Boaz Yaari – Founder & CEO at Sharegain
2018 blew winds of change across global markets. Much of the ten years prior could be characterised by smooth and stable growth in asset prices. 2018 by comparison, was a tempestuous year, as volatility re-affirmed itself and global equity indices fell. In the main, there-emergence of volatility was met with concern. Many asset managers and investment banks including HSBC and BNP Paribas, highlighted market volatility at the end of ‘18 as a key driver for diminishing returns. Some analysts even heralded that 2019 will see the beginning of the next global recession, following the rough seas in Q4 2018.However, asset owners participating in securities lending will have a different perspective on 2018, as last year brought surges in revenue which surpassed $10bn, the highest annual figure since 2008.
In the last decade, capital markets have battled with the challenge of regaining trust, whilst complying with vast swathes of new regulation. The securities lending industry has suffered more than most during this battle. Whilst market capitalisation of global equities has trebled since its 2008 trough, the value of securities on-loan is still well below its 2007 highs, representing a ‘real’ shrinkage in the size of the industry. So why has the securities lending industry failed to keep pace with the rest of the market? What wider lessons can be taken from this and does this spike in revenue signal the beginning of a new era in the industry?
Let’s start with where the house of cards tumbled in ’08. Prior to ’08,securities lending grew exponentially, and the industry opted to increase hiring as opposed to looking for automation to meet this growing demand. Less automation meant higher operational risk. Furthermore, a significant amount of risk was created by an optional secondary activity known as cash-collateral reinvestment. As a result of this activity, and the investments that were made on the back of it, liquidity and financial risk for institutions rose to a level that ultimately threatened wider financial stability.
As the saying goes however, once bitten, twice shy. Following ‘08, the securities lending industry has responded strongly to the risks created by cash-collateral reinvestment. Firstly, and particularly in Europe,most transactions now operate using a non-cash collateral system. This, of course, removes any cash-collateral reinvestment optionality and also has the potential to simplify securities lending for beneficial owners. In addition, post-trade hubs, such as Pirum Systems have emerged and contributed to the removal of former operational risks, by creating an industry standard automated solution and taking securities lending post-trade processes away from Excel spreadsheets and manual input – thereby reducing margins for human error.
So, if the industry appears to have corrected its shortcomings,why has securities lending remained a backwater of capital markets?
Ultimately,we believe that where the securities lending industry has failed is on user experience. Most beneficial owners still view securities lending as too complex, too opaque and not investor friendly. Incumbents have spent the last 10 years automating back-office processes and playing catch up with regulatory change, focusing largely on complying with MiFID (I and II), Basel III and a raft of other reporting and regulatory requirements.Don’t get me wrong, automation of back-office and other manual processes is important, and participants in the industry are no doubt grateful for the reduction in manually-intensive tasks, but ultimately this won’t grow the pie, this will only slow its subsidence.
For securities lending to prosper, the industry must recognise its place and then play to its strengths. For most investors and asset managers, securities lending will never be their primary investment objective and hence they would not want to manage it as a line of business. It can, however, become a secondary-investment objective if extracting additional value from a portfolio can be done with minimal risk and in a simple and transparent manner. In that respect, user-experience is not just a fancy dashboard with buttons and dials. Rather, it is the ability to deliver a simple solution which most investors can ‘set and forget’, retaining full control, transparency and the peace of mind that it won’t come back to bite them.
Put yourself in the shoes of an asset manager who hears about securities lending and wants to start generating those additional returns. Firstly,what they really want to understand is, what’s in it for me?How much money can I make from securities lending?Unfortunately, for most beneficial owners, they may never truly understand what their portfolio is really worth. Securities lending is an OTC, relationship-based and opaque ecosystem that is supported largely by systems that were designed 15-20 years ago. There is little transparency for beneficial owners on what the market price is or its underlying dynamics. Often, beneficial owners settle for a blanket offer of a few basis points across their portfolio – oblivious to its hidden gems and whether they’re getting a fair deal.
If you, as an asset manager,are willing to sacrifice and compromise on understanding your upside, you would still need to understand a host of jargon and complications. What’s the difference between an SLAA, GMSLA and a CoMMA? Am I safer if my lending is done under a CCP model, full transfer of title or pledge structure?Bilateral vs triparty? All of this ultimately means you cannot fully decipher the risk-reward of securities lending.
If you choose to invest the time and resources into evaluating the different models and discover the ‘right route to market’for you, thereafter begins the long and thankless onboarding process, which can discourage even the bravest and most tenacious investors.In the end,like many other beneficial owners,due to lack of resources or time, you would decide to shy away from the industry, dismissing the additional revenues and the alpha creation altogether.
So what’s next for securities lending?
Whilst the last ten years were burdened bya tunnel-vision focus oncomplying with regulation and automating back-office processes, we believe there is still hope for this industry. By shifting focus towards a relentless pursuit for client-centric user-experience, securities lending could become an opportunity which all investors can benefit from.At the forefront of this pursuit must be greater transparency. SFTR, Securities Financing Transactions Regulation,(coming into effect in 2020) certainly has the potential to act as a catalyst for this. Furthermore, inspiration in this pursuit can be drawn from the democratisation in other areas of capital markets including equities, derivatives and FX. In these areas’ transparency, availability, and ease of use have enabled many new participants to engage, which in turn has increased volumes and liquidity as a whole.
We should also remind ourselves, that notionally every owner of stocks, bonds, and ETFs has the right to lend them and globally there are over $40tn of securities sitting idle, collecting dust instead of collecting income. They belong mainly to private investors, through their banks and online brokers, as well as small and medium asset managers, wealth managers, and robo-advisors that are underserved or completely shut-out of the existing securities lending industry.
By combining robust processes with client-centric user-experience, these beneficial owners could access this industry and its benefits, just like the big financial institutions have been doing for decades. Capturing this opportunity is essential for securities lending to flourish and keep pace with, or even front-run, the wider market.
At Sharegain, we offer a securities lending solution fit for the 21st century, which we have achieved by relentlessly focusing on the user. In doing this, our offering finally brings a fully automated solution that enables investors to define their desired lending terms and lets our tech work for them within these parameters. By introducing the world’s first digital agent lender, we eliminate the need for operational overhead and high proficiency,enabling all investors to benefit from this basic right.Our vision is to fully democratise the securities lending industry, effectively bringing the ‘Airbnb moment’ to the stocks, bonds, and ETFs of EVERY investor.