ISLA Securities Lending Market Report – 15th Edition
As I returned to the office after something of a summer break, it was great to see shops and bars coming back to life. The development of safe and effective vaccines has allowed societies to reopen far sooner then perhaps one would otherwise have expected, although some of the longer-term impacts of COVID-19 will be with us for years if not generations to come. Within that process, we have seen how health authorities have increasingly used data as a front foot tool to better understand the pandemic, but also develop strategies to minimize its impact. If we look across into the world of financial services, the use of data is a tried and tested concept, ranging from retail credit checks for individuals buying consumer goods, through to detailed analysis undertaken by quant funds to spot trading anomalies across markets and asset classes. In both cases, data has allowed us to better understand how independent variables can change behaviour and outcomes.
One of the key recommendations of the FSB Workstream 5 that deliberated on the role of SFTs during the financial crisis, was for the development of a broadly-based and detailed reporting regime to allow regulators and other stakeholders to better understand how these markets behave. Whilst the implementation of those recommendations has not been seen universally, Europe took the decision to develop and ultimately adopt the SFTR legislation. As that regime has now been with us for some time, we have begun to see limited public disclosure of certain metrics that reveal aspects of our markets never seen before.
As part of the latest edition of the ISLA Securities Lending Market Report published last week, we have provided some interesting analysis and commentary on aspects of this dataset. Notably the implications of Brexit, where the two-sided reporting regime is highlighting the source of securities lending liquidity, as well as the extent to which the market is already coalescing around the use of pledge collateral as an alternative to the traditional title transfer model.
Whilst the analysis of data is inevitably an art rather than a science on this occasion, we saw some very clear and recognisable signals of note. Towards the end of the Brexit transition in December, we saw a very marked and notable shift in the reportable volumes of SFTs going through the respective trade repositories in both the European Union and the UK. As the market went through the Brexit end date, we saw reported volumes within European trade repositories falling by some 40% over the turn. Not unexpectedly, we saw a corresponding uptick in reported numbers from UK-based trade repositories. In fact we have seen reported numbers in the UK grow at an exponentially higher rate in the past six months. Whilst not necessarily unexpected, this does confirm that from an industry association perspective, we now have to be mindful that we have to represent and consider the demands and aspirations of two quite different and potentially diverging markets.
As regulators developed the original concepts for SFTR, they were very much wedded to the idea of dual-sided reporting, allowing for any misreporting from one side to be highlighted as a break. Whilst ISLA and others advocated against the idea of dual-side reporting, highlighting how much of the relevant data needed for SFTR reporting could only be provided by lenders and their clients, the implementation of SFTR went ahead on a dual-sided basis. Interestingly, rather than highlighting inefficient or incorrect reporting, the two-sided regime has shone a light on how potentially dependent Europe is on liquidity from clients outside of the region. Reported data of SFTs suggests that between 8 and 12% for Europe, and between 6 and 7% for the UK, transacted on a dual basis (i.e. both parties to the SFT are bound by the reporting regime). If we assume that most borrowers will be borrowing onshore in Europe, this suggests that over 85% of all loans are coming from lenders who are outside of Europe (EU 27 and the UK). Whilst we have to accept that these initial numbers are indicative, and that there will be noise associated with factors such as central bank activity, there is no doubt that Europe is reliant from a financial stability perspective on external liquidity. This raises important questions about the further development of the Capital Markets Union, and more specifically how funds like UCITS can play a more active role in providing the market liquidity that Europe needs.
The third element of the SFTR data that we considered was the use of pledge collateral. We further aligned this analysis with the independent work done concurrently with our tri-party data providers, to better understand the same dynamic. Whilst in both cases, this data is again very much work in progress, initial estimates do suggest that around 15% of the European market is transacting using pledge collateral. From discussions with member firms, it is clear that this number is set to grow. As it becomes an increasingly important part of the market, this raises questions around areas such as collateral reuse and any interrelationship with the reuse of collateral for the purposes of collateralising derivative transactions. Pledge may also have a role to play in response to the arrival of the Basel IV capital regime in early 2023.
We will of course monitor the SFTR datasets over time, and hope to have the opportunity to discuss these outputs and the infinitely greater detail that the regulators will see, at some point in the future. I have said before how securities lending provides a unique window into the world of the broader capital markets arena, and greater appreciation of the SFTR based datasets will only enhance that understanding.
Andrew Dyson, CEO