Chris Jaynes was one of eSecLending’s founders when the company was created in 2000 and the CFA charterholder has worked at the Boston-based lender since its creation, previously as chief operating officer, as co-CEO and currently as president.
Since the company was founded in 2000, eSecLending has grown to become one of the largest lending agents in the market, with more than US$100 billion in assets on loan, and it features some of the world’s largest pension funds, asset managers, insurance companies and sovereign wealth funds among its client base.
Having helped to guide the company from infancy to adulthood, Jaynes is well placed to evaluate how its core principles have evolved over almost a quarter-century and the direction in which clients’ lending and financing requirements are leading its strategy.
Reflecting on this evolution, Jaynes tells SFT that the focus of eSecLending’s strategy since formation has been on delivering flexible market access to its clients, offering exclusives alongside discretionary lending and employing proprietary auctions as a means of price discovery for the lender prior to making their execution decision. These principles have been central to the company’s approach, he explains, and a key differentiator for its business.
Overarching these delivery mechanisms has been the provision of segregated and customised lending programmes for its clients. For each lender, eSecLending provides a segregated, bespoke lending programme that is tailored explicitly to the objectives and strategy preferences of that customer.
Having grown initially out of the securities lending business of an asset management company, United Asset Management, the founders recognised the virtues of this segregated, customised approach to lending as a way to address the shortcomings of competing offers provided by the large custody banks that operate through pooled lending structures.
“As a buy-side lender, we had specific expectations in terms of flexibility and control over how our assets would be managed that we felt were best served through a segregated, individually managed programme — and this was hard to find in the market at that time,” he says. As founders, they valued the flexibility offered by having a choice of routes to market, with exclusive strategies available alongside discretionary lending. “Lending within a large pooled programme did not offer what we were looking for in terms of flexibility and control, nor did it meet our expectations in terms of transparency,” he adds.
It was this experience as a buy-side lender that defined the team’s approach on launching eSecLending. For an agency lending desk at a large custodian bank, it is impractical to tailor an individualised, segregated lending programme for each of several hundred clients — a pooled approach thrives on offering a broadly standardised lending model and delivering efficiencies through scale.
In contrast, eSecLending identified a demand for bespoke solutions from some of the world’s largest institutional lenders, enabling them to earn a substantial premium from their loan inventory and to benefit from the transparency and price discovery offered by eSecLending’s proprietary auction programme, whereby borrowers submit blind bids for the client’s portfolio or for a parcel of assets within that portfolio.
For Jaynes, the auction process generates premium returns for certain asset classes and markets and the pricing transparency provides the lender with the information to make better-informed execution decisions. All bids from borrowers are legally binding and when an attractive bid is received, this may provide an opportunity to increase revenues by lending through an exclusive arrangement. For assets where the bids do not offer a revenue premium to the market, the lender is often best served by lending on a discretionary basis.
Looking back over the evolution of the business, Jaynes notes that the firm’s core strategy and approach to the market has remained consistent since its creation, but he focuses on two main areas that have changed over time. First, the depth and breadth of the firm’s client base and service offerings have broadened significantly. In the initial years, the team was focused primarily on exclusives and equity portfolios for US-based clients, but subsequently they have extended the scope of eSecLending’s services to include discretionary and exclusive lending in all asset classes and markets globally.
The client base has expanded, with the business supporting clients across Europe, the Middle East and now Asia. The team is also doing more to support their clients with solutions to manage the collateral management and financing needs of the major institutional investors that they service.
A second important change is linked to the growth of the management team. Some key managers, like Jaynes, have been with the company throughout the early years. Over time, however, the business has added senior executives from several of its large custodial and third-party competitors, creating a deep bench of talent and a management team with experience that, Jaynes believes, cannot be matched by any other firm in the market.
Alternative trading structures
In financial services, every business decision is to some degree shaped and constrained by regulation — and securities finance aligns with this general rule. For the service provider, the skill is to help the client to negotiate this rules-driven adaptation process and to take advantage of the opportunities this presents.
For eSecLending, unsurprisingly, a priority is to assist borrowers with managing the balance sheet impact of their borrowing activity and to fulfil liquidity standards imposed under liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) obligations. In the wake of the global financial crisis, financial supervisors have reinforced steps to ensure that banks have strong capital positions, complemented by liquidity standards designed to ensure the resilience of a bank’s funding profile over a 30-day and one-year timeframe.
To optimise lending opportunities, the firm has implemented alternative trading structures and identified trades that best match a borrower’s needs to the risk tolerance and collateral eligibility criteria applied by lenders. “Again, we believe that offering segregated account structures offers significant advantages, enabling eSecLending to engage in detailed individual discussions with clients and the flexibility to implement bespoke trades that best match the requirements of borrowers and each individual client,” says Jaynes.
