Fidelity
Spotlight on agency lending: through the eyes of the institutional client -
26 April 2022
SFT recently spoke with three senior Fidelity leaders to discuss agency lending and the latest insights they are hearing from institutional clients. For this conversation, Bob Currie is joined by Fidelity executives Justin Aldridge, head of agency lending, Doug Brown, head of business development for agency lending, and Yuri Brightly, head of securities finance product
Image: Fidelity
Justin, I will start with you. What are the key trends you are seeing in the agency lending space?
Justin Aldridge: One of the prominent trends we are seeing is that firms are finally starting to review their agent lender providers again. Firms have been reluctant to review and change providers while working from home during the COVID crisis and many programmes have gone unreviewed for five years or longer. Now that people are comfortable with working from home, or are returning to the office, they are engaging with the industry providers to evaluate their options.
It is important for firms to review providers, given that the dynamics of the industry are changing rapidly with increased regulation, industry consolidation and retrenchment, and the technology advances needed to perform agency lending services. These factors may influence the performance of a client鈥檚 lending programme. Firms need to do their due diligence to understand how their programme is being impacted.
In April 2021, Fidelity began marketing Fidelity Agency Lending to asset managers, insurance companies and other institutional clients. What are you hearing from prospective clients?
Aldridge: Since our launch, we have engaged with many prospective clients and there are three key areas that consistently come up in our discussions. The first is the disappointing results, compared to the market or estimates obtained during the RFP process. The second is a need for more customisable programme parameters. And the third is a strong demand for transparency tools.
Lately, many prospects have expressed disappointment with their lending returns 鈥� and some have even highlighted their frustration with the estimates they received during the RFP process and the actual results experienced. There are many flaws in the estimate processes, specifically around trying to predict future results with a one-day snapshot of holdings. It is hard to predict the future, so we recommend that prospects utilise backward-looking estimates with multiple holding periods to evaluate performance with other agents. It is far more reasonable and reliable to do a lookback and benchmark your programme with an 鈥渁pples-to-apples鈥� comparison during the same time period on comparable securities.
Customisation is a hot topic and generally all agents say they can do it. However, we are hearing from firms that this is not being executed in an automated fashion and this is leading to exceptions and creating dissatisfaction. In general, registered investment vehicles (RICs) require more customised and tailored programmes and firms want the ability to control the lending parameters to protect their information while maximising returns. Fidelity鈥檚 programme was built to allow for customisation at a very granular level using sophisticated, automated technology and this is resonating with our prospective clients.
Clients continue to demand more transparency to help with programme management and to improve investment decisions and corporate governance. The tools that we have developed in our affiliated fintech, PB Optimize, have really resonated with prospects and these are seen to be a valuable addition to our programme. Specifically, clients are looking for tools to manage their proxy voting decisions, evaluate their providers on a more granular level, and assist with programme optimisation and oversight.
Which red flags should a firm look for that will signal that it may be time to seek a new provider and begin the RFP process?
Aldridge: Fidelity believes that you should evaluate your agency lending programme every three to five years. There are a few things to keep an eye on 鈥� for example, significant changes to your firm鈥檚 assets, major changes to the agency lending provider landscape, and underperforming assets in relation to benchmarks or a steady decline in revenue and balances. Other red flags you should look for are an uptick in compliance violations and operational issues, major staffing changes, and a shift in the overall focus and quality of the company providing the service.
Doug Brown, you head up the sales efforts for the Fidelity Agency Lending programme. What are the key elements you suggest a firm looks for when reviewing providers?
Doug Brown: One of the first things to consider is the business focus of the agent lender. Are they focused or specialised on the structure of your firm (i.e. 40 Act or pension)? Or are they a generalist provider trying to serve the needs of many different client types that may have competing interests? It is important to ensure that the agent鈥檚 focus aligns with your firm鈥檚 needs and that they can help to improve oversight, programme management and performance 鈥� along with any other key areas important to the firm.
You should ask probing questions about technology and how much they invest in technology. Determine whether they are more focused on people and spreadsheets, or if they place a premium on AI-powered technology for efficiency and automation. Gain a good understanding about the connectivity and size of their relationship with their custodian and other custodians. Additionally, take a good look at the leadership team in place that will support the agency lending programme. Look at the team鈥檚 experience, tenure, and professional designations, and discuss any specialised areas within the organisation that are in place to successfully support the agency lending programme.
