Luxembourg
08 January 2013
Luxembourg is quietly continuing with securities lending activity, be it in or out of the country, as SLT finds out
Image: Shutterstock
鈥榃ell-maintained鈥� and 鈥榩rosperous鈥� would be two descriptions that come to mind when thinking of Luxembourg, and the landlocked country has built on this reputation quietly over the years. Most banks are foreign-owned and have extensive foreign dealings, but Luxembourg has lost some of its advantages as a tax haven because of OECD and EU pressure. The economy depends on foreign and cross-border workers for about 60 percent of its labour force, and non-natives can enjoy an extraordinarily high standard of living.
But while foreigners may be flocking, lending activity for the large pool of assets that is domiciled in Luxembourg is not generally done in the country, with trading desks situated in London or Frankfurt. Citi noted that its Global Markets business has a securities lending and Delta One trading desk in Luxembourg, but added that the firm also deals with Luxembourg funds via its Global Markets London entity and Citi NA agency lending desks in Dublin and London.
ASLplus, a Clearstream offering that provides strategic lending to custody clients to earn additional revenue (with Clearstream acting as a principal lender), also operates from a trading desk in London. As for other firms, three entities that have advertised their securities lending operations in Luxembourg in the past declined to comment, citing a lack of activity in the region.
G枚sta Feige, head of global securities financing sales and risk management in the EMEA at Clearstream, insists that lending activity is as competitive as ever.
鈥淕iven the sound legal framework and efficient CSSF regulation, Luxembourg is a perfect place for securities lending business and we definitely see immense growth in the actual securities lending business as well as the surrounding services. In our specific role as principal, the development of our strategic lending programme ASLplus speaks a clear language and has a solid growth track record which we foresee to continue, given regulatory pressure, industry need for sophisticated lending solutions and market need for reliable loan and collateral management services.鈥�
鈥淢any of the major European banks have treasury desks in Luxembourg who transact securities lending and repo so the financing side of the market is already established although not significant compared to other European countries,鈥� says Jane Karczewski, EMEA head of equity finance sales at Citi in London.
鈥淢ost of the large asset management companies have their fund managers and heads of asset management based in their country of origin, so although more fund managers are being relocated to Luxembourg the decision making is generally managed by the local office. Until that trend changes, I do not think Luxembourg will grow substantially as a securities lending centre. Together with Dublin, it is one of the centres of European excellence for fund administration. That is a critical part of the securities lending, custody and UCITS markets.鈥�
Looking for the one-offs
Increasing demand from lenders for independent collateral management services means that the days of lenders giving mandates to a single custodian or agent for a host of services may be coming to an end.
Karczewski says: 鈥淚n the context of OTC derivative collateral management, many institutions are indeed looking at the most efficient ways to centralise their collateral management. If they do not have the infrastructure to handle this operationally they are certainly looking at independent providers. Citi offers several collateral transformation options using Global Markets and Citi Transaction Services. We have securities lending clients using Citi or third part providers and similarly Citi provides collateral financing to clients who are not necessarily on the securities lending platform. I think it is safe say there is definitely more due diligence undertaken by beneficial owners with regard to collateral management, but the extent to which this is true still depends upon individual company profiles. 2013 will be a formative year in this respect.鈥�
Feige adds: 鈥淲hile we see indeed a growth of service providers in the collateral management area, we would rather say that there is a true need for reliable and holistic solutions, covering the whole value chain in a truly global liquidity hub, across boarders, settlement locations and service areas to combine repo, securities lending, collateral management services to ensure that clients can rely on exactly the services and tools and collateral whenever they need it. As those services, however, are rather complex to build and develop, we see true growth possibilities only for certain few very sophisticated players, based on their origin as market infrastructure and settlement depository.鈥�
As for diversification seen from beneficial owners鈥攂oth in their investment and collateral portfolios鈥攖he consensus seems to be one of consistency.
