Less fire and fury, more wait and see
02 October 2018
The US has experienced a radical few years under US President Donald Trump. To what extent have his executive orders and other regulations impacted US securities lending?
Image: Shutterstock
Now is an unprecedented time for securities lending in the US. As the midterm elections approach, the US faces a new wave of governmental uncertainty, and could possibly be spearheaded in to even more unpredictability with the possible strengthening of its current Republican stronghold across US Congress.
Added to that, is the possible continued tenure of one of the most controversial US presidents in modern history鈥擠onald Trump who, over the last two years of his presidential term, has radically attempted to deregulate US financial services.
From its own side of the pond, the US has the Dodd-Frank Act (also known as the Volcker Rule) to consider, and to the east, coming in from Europe, the 麻豆传媒 Financing Transactions Regulation (SFTR) approaches fast with a confirmed implementation date next year.
As of 29 June, there were circa 鈧�950 billion of equity securities on-loan from an available lendable supply of just over 鈧�12 trillion, according to an equity markets report by the International 麻豆传媒 Lending Association (ISLA).
It said: 鈥淲hile we cannot be specific around the causes of this growth, increased political uncertainty that is feeding through into economic concerns is fuelling much of this growth.鈥�
鈥淗edge funds and other arbitrage players are trading into the anomalies created partly by the current political regime,鈥� it added.
This finding is further reflected in another report by eVestment released at the end of August, which reported US equity managers saw net redemptions of minus $64.8 billion, a further sign of economic volatility and political uncertainty.
Collateral
Possibly, the most important regulation for collateral right now is Rule 15c3-3. First introduced in 1972 by the 麻豆传媒 and Exchange Commission (SEC), Rule 15c3-3 was initiated to protect client accounts in securities firms.
Rule 15c3-3 cites the amount of cash and securities that broker-dealer firms must segregate in specially-protected accounts on behalf of their clients.
Broker-dealer firms must calculate the cash and securities they owe to clients and what clients owe to them. In the event that the amount owed to clients exceeds the amount owed from clients, the firm must keep hold of a portion in a special reserve bank account.
The SEC鈥檚 reasoning is to ensure that clients can withdraw the majority of their holdings on demand, even in the midst of a bank鈥檚 insolvency.
George Trapp, head of client relations for North America at Northern Trust, global securities lending, said: 鈥淥ver the past year US equity markets indices have reached new highs and many clients took the opportunity to reassess their securities lending programme objectives. We have seen a number of clients expanding their programmes by accepting a wider variety of collateral.鈥�
Peter Economou, head of markets, risk, and operations at eSecLending, says: 鈥淸Rule 15c3-3] could change the industry for the better.鈥�
鈥淸The] ability for US brokers/dealers to pledge equities as collateral and the permission for registered investment companies to accept equities as collateral [...] will increase revenue opportunities for beneficial owners at risk levels well within existing tolerances.鈥�
He also says: 鈥淲e continue to believe that non-cash collateral will expand in asset types and preference to the borrower community. For some borrowers, the provision of USD cash as collateral is expensive; therefore, other options such as non-cash collateral are more attractive.鈥�
A sign of the times
In 2010, the Dodd-Frank Wall Street Reform was signed into federal law by the Obama administration.
Although, the Obama administration brought in the Dodd-Frank Reform Act to damage control the crisis; making US financial services follow investor guidelines, it is clear Obama鈥檚 successor, US President Donald Trump, has a different agenda through his executive orders across the first half of his current term, as well as last year鈥檚 signing of the Financial CHOICE Act.
Just ten days after his inauguration day, on 30 January 2017, Trump signed an executive order titled 鈥淩educing Regulation and Controlling Regulatory Costs鈥�. The order stated that for every one new regulation that is proposed, executive departments and agencies must remove two in its place.
In addition, the Republicans initiated the Financial CHOICE Act in June last year, which was fiercely backed by the president, and is predicted to directly affect foreign banking entities.
It scales back the authority of the Dodd-Frank Reform to regulate large banks and also repeals the so-called Volcker Rule (created by former US Federal Reserve chairman Paul Volcker), which prevents government-insured banks from making bets with investments.
The Dodd-Frank Reform expanded federal laws to potentially handle insurance companies and non-bank financial companies, changing these types of liquidation laws, which could affect securities lending.
