securities lending in an ESG-friendly way. Not long ago we became a member of ICSF. Also, internally we have some ESG policies, so we have an ESG team and they have an engagement list, those were the names which we actively engage with, so we are also actively voting for it; those shares are not going to be lent until the voting period is over. Those are all ways our programme protects ESG as much as possible.

NICK DAVIS: It’s going to be challenging both from a trading and collateral perspective. For trading, you’re going to have clients who want to vote therefore you need to make sure you have the platforms readily available to support that. From a collateral perspective, you can’t just create an ESG schedule and say, ‘this is going to be the standard ESG schedule across the lending businesses’. That strategy is not going to work as client’s will have a different ESG scoring to each other, and in the current environment this would mean separate collateral schedules. A possible solution would be for the Tri-Party agent to take in the collateral at the parent level and then split it out to make sure it meets the client’s ESG parameters.

In my view, I think there is continued work to be done from an Agent Lending perspective. Of course, it can be supported right now, but technology will play an important part in supporting ESG. ESG continues to gather pace and not just in Europe, we have clients globally asking about supporting our ESG functionality.

STEVE KIELY: I think ultimately the G of ESG, which mainly affects the securities on loan, and as an industry, we have seen greater automation around proxy voting and recalling shares for that purpose. The E and the S is more difficult to manage, pertaining to collateral, and I think ultimately this will be something that the big tri-party collateral agents are going to have to solve. As Nick said, it’s not easy because clients are interested in or impacted by different things, be it alcohol stocks, tech and aviation stocks that have defence contracts, tobacco, oil, all sorts of things, so it really is  diverse. I can’t remember who said it earlier, or they hinted at this, but everything’s doable. It‘s doable, but it costs; do you want to pay the price, yes or no? Potentially it’s a price that everyone consents to pay and is worth doing, but it’s not going to happen for free, there will be lost opportunity costs as a result.

FUAD AHMED: Yes, that’s the question for us, with respect to collateral sets I think the first question is should we be filtering out certain assets because we don’t invest in them from an ESG perspective? The second question is what is the impact of doing that? Will it actually impact the lending programme in a dramatic way?

Just to wind back, I’d like to also just reiterate that Phoenix is supportive of the ICSF, I think it’s a real positive to have a set of principles which we could all aspire to and work towards. In terms of our programme, I would say that investment management comes first, so from an ESG and responsible investing point of view that’s the way in, securities lending has to be consistent with that, so issues around tax or the correct tax treatment and voting, that’s never been an issue for us, it’s always been our policy to make sure we’re doing the right thing for our policy holders so that they’re paying the right tax rates, etc. and getting the right level of return.

CATHRINE POULTON: To your original question Oliver, is ESG compatible with securities lending? Absolutely. We very much welcome the work of the ICSF and the Principles for Sustainable Securities Lending. I think that will very much help both from an agent lender standpoint - be able to facilitate our beneficial owners complying with those principles. I think as well, we’re trying to enable our beneficial owners with answers to questions they may have. For example, are short sellers negatively impacting my long portfolio value or my long-term investment strategy? We’ve tried to take an academic approach to that, and we’ve worked with our State Street Associates arm to launch some research papers around that, that have established some empirical evidence around short selling effectively not having a detrimental impact on long-term value. For our beneficial owners to be able to see and to understand really that there is now proven evidence that it doesn’t impact the underlying portfolio value in the long term.

I think from the ESG angle, there’s a lot of discussion around whether we should be supporting short sellers. We’ve seen what’s happened in Wirecard, the short sellers identified potential issues a while ago, they identified that something was not quite right there around the governance of that company. I think there is a lot of traction building and a lot of conversation around, not whether we should stop short selling, but whether we should encourage it, because that is how investors can take a view on ESG-compliant companies. I think that’s a very interesting angle that we’re seeing, there has always been this historical challenge around short selling but now we enter the ESG world again and we are looking for empirical arm’s-length evidence and research to substantiate those points, and I do think that from an ESG standpoint, investors should take short positions on companies to show their intent and what they believe is happening there.

MATTHEW CHESSUM: It’s opinions that make market prices, whether that’s positive or negative, that’s what forms the pricing points and that’s why it’s important.

CHAIR: How is demand going to change once the Securities Financing Transactions Regulation is live?

CATHRINE POULTON: What’s very important is we are live in some aspects and we’re due to go live with a lot of our beneficial owners very shortly. From where I sit everything is in hand, I’m not worried.

What is interesting is what will happen once that SFTR data is out there and once our prime brokers or our end users can start to analyse that data. The interesting dynamic here is, and this probably links back to Dimitri’s original slide around the lendable assets in certain client categories versus the on-loan balances, that SFTR may make those statistics even more staggering. When we start to look at SFTR and we see that data coming in same day, we see our borrowers being able to identify who they want to borrow from in terms of their LEI’s, their RWA weightings and their domiciles, it gives them a lot more data upfront to be able to manage their risk positions, to manage their financial resources and to ultimately decide who they want to borrow from.

