I see more press releases about new central counterparty launches for securities lending than there are bank bailouts and re-bailouts, so I thought that it was about time I started to discuss the subject here.
I say “start” to discuss, because despite all the announcements it is still very early days. At this point in time, there are no live central counterparties (“CCP”) for securities lending activity that I am aware of, but within the next six to nine months there could be a flurry of activity in the space. There have been various combined announcements from (at least) SecFinex, LCH Clearnet, Euro CCP, SIX x-clear, Quadriserv, OCC, DTCC, LendEx (apologies for missing it the first time) Clearstream and Eurex Clearing. Let me know if I’ve missed any.
In this post, I just want to highlight what I believe the potential benefits to be, and will use this in future as a benchmark as to their success. I will return over the course of the coming months as to how the various CCP arrangements measure up against these criteria.
What benefits could a CCP provide?
• Counterparty risk reduction
• Capital charge reduction
• Increased reach to a wider universe of counterparties
• Administrative benefits
There are questions that remain and here are some of the key ones from my point of view.
• What will the impact be on revenues? There is potential for negative revenue impact due to a more level playing field and reduced cash reinvestments versus the substantial positive effect of reaching out to a much wider universe of counterparties
• Will benefits accrue to all market participants? Not all firms have capital constraints. Additionally, some existing lending arrangements would need to be changed to accept delivery versus payment instead one day pre-pay.
• Can the CCPs provide the functionality they promise? Issues in cross-border trading such as dividend processing are critical to the equation.
• Will the increased operational burden be offset by the potential efficiencies CCPs bring? For the foreseeable future, only a portion of any firm’s business will be processed through CCPs. This will mean an additional operational process for each CCP market. Will the extra effort be offset by financial (capital reduction and collateral efficiency), risk (counterparty risk reduction) and other operational benefits?
• What volume of business will be required before firms start to realise the advantages of CCPs?
The success of CCPs will be based on the answers to three questions:
1. Do the CCPs deliver the promised functionality and benefits?
2. Are the benefits substantial and wide-ranging enough to be attractive to a significant proportion of the market?
3. Will the securities lending industry embrace change and actively support the development of CCPs?
I have a little sign over my desk that says the following:
“Coming up with new ideas isn’t the issue. The challenge lies in letting go of the old ideas”.
Watch for Central Counterparties Parts Two, Three, etc … in the coming weeks and months. I’m really interested in your thoughts on this subject.
Have a great weekend, and I will be writing to you next from sunny Scottsdale at the IMN 15th Annual Beneficial Owners Securities Lending and Repo Summit. DON'T MISS IT - I hope to see you there. If you haven’t registered yet – there is still time, but don't delay.
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