Contributor: Tim Smith
Securities financing has evolved over the last 30 years from a quasi-back office activity to a high-profile business in its own right. The main causes and results of this evolution can be grouped into 10 major themes.
Thirty years ago only RMA existed, and they were Robert Morris Associates, not the Risk Management Association. During the past few decades, there has been an extraordinary growth in the number of industry bodies that have all battled against initial skepticism to become influential and respected associations in the securities finance space. Groups like ISLA, PASLA, ASLA, SASLA, CASLA, and of course RMA are at the forefront of industry change and response to external friends and foes.
Many believe that regulatory scrutiny of securities financing is a new phenomenon since the 2008 crisis. This is untrue. Regulatory frameworks have kept market practitioners and their compliance officers and lawyers quite busy during the last 30 years. German, U.K. and Hong Kong tax regulations, U.S. uptick and purpose test rulings, and on-off decisions in many emerging markets such as Malaysia have made for exciting times in securities lending. Sometimes, in fact usually, the activity is caught up by accident in some rule change, e.g. the Japanese rule changes of 1998 that made the return of a loan a short sale. In cases like this, the industry has had to respond and scramble for a way round or through.
Years ago, there were very few systems, and most of them were in-house and stand-alone. Starting with early Excel spreadsheets, the number of service providers has grown. Early single currency-capable systems have been augmented and replaced to cope with the growing cross-border nature of the securities finance business. Local regulatory reporting requirements in many cases have necessitated the abandonment of in-house systems. Ultimately, systems integration is required for efficiency, risk monitoring, and the faster and faster settlement cycles being introduced around the world.
Decades ago there were only really two regions of securities lending and borrowing – North America and Europe. Indeed, even securities lending for other countries was undertaken by entities based in these two areas. This has clearly changed. Asia-Pacific has seen its footprint expand while the mature regions have plateaued. The newer markets of Hong Kong, Singapore, Korea and Taiwan have augmented the locally mature markets of Japan and Australia. India and China are poised to further change this dynamic. Latin America is fast coming up in terms of scope and ease of doing business, with Africa and the Middle East not far behind.
The way that the business has been structured internally to an organization has changed radically over the last 30 years for every stakeholder. Thirty years ago, fixed income repo groups and securities lending operations did not even acknowledge each other’s existence. Now, both groups are intertwined in many firms. The biggest change, though, has been the move from the back office to the front office in many broking firms. Even the lenders and hedge funds have changed their rather laissez-faire approach to one of more active engagement by dedicated personnel.
Pay-to-hold, equity repo, and portfolio bidding, while still in existence, all went through phases as being the perceived rocket launchers of growth and land grab. In addition, 30 years ago, third-party lending agents were not really a serious contender for business and their jobs were made harder by custodian agents. Now most if not all custodian lenders have their own third-party operations. Even letters of credit, although still used, are not as ubiquitous as they once were due to capital usage and cost.
Over the years, attitudes toward transparency have shifted from the desire for one-way mirrors through frosted glass to single-pane, ultra-clear windows cleaned each and every day. This change has sometimes been mandated, but at other times grasped and embraced as a way to keep clients close. This is set to continue as business attitudes to transparency become more aligned with regulatory mandates and system abilities.
The cases of Barings and LTCM had major impacts upon business, legal and operational structures. These were further tested in 2008 – perhaps it was lucky that the previous events had occurred because the results may have been even worse without the learning experience. At least now, for example, there are known ways of cashing in collateral, which was not the case thirty years ago when the methodology was arcane and obscure because it had not been tested.
Rates and Levels
Thirty years ago, rates for borrowing Japanese callable securities were in the 300-400 basis point range. Not so today. These sort of rates can sometimes be seen in new markets as they emerge but the rates tend to ease off much more quickly to normal levels based on experience of bringing on new markets and supply to wider access.
The whole GC versus Special dynamic has ebbed back and forth over the years as well. Participants sought to obtain allocations of specials based upon GC balances. During times of market stress, this dynamic has been broken and then re-established when more stable times have resumed. It is probably the case that it will continue to ebb and flow.
Finally, the attitude of all participants has changed over the past 30 years. There used to be a certain innocence as everyone was learning as they went along. This produced a very strong esprit de corps among both counterparties and competitors, as all realized that it was to no one’s benefit if securities financing suffered a setback or mistake of its own making. This attitude, while still present, has evolved in a natural growth of confidence and professionalism. There seems to be a general feeling of existing as a valid business as opposed to being an ancillary service built only to support other mainstream activities.
A lot has happened over the past few decades in the securities finance industry. From the rise and fall of emerging markets activity to the development of securities financing systems, from an era of learning to an increasing sense of confidence, there is no question the last 30 years in this business have been both challenging and exciting. Are there other trends you would add to the list? How would you expand on any of the trends mentioned here? We all have many memories, of course. I look forward to seeing your thoughts.