What should be on Top of a Beneficial Owner's To-do List for 2017?

February 07, 2017
By Chip Dempsey

At OCC, we see that stock lending is becoming less profitable for the borrowing banks that facilitate such transactions, which has diluted their incentive to provide clients with better service.

There are three drivers to the benefits of a central counterparty (CCP) like OCC for stock lending transactions:

  • Central clearing affords more favorable capital treatment, with the CCP as counterparty or trade performance guarantor;
  • CCPs that accept non-cash collateral create opportunities to optimize collateral pledging, using securities that are otherwise un-utilized, further preserving balance sheet; and
  • CCPs process listed instruments in highly automated ways, which can be leveraged to the cost-efficiency of the stock loan post-trade processing flows.

Our traditional clearing members, many of which are bank-owned broker/dealers, were early adopters of our securities finance clearing. Basel III has had a very direct effect on their need to preserve their balance sheet by switching to lower risk weighted assets. The competitive edge is always moving: the conversations we are having with agent lenders suggest that utilization, and maybe even rates, will reflect the borrowers' costs, and the borrowing banks are unequivocal about the relative costs of CCP versus higher risk weighted counterparties. Understanding how CCPs effect their competitive position is worthy of being on a beneficial owner's to-do list.

How will higher interest rates affect your transaction choices?

It is all about collateral optimization. The opportunity cost of higher interest-bearing instruments is driving efforts to optimize the use of cash equities as collateral.

Will the current low-yield environment affect the shift to non-cash collateral?

The most significant driver towards non-cash collateral is more desirable balance sheet treatment, versus cash collateral, on the part of the borrower. If the lender is sufficiently collateralized and comfortable with that collateral then they may find better pricing on non-cash loans, which can counterbalance shrinking returns under the current low-yield environment.

Is President Trump and the economic/regulatory changes he will likely bring forth be a good thing for the securities lending market?

OCC supports the idea of efficient and effective regulation that enables a diversity of innovative investment strategies without increasing systemic risk. Our focus on developing safe and secure markets through effective risk management aligns with the goals of Dodd-Frank to reduce systemic risk and ensure confidence in the financial markets and the broader economy.

It is too early to tell whether there will be any economic or regulatory disruption for the securities lending market until President Trump announces his economic policies along with his newly formed cabinet.

However, based on what we have seen and heard, his platform appears to be more focused on freeing up capital for small business loans. Some of his potential nominees for the Federal Reserve and other relevant policy positions in his administration have been calling for higher liquidity ratios in lieu of tighter regulation. If such actions were to occur, that could portend tighter access to balance sheets, more expensive bilateral credit, and an enhanced need to reduce risk weightings. This could pose a challenge to OCC's clearing member firms and could cause us to provide novation for a wider range of the stock loan market in order to afford our member firms our two percent risk weighting as opposed to twenty percent or one hundred percent with other counterparties. OCC estimates, supported by industry research, a clearing model reduces a clearing firms' cost of capital by 71 percent.

To learn more about OCC's thought leadership on industry issues, visit OCC's Blog.

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