Now, the regulations don’t allow for some of our clients to be as competitive as others, but I think SFTR will start to bring a lot more of those discussions to the fold around who are good clients, for want of a better word, and who are the more challenging clients? Ultimately, where is the demand going to go?

MATTHEW CHESSUM: I want to know whether we’re going to see all of the data, I want to know whether we’re going to see the rates that banks are lending to hedge funds to and the rates that beneficial owners are lending through their agent lenders. If we see the other side of the coin then that would make for an interesting conversation. If that means that beneficial owners get better pricing, then that’s a good thing, but if we could see the differential between the two, then I think we’re going to be in a more powerful position than we’ve ever been in.

The other point I would make is, SFTR has been live for many beneficial owners for many months now and in the back of every annual and semi annual report for a UCITS fund there’s a table that will tell you the top ten borrowers, the top ten stocks on loan, the top ten pieces of collateral, which has been designed to add further transparency.

The last point I would make is that if this brings us out of the shadows, if you like, and into the clear light of day from a regulatory perspective, then it can only be positive. I think going forward, from an industry point of view, getting over that last hurdle of implementation and getting that data out there and into the mega-frames of the regulators helps the reputation of the market as a whole.

STEVE KIELY: I think Matt’s right on that – any level of transparency is generally a force for good. I think the industry needed to do this, we needed to show that we could do it and we would do it, and I think that will have positive repercussions. I think the pricing that Matt talks about is interesting and that could lead to some positive outcomes. My only concern, and it’s something that’s already happened, is that there are a number of smaller agent lenders and a number of self-lenders that pulled out the market because they just found SFTR too difficult to implement, and I think that’s a bit of a shame in that it’s concentrated more of the market traffic through the larger players. You’d probably not expect me to say that as one of the larger players, but I just think from a competitive perspective it’s a negative.

CHAIR: How can we leverage technology to streamline and improve securities lending?

DIMITRI ARLANDO: Everybody here seems to be in agreement that we’re at BAU. Looking back to March and the start of lockdown period, where a lot of us were shifted from office environments to working from home, we actually saw record levels of activity on our trading platform, NGT. We actually had a one-day record in March where $170 billion of notional was executed on the platform. I think that just goes to show that people had to rely on technology during this time of disruption and because it was so robust, they had confidence and continued to trade. That shift to electronic trading isn’t new, NGT has been in existence for a number of years now and there has been a steady increase of activity on the platform but the peak was interesting.

Aside from trading, from our perspective there’s been a lot of interest in data coming directly onto clients’ trading screens as well. We’ve had a lot of demand for our API and file transfers specifically so that clients can allow traders to see data instantly on their front-end screens when they’re making trading decisions; that’s been increasing a trend.

At EquiLend, we also understand that artificial intelligence and machine learning are going to play a really big part in how we run our businesses in the future. Our data science team has done a lot of work in the post-trade environment and created a beta product for post-trade, but we’re also now speaking to our clients to see how our data can be incorporated into their own machine learning and artificial intelligence initiatives.

DONGYI YIN: Overall, we see that artificial intelligence and automation are currently the keywords in improving operations. Especially in the securities finance world we see more usage of artificial intelligence in the front office, at the trading desk, and also at the agent lenders we see some development of using more artificial intelligence so they can focus more on revenue maximising opportunities like specials, and then they can just use the algorithm for their GC. We also see a lot of automation, and that’s more in the mid and back office parts in the securities finance world, and that has more to do with making the processes more efficient, integrated, and they are purchasing new systems to make it more flexible, and in the end we have the result that all the processes are more efficient and less time consuming. So, in the end we see the development at the buy-side part but also at the sell-side, so I think that the combination is very good for having more efficient lifecycle.

FUAD AHMED: Fundamentally, all I care about is returns on the programme, so if technology could be utilised in a way to boost the returns and do that in a better, controlled way which reduces operational risks as well, then that’s great, we’re all for that.

STEVE KIELY: We’ve now got fewer than 30 traders worldwide and we’re doing up to 10,000 trades a day. We couldn’t do it without technology, and we couldn’t do it without our front-end system. We’re doing this today to an extent, but in future we will likely see even more automation so that traders will be looking at fewer and fewer trades and concentrating on the trades that require their input - it’s absolutely the way forward.

CATHRINE POULTON: I think we’ve got two factors almost going on here - we’ve obviously got our front office developments where we are trying to maximise revenue for our beneficial owners, so really what we’re looking at there is machine learning, artificial intelligence and predictive pricing. We’ve got teams of people within our trading teams, very similar to what Steve said, we’re moving away from traditional trading to more algorithmic, smart trading effectively to  get the most value from those portfolios, so that’s the very interesting piece that’s going on in our front end.