鈥淭he investment profile from beneficial owners has not changed greatly over the last few years with ratios between fixed income and equity remaining quite stable,鈥� says Karczewski. 鈥淐ertain asset managers have been moving into equities and focusing on the dividend paying names to compensate for the lack of fixed returns from bond portfolios. Pension funds specifically seem to be moving slightly more into equities to take advantage of the discounted market value and also appear to shifting a portion of their investment into index products. This could have a positive impact on the securities finance business but until both leverage and short interest increases we will not see any major benefits from this move.鈥�
鈥淐ollateral profiles are driven by the legal requirements determined by the jurisdiction of the beneficial owner. They are also determined by the operational efficiency of their lending provider and the beneficial owner鈥檚 appetite for risk. We have seen larger beneficial owners opting for greater collateral flexibility in the forms of collateral accepted (cash, equities, government bonds) but, on the other hand, stricter parameters defining concentration limits and reinvestment products. Greater flexibility in forms of collateral accepted allows for a better distribution of assets.鈥�
Feige adds: 鈥淲hile we see鈥攊nterestingly enough鈥攊ncreased securities lending business and lending mandates from beneficial owners due to our role as ISCD and neutral market infrastructure, where clients rely on our solid Luxemburgish legal grounds and our conservative measures and procedures, some clients indeed investigate details and background of our securities lending programmes, which we welcome.鈥�
鈥淓ffectively, customers join our programmes鈥攁gain, where we act as agent, guarantor or principal, depending on the programme鈥攖hanks to our restrictive collateral schedules and to risk adverse lending services. Lenders feel comfortable facing Clearstream as principal in the strategic programme or having Clearstream as guarantor, on top of the pledge of collateral, in our fails lending programme.鈥�
(Don鈥檛) celebrate the quirks
Luxembourg鈥檚 relevant regulation to lending, Circular 08-356, prescribes the conditions by which funds may enter into securities lending transactions. When it was overhauled in 2008, the regulator ended a 30-day limitation for securities lending transactions that put technical burdens on the back office.
One quirk of Luxembourg鈥檚 regulation involves the level of collateralisation required to protect securities lending transactions. The minimum is set at 90 percent of the global valuation of the securities lent (interests, dividends and other eventual rights included) during the lifetime of the lending agreement.
CACEIS collateralises at 105 percent and other market observers note that they are unaware of any agents that take advantage of this regulation, particularly in an environment where lenders are carefully scrutinising counterparty risk.
鈥ㄢ赌�
鈥淭he regulation states a minimum requirement for Luxembourg regulated funds. However the standard of the securities lending market is 102 to 105 percent for bonds and equities respectively. The 90 percent minimum level allows for a buffer around market valuations and is not something Citi takes advantage of,鈥� says Karczewski.
Feige comments: 鈥淕iven our nature as ISCD and market infrastructure, we are risk adverse and hence don鈥檛 take advantage of this. Actually, we always take for our lenders a minimum of 102 percent of collateral. Our lending system manages collateral constantly and performs marking to market all over the day in order to make sure that our lenders are always collateralised.鈥�
This commitment to honesty is a characteristic that can only help the country鈥檚 reputation. 鈥淏eing based in Luxembourg helps in many ways,鈥� concludes Feige. 鈥淣ot only due to the physical neighbourhood in the Grand Duchy itself as well as in central Europe to major sec lending players but also due to the favourable legislation, providing a solid and reliable framework on both the loan and collateral side.鈥� SLT
But while foreigners may be flocking, lending activity for the large pool of assets that is domiciled in Luxembourg is not generally done in the country, with trading desks situated in London or Frankfurt. Citi noted that its Global Markets business has a securities lending and Delta One trading desk in Luxembourg, but added that the firm also deals with Luxembourg funds via its Global Markets London entity and Citi NA agency lending desks in Dublin and London.
ASLplus, a Clearstream offering that provides strategic lending to custody clients to earn additional revenue (with Clearstream acting as a principal lender), also operates from a trading desk in London. As for other firms, three entities that have advertised their securities lending operations in Luxembourg in the past declined to comment, citing a lack of activity in the region.
G枚sta Feige, head of global securities financing sales and risk management in the EMEA at Clearstream, insists that lending activity is as competitive as ever.
鈥淕iven the sound legal framework and efficient CSSF regulation, Luxembourg is a perfect place for securities lending business and we definitely see immense growth in the actual securities lending business as well as the surrounding services. In our specific role as principal, the development of our strategic lending programme ASLplus speaks a clear language and has a solid growth track record which we foresee to continue, given regulatory pressure, industry need for sophisticated lending solutions and market need for reliable loan and collateral management services.鈥�
鈥淢any of the major European banks have treasury desks in Luxembourg who transact securities lending and repo so the financing side of the market is already established although not significant compared to other European countries,鈥� says Jane Karczewski, EMEA head of equity finance sales at Citi in London.
鈥淢ost of the large asset management companies have their fund managers and heads of asset management based in their country of origin, so although more fund managers are being relocated to Luxembourg the decision making is generally managed by the local office. Until that trend changes, I do not think Luxembourg will grow substantially as a securities lending centre. Together with Dublin, it is one of the centres of European excellence for fund administration. That is a critical part of the securities lending, custody and UCITS markets.鈥�
Looking for the one-offs
Increasing demand from lenders for independent collateral management services means that the days of lenders giving mandates to a single custodian or agent for a host of services may be coming to an end.