As Stephen Malekian, head of US business development at Elixium, states: 鈥淚t鈥檚 hard to muster a counter-argument that rolling back regulation won鈥檛 put the banks back to where they were pre-crisis.鈥�
鈥淲henever regulators and central banks intercede in markets and endeavour to make the banking system 鈥榞reat again鈥�, there are inevitable repercussions鈥�, he says.
Only time will tell how future US government legislation will change the rules for securities lending specifically, though there are concerns about the Financial CHOICE Act and Trump鈥檚 influence over US financial services, of which the latter could last another fifteen months, until the next possible inauguration in January 2020.
According to a TABB Group report, released in February of this year, the US options market is stagnating as a 鈥渞esult of political and regulatory change鈥� in Washington DC.
The total volume in the US options market was 1.9 percent lower in 2016 than 2015, due to a lack of sustained volatility, TABB explains.
TABB elaborated that this was due to the inauguration of 鈥渞egulatory-sceptic US President Donald Trump [who] has caused a decline in market correlation鈥�.
But despite this decline in market correlation, OCC found that in it鈥檚 most recent monthly report, total cleared contract volume in August reached 433,740,316 contracts, an increase of 10 percent compared to last year.
Equity options volume reached a total of 384,002,068 contracts, a 17 percent increase from a year earlier.
But while options activity looks like it鈥檚 rising positively, it鈥檚 important to remember that鈥檚 only one slice of the American securities lending pie to digest.
Predicting the future
Post-crisis and under the Trump Presidency, what do the next few years hold for US securities lending, are we able to even predict it?
In January this year, the debate on the controversial leverage ratio rules under Basel III was reopened, showing a consideration for concerns within securities lending.
The rule, which many think currently stifles securities lending activity in the US, requires equity capital to be held against assets, including cash, on an unweighted basis.
Conflicting views around the appropriateness of the measures, which are less strict in other major markets such as the EU, has been ongoing since the implementation of the rule began in 2014.
However, looking forward to 2019, there seems to be an understanding of a re-shaping of, not just securities lending, but of financial services as a whole.
As Trapp says: 鈥淚n 2019, we expect to see the initial impacts of stay regulations under various special resolution regimes, including the US. We also anticipate the release of further regulations on the UK鈥檚 SFTR regime.鈥�
He adds: 鈥淭hese two sets of regulations have a broad global impact, with the potential to reshape the landscape for cross-border securities lending.鈥�
鈥淎lthough these [regulations] are expected to be significant changes for the market, we are optimistic that the market will absorb and adapt positively to these regulations in much the same way it did to the Volcker Rule and other Dodd-Frank era rules.鈥�
Added to that, is the possible continued tenure of one of the most controversial US presidents in modern history鈥擠onald Trump who, over the last two years of his presidential term, has radically attempted to deregulate US financial services.
From its own side of the pond, the US has the Dodd-Frank Act (also known as the Volcker Rule) to consider, and to the east, coming in from Europe, the 麻豆传媒 Financing Transactions Regulation (SFTR) approaches fast with a confirmed implementation date next year.
As of 29 June, there were circa 鈧�950 billion of equity securities on-loan from an available lendable supply of just over 鈧�12 trillion, according to an equity markets report by the International 麻豆传媒 Lending Association (ISLA).
It said: 鈥淲hile we cannot be specific around the causes of this growth, increased political uncertainty that is feeding through into economic concerns is fuelling much of this growth.鈥�
鈥淗edge funds and other arbitrage players are trading into the anomalies created partly by the current political regime,鈥� it added.
This finding is further reflected in another report by eVestment released at the end of August, which reported US equity managers saw net redemptions of minus $64.8 billion, a further sign of economic volatility and political uncertainty.
Collateral
Possibly, the most important regulation for collateral right now is Rule 15c3-3. First introduced in 1972 by the 麻豆传媒 and Exchange Commission (SEC), Rule 15c3-3 was initiated to protect client accounts in securities firms.
Rule 15c3-3 cites the amount of cash and securities that broker-dealer firms must segregate in specially-protected accounts on behalf of their clients.
Broker-dealer firms must calculate the cash and securities they owe to clients and what clients owe to them. In the event that the amount owed to clients exceeds the amount owed from clients, the firm must keep hold of a portion in a special reserve bank account.
The SEC鈥檚 reasoning is to ensure that clients can withdraw the majority of their holdings on demand, even in the midst of a bank鈥檚 insolvency.
