How confident are you that the securities lending market understands your CCP model?
Eurex Clearing has already received significant market support for its model since the original concept was introduced. But in particular, there has been significant support over the last 12 months with a number of important top-tier borrowers, lenders and infrastructures joining as strategic partners. Numerous market participants across the range of beneficial owners, agent lenders and borrowers understand and support our initiatives. We have more than 15 participants currently using or preparing to start using the Lending Central Counterparty (CCP) service.
It has been suggested that CCPs need to do more to appeal to agent lenders in order to attract beneficial owners. Do you agree and are there any plans to do this?
At the start of this year, we announced a collaboration with two of the largest securities lending agents, BNY Mellon and State Street, which alongside other leading agent lenders are committed to utilising the service. Additional participants will be announced in the coming months.
We feel that there is adequate support from all of these organisations to attract their clients to adapt to a cleared market for securities lending. There are many other firms and their clients that already have the knowledge and experience of CCPs, either through existing use of CCP models in Brazil and the US for securities lending, as well as across Europe and the US for repos and derivative transactions.
Beneficial owners will be able to access a wider range of borrowers while retaining their existing relationships and infrastructure with their agent lenders. However, we are aware that further levels of the take-up for the Lending CCP service can be achieved as the model is enhanced to extend the range of equity markets across Europe and North America, as well as the introduction of additional innovative solutions for collateral management and membership access models that will enable more agent lenders and their clients to participate on a global basis.
We see this further phase of development and enhanced awareness as a joint effort among ourselves, our strategic partners and our existing clearing members, which include borrowers and agent lenders.
Indemnification is becoming a burden to agent lenders. Do you see CCPs as an alternative risk mitigation tool for beneficial owners?
It can be argued that the very nature of the CCP’s risk management methodology, along with the CCP’s guarantee to return the loaned securities in the event of a borrower default, can replace the current format of indemnification that beneficial owners have in place from their lending agent.
This development is very much part of the education and awareness that has increased over the years from the consultations that Eurex Clearing has conducted with agent lenders and their clients. The CCP as an alternative to the agent lender’s indemnification is just one of the advanced benefits of the CCP model that will become more apparent in the long term.
Some beneficial owners say their investment parameters mean using a CCP doesn’t make sense. What are the barriers preventing beneficial owners from using CCPs for a significant amount of their business, and what have you done to address these??
As mentioned, there are numerous beneficial owners already using CCPs across their business and to execute their current investment strategies, so why shouldn’t this make sense as well for securities lending? One of the major benefits of using CCPs for financial markets is an overall increase in the capital and collateral efficiency. It is becoming increasingly more expensive for counterparts to conduct business on a bilateral basis. By using a CCP service, there is a significant reduction in capital costs and a significant increase in collateral efficiency.
This, combined with the use of a broader range of lending and borrowing counterparts, ensures that centrally cleared transactions are more cost efficient than those transacted bilaterally. Borrowers will benefit directly from the capital efficient CCP model. Some or all of these cost savings can be passed through to the lender as price improvement as a result of using the CCP.
The strength of the Eurex Clearing model has been to incorporate the entire function and characteristics of the securities lending market into its systems. This includes trade capture and settlement, transaction management, asset servicing and corporate action processing, as well as the management of all risk and collateral functions, while retaining the bilateral characteristics of the business such as choice of counterpart and flexible collateral schedules.
Additionally, Eurex Clearing is leading the way in implementing innovative solutions for direct access models that allow for a wide range of different types of clients in multiple global jurisdictions to participate in the key markets via our CCP service.
The issue of cost is a major sticking point for some beneficial owners. Can you outline these costs and why you think it’s a fair deal?
The determination of the fee for any securities lending transaction, whether bilateral or centrally cleared, is agreed by the agent lender and the borrower and will take into consideration many different cost factors, such as the type and location of the underlying client, the collateral type and term of the trade. Within the CCP model, it is the role of the CCP to undertake all of the settlement, asset servicing, collateral and risk management functions—all of these functions are costs for the CCP but are also essential value added services of the CCP service.
The ‘fair deal’ for the participants in a CCP-based trade is that the capital and collateral efficiencies outweigh the costs of using the CCP model. The business case and cost-benefits for using the CCP differ across many different types of firms—for some it is the advantage of lower risk-weighted asset charges, for some it is broader distribution, for others it is credit intermediation or more effective use of its balance sheet—so there is not yet a standardised cost-benefit metric associated with a CCP trade.
A more favourable price for securities lending activity via the CCP can be achieved with borrowers offering a basis between the same trade, whether cleared or uncleared.
To assist in finding this, Eurex Clearing is introducing a flexible and scalable fee model that allows agent lenders and borrowers to continue to determine the right level of pricing for their business and ultimately the revenue generated on behalf of the beneficial owners.
What advantages does your CCP model have over versions in markets with mandatory CCPs such as Brazil
There are many differences and particular advantages. One significant feature is that our model allows for the direct access of beneficial owners via the so-called specific lender licence. This enables beneficial owners to continue to be the principal in the transaction and determine the type and quality of the collateral they can receive. There is no need to clear through a third-party clearing member, nor do they have to pay margin requirements or contributions to the CCP default fund.
The received non-cash collateral is held on a segregated basis for the beneficial owner at a triparty collateral agent and has immediate access to the collateral in the event of a CCP default. The lender retains full visibility of the loan, the collateral and its borrower counterparts at all times. This is a unique feature to Eurex Clearing’s Lending CCP. SLT
← Previous interview
US Treasury’s Office of Financial Research
Ben Munyan
Next interview →
Risk Management Association
Scott Olson
Image: Shutterstock 