When evaluating a new agency lender, a firm should get a good sense that securities lending and capital markets expertise are core competencies. Of course, you also want to ensure that the agency lender has enough scale to be relevant and stable for borrowers.
Contract negotiations can be an unforeseen issue and expense. As the firm narrows the list of potential providers, ask for the contract and assess whether there are major pain points. Then discuss how much flexibility is available to address these challenging areas. To complement this information, it is valuable to talk to some of the provider鈥檚 most recent clients and ask about the onboarding experience.
Lastly, evaluate the strength of the relationship between your two firms and the importance of that relationship. It may be valuable to deepen the strategic relationship.
I anticipate that risk mitigation features regularly in these discussions. Doug, what are the most important risk concerns prospects and clients should be thinking about?
Brown: Yes, for sure 鈥� it is a key area of focus, especially as it relates to operational risk. A firm should ask questions about how the agency programme mitigates this risk. At Fidelity, technology is critical to help manage risk. You should ask what percentage of a provider鈥檚 lending transactions are automated with their street-side counterparties and global custodians. A high percentage of automation will help reduce operational risk, generate additional returns, and get to the top of the queue with borrowers.
Many firms will be interested to discuss indemnifications, providing a clear understanding of the liability they will bear if certain events arise. What are you hearing?
Brown: Indeed, a firm should have comprehensive discussions about indemnifications and come away with a solid understanding of the liability the firm will assume if certain, common events occur. A good example would be borrower default indemnification. There are a number of key questions you should ask. Who are the counterparties? How do they approve and monitor the counterparties? Have any counterparties defaulted in the programme and has the agent used capital to cover past defaults? Also, how much capital do they have to support their indemnification?
I imagine that you are getting a lot of inquiries about sustainable investing and ESG. What is top of mind with prospects?
Brown: Yes, that is true, we get many inquiries about meeting the requirements of ESG and sustainable investing. Given our client roster and prospect base, the focus tends to be on the proxy voting aspect of ESG. Many firms are looking for a technology solution that provides real-time lending and proxy data to determine the relevance of an upcoming vote.
It is important for lenders to evaluate how much potential income could be generated if they continue to lend the securities and the revenue they would forgo if they decided to participate in an important shareholder vote. In conducting this analysis, firms should determine how difficult it is to have shares returned from loan and the expected timeframe needed to have the shares back to vote.
These complexities demand a strong technology solution that can really simplify this process for clients 鈥� so I would say this is an important area to discuss during the evaluation process. Tools that can help with these complex 鈥渨hat if鈥� scenarios are important to meet the requirements of ESG and sustainable investing.
Yuri, you oversee product development for agency lending. Each firm may have specific needs based on its business and strategic goals. Is customisation important when it comes to an agency lending programme?
Yuri Brightly: It is very important to tailor a programme that fits the needs of the firm鈥檚 business objectives. This requires flexibility and the ability to leverage technology to make these customisable programme options systematic and efficient. These points are key for a successful programme.
Specifically, firms identify the need to tailor a programme to help manage ownership, trading volume, and percent of float, along with limits, minimum return thresholds, active limits designed to preserve qualified dividend income (QDI) and to maximise returns associated with non QDI, proxy voting, missed opportunity reporting, and more. Firms should think carefully about which options will be most important as they work to optimise the success of their programme.
Which areas of technology and product is Fidelity Agency Lending focused on for the remainder of 2022 and into 2023?
Brightly: We will continue to focus on improving our programme through our AI-powered automated-lending technology to maintain our status as a first destination for borrower鈥檚 needs. At Fidelity, we are continuously enhancing our reporting and data distribution technologies to ensure we can meet our clients鈥� evolving data needs. We are also focused on expanding our collateral flexibility for existing clients. A lot of time and effort is being applied to transparency and optimisation tools that help clients to maximise their returns. Our team is also doing some unique work on QDI optimisation for firms that view this as a binding constraint for their lending programmes.
The entire Fidelity Agency Lending team continues to be laser focused on streamlining operational processes and improving the overall experience for our clients and the entire securities lending ecosystem. For us, a major priority is to ensure that our technology is well positioned to manage changes driven by the regulators or general market dynamics to the lending market. We expect the demand for automation and efficiency to continue into the future.
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