7 Considerations for the Future of Your Lending Programme (UPDATED with additional Graph)

In previous blogs I have made it clear that I feel counterparty risk is the single biggest issue for a lender to contemplate.  Further, I think we are all in agreement that every market participant needs to take a step back from their existing securities lending business activity and re-examine their business from the ground up.  I am absolutely not advocating that anyone stops lending in part or in whole.  I believe in a free market and am against all of this government intervention, but even so, no regulator has asked the institutions to stop lending.  The restrictions have been focused on the borrowers, and if regulators are trying to target anyone, that is the correct focal point.

Nevertheless, the market is in the midst of unravelling the biggest default that we have experienced in our business and it is a seminal point in the history of securities lending.  We are fortunate then that Spitalfields Advisors has recently a paper on the Impact of regulatory changes and economic events on beneficial owner participating in a lending programme.  OK, so it won't win an award for the snappiest title, but as the TV commercial in the UK goes:  "It does what is says on the tin".  I recommend that you download, read, and then check your own thought processes against it.  It discusses the relevant issues and the topics beneficial owners should consider and are neatly summed up in the report as follows:

• Risk Management
• Risk Adjusted Returns
• Counterpart Exposures
• Legal Documentation (including indemnification language)
• Use of triparty agents
• Collateral requirements
• Use and application of exclusives

What actions have been taken by so far?  I posted a survey a little while ago, and the results are posted below.  Responses were received from firms in Belgium, Denmark, France, Netherlands, Japan, Sweden. Switzerland, UK and US, so a pretty wide universe of firms.  (If you click on the image, you will get a pop-up with more clarity.)

What does the survey tell us?

• It is no doubt a difficult time for firms at the fringe.  Just about every respondent reduced the number of counterparties they deal with.
• The next most common change is to the range of acceptable collateral.  I didn't go into any more detail in the survey, but presumably there was a "flight to quality".
• Forty percent of firms stopped lending restricted stocks - even though there was no legal requirement to do so.  This reinforces the anecdotal evidence of a reduction in availability of these stocks and an increase in recall activity.  40% of firms took actions that were not required by regulators and may have had a negative impact on the liquidity of the markets.
• Collateral margins were also increased by forty percent of respondents.  An obvious and interesting follow-on question is whether firms increased the margins across the board or on a counterparty specific basis.  Also, more detail on the increased levels by collateral type might be useful.