In recent times, the industry’s focus has turned to lender indemnification and the widely-publicised pressures that this puts on lending agents in terms of the balance sheet cost of lending. The regulatory capital cost of providing loan indemnification for the agent lender is estimated to be between 10 and 14bps under the Basel III bank capital adequacy regime and this will continue to represent a significant overhead with implementation of Basel IV.
Trade bodies have highlighted a need for dialogue, with some commentators indicating that agent lenders will need to adjust their pricing, or lenders will need to forfeit their requirement for indemnification, for agent bank intermediation in securities lending trades to remain economically attractive. Participants at the Bank of England Â鶹´«Ă˝ Lending Committee meeting in March proposed that, given returns on securities lending are relatively low, the bulk of lending is unlikely to be profitable for the lending agent if they continue to provide indemnification to the lender. Jaynes indicates that this regulatory environment is creating additional opportunities for eSecLending, since as an independent firm that provides indemnification through insurance, it is not impacted by the increased capital costs that are putting pressure on the large custody bank programmes.
A few large beneficial owners have now waived their indemnification, notes Jaynes, but this has been the exception rather than the norm. Typically these firms have committed a lot of time and resources to enhancing their own internal trading and risk management structures such that if there was a default, they will be in a position to manage that unwind. However, the vast majority of clients are not in this position and will continue to expect their agent to provide indemnification.
In practice, it is a challenging decision for senior management of a beneficial owner to forgo that indemnification, often with little obvious upside for the firm or individuals concerned,” observes Jaynes. “Consequently, we do not see agent bank indemnification disappearing from the market. In recent months, we have seen increased interest in our services from lenders who are being presented with difficult choices on indemnification from their existing agents."
Peer-to-peer engagement
As central banks tighten interest rates and signal the potential unwind of their long-running asset purchase programmes, buy-side firms continue to seek new sources of financing and look to diversify their funding counterparties.
In this context, P2P lending refers to direct lending of cash or securities from beneficial owner to beneficial owner — referring to financing or securities lending relationships between large pension funds, insurance companies, sovereign wealth funds and asset managers, for example.
Jaynes indicates that there has been a meaningful upturn in this type of direct lending between beneficial owners in recent years — although this typically serves as a supplement to traditional trading activities rather than replacing them. Some large beneficial owners are seeking alternative sources of financing through direct lending channels, potentially offering better pricing and better stability of supply — for example over period ends when liquidity conditions can tighten substantially.
For counterparties, Jaynes identifies three primary barriers to the expansion of P2P lending and financing — specifically legal, credit approval, and operational support — and he indicates that eSecLending provides support for clients in each of these areas.
The first is the challenge of managing legal documentation. If a peer wishes to trade with 10 different counterparties, this commonly requires that they set up bilateral legal documents with each of these trading parties. This documentation overhead can be a significant obstacle to peer-to-peer, particularly for beneficial owners that do not have a large in-house legal department. “Sitting in the middle of these trades, we make the legal overhead substantially easier for the client,” he says. “By utilising eSecLending to administer these transactions, clients can leverage the broad library of contracts that we already have in place, thereby reducing the burden of establishing bilateral documentation directly with each of their P2P counterparties.”
There is also a significant operational overhead in managing P2P lending — from managing trade and settlement instructions, to moving and valuing collateral, to managing lifecycle events across the life of this securities financing trade — and many beneficial owners are not set up to manage this in house. Consequently, using a specialist agent such as eSecLending can offer significant advantages in managing this operational complexity.
A third prominent challenge is in managing counterparty risk. “eSecLending is well positioned to assist peers in evaluating the credit risk associated with their lending and financing relationships and will also provide indemnification over peer-to-peer activity,” says Jaynes. “Whether a pension fund is lending assets to a bank counterparty such as a prime broker, or it is lending to another pension fund, we have indemnification insurance in place and provide confidence that clients’ assets are protected across the term of the loan agreement.”
In these key respects, Jaynes suggests that eSecLending is different from other peer-to-peer matching and lending platforms. Few of these solutions, he believes, have solved effectively for the credit risk component or provided an effective solution for the operational challenges. And few have developed an effective solution to manage the legal documentation.
Although some beneficial owners, particularly in the Canadian market, are now lending P2P and managing their trading requirements directly, Jaynes indicates that as peer-to-peer activity continues to grow many lenders will continue to require third-party support for the associated legal, operational and counterparty risk management obligations.