Then, away from that, we’ve always been very focused on operational efficiency, if we can do things faster and more efficiently that’s exactly what we’re going to do. I’ll reiterate what Steve said as well, using platforms like NGT in our front office, using some of the platforms within our operations teams to make it more streamlined, all of those are very welcome and we consistently work on those. This is something that SFTR and CSDR is also helping with, so it’s very much helping with the efficiencies, it’s very much helping with operational smoothness, and I think that’s really where we have to go. We have to make this a much more STP, for want of a better word, operation and market.

FUAD AHMED: Just a question on that in terms of the automation and the straight-through process, is it dependent on a degree of standardisation in terms of for example collateral sets or am I still able to have my own requirements based on my own risk appetite?

CATHRINE POULTON: The collateral sets are much more around how can you monetise your portfolio, so how can we get you into the best trades that we can that fit those criteria? I think your collateral sets are much more around maximising your revenue or not losing out on opportunities. When it comes to the operational environment it is a little bit around standardisation, but that standardisation is coming really from the demand side, and what are prime brokers looking for? They’re looking for standardisation of collateral schedules from our beneficial owners, it’s not necessarily to do with our operational BAU function.

NICK DAVIS: JP Morgan have always invested in technology and will continue to do so. We and the other Agent Lenders have invested in automation as the business continues to work on efficiency.

Regulatory investment in CSDR and SFTR will continue. For example, here at J.P Morgan we can advise clients today what their CSDR penalty impact would be over a daily, quarterly or monthly basis, and how we can partner with them to reduce that number. However, for the rest of the year and into 2021 the focus will most certainly be around ESG and supporting this for our client base.

CHAIR: How sustainable is securities lending?

CATHRINE POULTON: I’ll give you one green shoot: there is starting to be cap raising, and I think that will continue, and I think we will see a lot more activity there. My prediction, for want of a better word, is we’ll start to see less seasonal activity as we have over the years, and I think Covid has almost exasperated that. Obviously, with a lot of companies cancelling AGMs, cancelling dividends, redistributing capital, etc. I think we’ll see limited revenue coming through in that space, so what you will start to see is that they will become more specials-based portfolios. What does that mean for revenue streams? There was an interesting point from Dongyi around the exclusives, because I think what will happen is if the revenue streams become more specials-based, particularly in the equity space, that almost gives more volatility to the beneficial owners, you will start to see a lot more volatility in those revenue generations. It will be interesting to see what the beneficial owners think that looks like going forward in those portfolios, because I think it will become somewhat harder to predict as well and to estimate what those revenues will be.

MATTHEW CHESSUM: We can all take comfort that very few beneficial owners actually pulled out of lending over the last few months during the Covid crisis, and we can all take comfort that securities lending continued to function well throughout the major markets of the world. That fact alone gives a lot of comfort to beneficial owners, and more importantly to the regulators. The increase in volatility should normally translate into hedge funds employing different strategies. Continual quantitative easing lead to the constant inflation of asset prices over the last few years meaning many previously employed hedge fund strategies were either redundant or un-profitable to employ. The emergence of new strategies will translate into more diverse demand and hopefully higher fees and on-loan balances.

One of the questions surrounding CSDR and whether that’s going to limit supply into the market until beneficial owners truly understand what the consequences of some of those buy-in risks are. As we’ve already touched on, SFTR, I’m hoping that’s going to translate into more competitive pricing for the beneficial owners, and I think that the second half of the year it’s going to look completely different to the first half of the year. As Cathrine says, with all the capital raisings, some of the mergers and acquisitions activity and therefore the increase in the number of specials that are going to present themselves I think it’s going to be interesting, and I think the market’s going to come back. I predict a strong second half of the year.

STEVE KIELY: I’m an optimist about the market and I think there’s lots to look forward to. After the last big financial crisis, we used to talk about the return to a normal interest rate environment; well, we’re 12 years on, it hasn’t happened. It looks like it’s not going to happen for quite some time, so maybe this is the normal interest rate environment. I think, and Matt alluded to this earlier on, that the environment combined with the need to earn some extra revenue from somewhere, is going to bring more participants into the lending market to try and make the assets sweat a bit more. I agree with what Catherine said about the equity space – in the fixed income space we’ve just gone through and will continue to go through, a period of big bond issuance by governments as they pay for lockdown effects, we’re also going into a sustained period of QE which we thought had come to an end two years ago, so that’s going to affect the supply and demand side of the fixed income world.

NICK DAVIS I’m in agreement with my panellists as well, I think that the second half of the year is going to be more positive. Supply coming to market, which is a continuation of 2019, specials, we have already seen an increase in US IPOs with opportunities continuing for the rest of the year. In Europe and APAC we expect to see sector specific and funding opportunities.   

Catherine makes a good point on RWA as that also focuses the demand back on to pledge collateral. Clients accepting pledge eliminates the RWA impact that they may be experiencing as Borrowers continue to look at the capital cost per trade.

This roundtable featured in the Summer edition of the Global Investor Magazine, which can be accessed by clicking here.