George Trapp, head of client relations for North America at Northern Trust, global securities lending, said: 鈥淥ver the past year US equity markets indices have reached new highs and many clients took the opportunity to reassess their securities lending programme objectives. We have seen a number of clients expanding their programmes by accepting a wider variety of collateral.鈥�
Peter Economou, head of markets, risk, and operations at eSecLending, says: 鈥淸Rule 15c3-3] could change the industry for the better.鈥�
鈥淸The] ability for US brokers/dealers to pledge equities as collateral and the permission for registered investment companies to accept equities as collateral [...] will increase revenue opportunities for beneficial owners at risk levels well within existing tolerances.鈥�
He also says: 鈥淲e continue to believe that non-cash collateral will expand in asset types and preference to the borrower community. For some borrowers, the provision of USD cash as collateral is expensive; therefore, other options such as non-cash collateral are more attractive.鈥�
A sign of the times
In 2010, the Dodd-Frank Wall Street Reform was signed into federal law by the Obama administration.
Although, the Obama administration brought in the Dodd-Frank Reform Act to damage control the crisis; making US financial services follow investor guidelines, it is clear Obama鈥檚 successor, US President Donald Trump, has a different agenda through his executive orders across the first half of his current term, as well as last year鈥檚 signing of the Financial CHOICE Act.
Just ten days after his inauguration day, on 30 January 2017, Trump signed an executive order titled 鈥淩educing Regulation and Controlling Regulatory Costs鈥�. The order stated that for every one new regulation that is proposed, executive departments and agencies must remove two in its place.
In addition, the Republicans initiated the Financial CHOICE Act in June last year, which was fiercely backed by the president, and is predicted to directly affect foreign banking entities.
It scales back the authority of the Dodd-Frank Reform to regulate large banks and also repeals the so-called Volcker Rule (created by former US Federal Reserve chairman Paul Volcker), which prevents government-insured banks from making bets with investments.
The Dodd-Frank Reform expanded federal laws to potentially handle insurance companies and non-bank financial companies, changing these types of liquidation laws, which could affect securities lending.
As Stephen Malekian, head of US business development at Elixium, states: 鈥淚t鈥檚 hard to muster a counter-argument that rolling back regulation won鈥檛 put the banks back to where they were pre-crisis.鈥�
鈥淲henever regulators and central banks intercede in markets and endeavour to make the banking system 鈥榞reat again鈥�, there are inevitable repercussions鈥�, he says.
Only time will tell how future US government legislation will change the rules for securities lending specifically, though there are concerns about the Financial CHOICE Act and Trump鈥檚 influence over US financial services, of which the latter could last another fifteen months, until the next possible inauguration in January 2020.
According to a TABB Group report, released in February of this year, the US options market is stagnating as a 鈥渞esult of political and regulatory change鈥� in Washington DC.
The total volume in the US options market was 1.9 percent lower in 2016 than 2015, due to a lack of sustained volatility, TABB explains.
TABB elaborated that this was due to the inauguration of 鈥渞egulatory-sceptic US President Donald Trump [who] has caused a decline in market correlation鈥�.
But despite this decline in market correlation, OCC found that in it鈥檚 most recent monthly report, total cleared contract volume in August reached 433,740,316 contracts, an increase of 10 percent compared to last year.
Equity options volume reached a total of 384,002,068 contracts, a 17 percent increase from a year earlier.
But while options activity looks like it鈥檚 rising positively, it鈥檚 important to remember that鈥檚 only one slice of the American securities lending pie to digest.
Predicting the future
Post-crisis and under the Trump Presidency, what do the next few years hold for US securities lending, are we able to even predict it?
In January this year, the debate on the controversial leverage ratio rules under Basel III was reopened, showing a consideration for concerns within securities lending.
The rule, which many think currently stifles securities lending activity in the US, requires equity capital to be held against assets, including cash, on an unweighted basis.
Conflicting views around the appropriateness of the measures, which are less strict in other major markets such as the EU, has been ongoing since the implementation of the rule began in 2014.
However, looking forward to 2019, there seems to be an understanding of a re-shaping of, not just securities lending, but of financial services as a whole.
As Trapp says: 鈥淚n 2019, we expect to see the initial impacts of stay regulations under various special resolution regimes, including the US. We also anticipate the release of further regulations on the UK鈥檚 SFTR regime.鈥�
He adds: 鈥淭hese two sets of regulations have a broad global impact, with the potential to reshape the landscape for cross-border securities lending.鈥�
鈥淎lthough these [regulations] are expected to be significant changes for the market, we are optimistic that the market will absorb and adapt positively to these regulations in much the same way it did to the Volcker Rule and other Dodd-Frank era rules.鈥�
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