Karczewski says: 鈥淚n the context of OTC derivative collateral management, many institutions are indeed looking at the most efficient ways to centralise their collateral management. If they do not have the infrastructure to handle this operationally they are certainly looking at independent providers. Citi offers several collateral transformation options using Global Markets and Citi Transaction Services. We have securities lending clients using Citi or third part providers and similarly Citi provides collateral financing to clients who are not necessarily on the securities lending platform. I think it is safe say there is definitely more due diligence undertaken by beneficial owners with regard to collateral management, but the extent to which this is true still depends upon individual company profiles. 2013 will be a formative year in this respect.鈥�
Feige adds: 鈥淲hile we see indeed a growth of service providers in the collateral management area, we would rather say that there is a true need for reliable and holistic solutions, covering the whole value chain in a truly global liquidity hub, across boarders, settlement locations and service areas to combine repo, securities lending, collateral management services to ensure that clients can rely on exactly the services and tools and collateral whenever they need it. As those services, however, are rather complex to build and develop, we see true growth possibilities only for certain few very sophisticated players, based on their origin as market infrastructure and settlement depository.鈥�
As for diversification seen from beneficial owners鈥攂oth in their investment and collateral portfolios鈥攖he consensus seems to be one of consistency.
鈥淭he investment profile from beneficial owners has not changed greatly over the last few years with ratios between fixed income and equity remaining quite stable,鈥� says Karczewski. 鈥淐ertain asset managers have been moving into equities and focusing on the dividend paying names to compensate for the lack of fixed returns from bond portfolios. Pension funds specifically seem to be moving slightly more into equities to take advantage of the discounted market value and also appear to shifting a portion of their investment into index products. This could have a positive impact on the securities finance business but until both leverage and short interest increases we will not see any major benefits from this move.鈥�
鈥淐ollateral profiles are driven by the legal requirements determined by the jurisdiction of the beneficial owner. They are also determined by the operational efficiency of their lending provider and the beneficial owner鈥檚 appetite for risk. We have seen larger beneficial owners opting for greater collateral flexibility in the forms of collateral accepted (cash, equities, government bonds) but, on the other hand, stricter parameters defining concentration limits and reinvestment products. Greater flexibility in forms of collateral accepted allows for a better distribution of assets.鈥�
Feige adds: 鈥淲hile we see鈥攊nterestingly enough鈥攊ncreased securities lending business and lending mandates from beneficial owners due to our role as ISCD and neutral market infrastructure, where clients rely on our solid Luxemburgish legal grounds and our conservative measures and procedures, some clients indeed investigate details and background of our securities lending programmes, which we welcome.鈥�
鈥淓ffectively, customers join our programmes鈥攁gain, where we act as agent, guarantor or principal, depending on the programme鈥攖hanks to our restrictive collateral schedules and to risk adverse lending services. Lenders feel comfortable facing Clearstream as principal in the strategic programme or having Clearstream as guarantor, on top of the pledge of collateral, in our fails lending programme.鈥�
(Don鈥檛) celebrate the quirks
Luxembourg鈥檚 relevant regulation to lending, Circular 08-356, prescribes the conditions by which funds may enter into securities lending transactions. When it was overhauled in 2008, the regulator ended a 30-day limitation for securities lending transactions that put technical burdens on the back office.
One quirk of Luxembourg鈥檚 regulation involves the level of collateralisation required to protect securities lending transactions. The minimum is set at 90 percent of the global valuation of the securities lent (interests, dividends and other eventual rights included) during the lifetime of the lending agreement.
CACEIS collateralises at 105 percent and other market observers note that they are unaware of any agents that take advantage of this regulation, particularly in an environment where lenders are carefully scrutinising counterparty risk.
鈥ㄢ赌�
鈥淭he regulation states a minimum requirement for Luxembourg regulated funds. However the standard of the securities lending market is 102 to 105 percent for bonds and equities respectively. The 90 percent minimum level allows for a buffer around market valuations and is not something Citi takes advantage of,鈥� says Karczewski.
Feige comments: 鈥淕iven our nature as ISCD and market infrastructure, we are risk adverse and hence don鈥檛 take advantage of this. Actually, we always take for our lenders a minimum of 102 percent of collateral. Our lending system manages collateral constantly and performs marking to market all over the day in order to make sure that our lenders are always collateralised.鈥�
This commitment to honesty is a characteristic that can only help the country鈥檚 reputation. 鈥淏eing based in Luxembourg helps in many ways,鈥� concludes Feige. 鈥淣ot only due to the physical neighbourhood in the Grand Duchy itself as well as in central Europe to major sec lending players but also due to the favourable legislation, providing a solid and reliable framework on both the loan and collateral side.鈥� SLT
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