Changing business practice
More broadly, a number of factors have been important in driving changes in how securities lending business is conducted. One has been the need for borrowers to manage the capital impact of their lending activity as efficiently as possible.
A second has been a drive for lenders to align their securities lending activity more closely with their broader financing and treasury management functions. Traditionally, securities lending has operated as a distinct and separate business silo established to generate additional revenue from a lender’s asset portfolio.
In recent years, many pension funds and asset managers are recognising that securities lending can be a valuable tool to support collateral transformation and to ease their financing requirements by using cash received as collateral. By utilising securities lending within their overall treasury management function, clients can lower financing costs and reduce their reliance on bank financing while at the same time reducing the risk of reinvesting cash collateral by mobilising it to meet in-house requirements.
This same message applies when borrowing securities. Buy-side firms running long-short strategies typically source their borrowed securities from the Street, when in many cases the required securities are sitting in inventory under the control of another business area within the firm. Lenders are increasingly working across business units to access internal supply and to make optimal use of liquidity and inventory at the enterprise level.
But this drive to break down silo-based approaches to trading, liquidity and collateral management has been ongoing for decades — and many firms claim they have made major advances in reducing this fragmentation over the past 20 years. So how far has the industry advanced in this area?
“US pension plans have traditionally been heavily siloed and have tended to source their cash and securities requirements largely through banks and broker dealers,” responds Jaynes. Until recently, there has been little use of internal supply or direct financing activity between large beneficial owners. However, this is changing with pension funds, insurance companies and sovereign wealth funds making better use of internal assets and taking advantage of their balance sheet strength to lend directly to each other through P2P transactions.
This upturn in P2P lending has aligned with traditional borrower counterparties pulling back from certain types of repo or securities lending trades, typically due to the narrow spreads and the reduced economic benefit as a result of increased regulatory and capital costs. P2P lending has helped to fill this void, adding capacity and supply and delivering the risk management benefit of wider counterparty diversification.
More generally, trading strategies are becoming more creative to meet the evolving needs of both borrowers and lenders. This may be through structured trades that deliver capital-efficient lending structures to the borrower, while ensuring they meet lender-specific guidelines and risk tolerances. “By offering flexibility through our segregated account structure, this puts eSecLending in a strong position to facilitate tailored transactions that pair borrowers directly to lenders to enable trades that benefit both parties,” says Jaynes.
Concluding thoughts
In wrapping up, Jaynes notes that he has seen a significant shift in how large asset owners are approaching their lending strategies in the 23 years since eSecLending was established. Most large pension funds, insurance companies, sovereign wealth funds and asset managers are employing multiple routes to market and are utilising specialist third-party providers, direct lending, or both, for at least a part of their loan book. Any large beneficial owner that is lending wholly through their custodian bank is an outlier today, while this was the norm back in 2000.
For large client portfolios, which will benefit from lending outside of a pooled structure, he believes that a segregated and individualised approach has proven to be very effective. “As a dedicated securities financing business, we offer the additional assurance to clients that our focus is exclusively on providing securities financing and related services and we are not competing with other business units for development resources,” he comments.
Looking historically, collateral eligibility criteria have certainly widened over the past 15 years. Prior to the 2008 financial crisis, a large majority of US clients favoured cash collateral, while most European clients were predominantly accepting non-cash. With the crisis, many US collateral takers have moved to a balance of cash and high-quality non-cash collateral. On the borrower side, banks are now looking to borrow against a range of non-cash collateral that extends well beyond US treasuries.
“With changes to guidelines in recent years most large pension funds today will accept cash, sovereign debt, main index equities and certain ETFs as collateral,” says Jaynes.
More broadly, Jaynes notes that many beneficial owners are expanding how they employ their securities lending strategies, not simply to generate intrinsic income but as an integral component of their financing strategies.
Projecting forwards, Jaynes predicts that asset owners will continue to move towards centralised treasury, breaking down silos and integrating securities lending more closely with their overall financing and treasury activities. He also expects to see further growth of peer-to-peer financing in coming years, with eSecLending continuing to play a key role in that expansion.
Geographically, eSecLending will continue to grow in North America and Europe and it expects further expansion in the Middle East and Asia Pacific, where their business pipeline is strong. “Though we have an active client base across these locations currently, we anticipate the percentage of our global footprint in the Middle East and Asia Pacific will grow as we continue to build upon opportunities with our bank partner, Standard Chartered,” says Jaynes. He notes that eSecLending is active in all asset classes and markets that can support securities lending from a regulatory and fiscal standpoint around the world. “In this capacity, the future is bright for our growth strategy across our North America, EMEA and APAC activities,” he concludes.
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Image: Chris Jaynes 