Ghost hunters

Iain Mackay, Global Product Owner for post-trade services at EquiLend, explains how CSDR will bring to the forefront the importance of collateral movements in line with the underlying settlement of a securities lending transaction, how some firms are missing an important element of the settlement process which may cost them millions, and how EquiLend Exposure is mitigating these risks.

The problem

With the advent of CSDR requirements, the need for securing a stock via a same-day stock loan transaction to avert a failed trade has grown. Without such coverage, fails will cost participants close to $300m yearly under the new rules according to one estimate.

Managing inventory to achieve timely settlement has become a particular challenge as the number of trades collateralised with non-cash collateral has increased. With more than 60% of securities lending now collateralised this way, ensuring a trade can execute, be instructed, have the collateral delivered and then settle – all in the same day – has become even harder.

These issues are further exacerbated by what Mackay calls ‘ghost settlement’.

“Securities lending transactions settle on a different timetable than cash equity trades - that is, on a free of payment (FOP) schedule compared to delivery-versus-payment (DVP),” he explains. “These can be hours apart. Therefore, a stock loan transaction initiated to cover a failing trade may settle just fine later in the day, but still result in the cash equity transaction failing because of the earlier cut-off time for DVP settlement.”

Mackay estimates these so-called ghost settlements cost market participants tens of millions of dollars per year.

The solution – EquiLend Exposure

EquiLend Exposure uses the data from booked trades to manage the collateral that is required to support those transactions, shortening the latency of the total trade lifecycle and thereby reducing fails including these ghost settlements. It operates at three stages of the trade cycle:

1. Firstly, it helps clients agree on the valuation of collateral to be moved. EquiLend Exposure collects the trade data from both counterparties and supports the validation of the data, either by reconciling the two valuations or providing clients with the valuation tools to do it
2. Once the trade information has been agreed, EquiLend Exposure automatically instructs the tri-party agent to move the collateral between the counterparties
3. Finally, EquiLend Exposure informs the lender that the collateral has been delivered to their account so they can release the loan. When the tri-party agent informs EquiLend that the collateral has been pledged, the lender sees that information immediately. EquiLend Exposure then provides the messaging to release the loan, thereby enabling full STP of the collateral management process

Eliminating ghost settlements is not the only benefit, of course. By automating this process, the latency between execution and settlement is significantly reduced, ensuring that securities lending (FOP) trades can settle within the cash equity (DVP) deadline.

Ultimately, EquiLend Exposure helps firms reduce RWA costs by eliminating under- or over- collateralisation, reducing operational costs associated with manually reconciling discrepancies and submitting required value numbers, and reducing settlement costs associated with failing trades or buy-ins, all within a single portal.

This article is part of the Collateral in 2022 Guide, and if you want to find more click here to download the guide.