Andrew Dyson, ISLA: There’s a lot to talk about and also quite a lot of positives that are coming out of the regulatory agenda. And if I think back to the early days of SFTR and CSDR, many of us, including ISLA, fought hard for certain provisions of that regulation not to come in.

The other thing about CSDR, more recently, is settlement discipline. So, what SFTR taught us about our market is that it’s a very big, diverse, broad market. But it suffers from lack of clarity and standardisation.

SFTR was the catalyst of that discussion. More recently, CSDR, a huge piece of legislation, has been much discussed and highly criticised from many quarters, including ourselves, over these two big things: the mandatory buy-in regime, and more specifically, the settlement fail fine regime. After quite a lot of extensive lobbying and work with all of you and several of our friends and other associations, the mandatory buy-in piece was excluded from the go-live of the fines earlier this month. And if you’re watching on catchup, that was February 2022. However, the buy-in thing hasn’t gone away permanently – just for a bit. I saw something from the European Commission, only this morning before I came down here, which suggests that around about the middle of March, you will see a proposal from them that will include the reincarnation of the mandatory buy-in. There are certain groups who feel that mandatory buy-ins are a good thing, because they engender market discipline.

We don’t agree with that view at all because we feel that our market has been quite good at policing itself. The master agreements that many of you know that we sponsor, and cover have this thing called a mini close-out, that effectively allows the same thing.

We need to start working on a dataset with empirical evidence that shows the impact this will have on things like market liquidity. You mentioned corporate bonds: we know that if they start getting mandatory bought in, they will disappear from the market, because clients will just pull them all back and leave them in custody accounts. This cannot be in line with the spirit of this piece of legislation.

Kiely: They tend to be the less liquid parts that we do.

Dyson: Yes, and Vodafone’s never failed ever. All the ones that disappear out the door and that you can’t get back will be the ones you make most money on, where you’ve got risk you manage already. These are the ones that will be hit hardest by this regime. On CSDR, the fines element came in at the beginning of the month. And to answer your earlier question, there is no doubt that heavy fines will change behaviour. We live in a world where we estimate that the fails levels in our market are around about 10%. If you’re above that you’re not doing as well, if you’re below, you’re doing better. Since we’ve been tracking that number, for 18 months, that’s gone up, which isn’t very encouraging.

What CSDR will do is - there will be some bills looking for a home. And the first incarnation of that cycle will be in about six weeks’ time, in mid-March. In the middle of March, you’ll begin to see what that means for you and your clients. And I think that could be quite a sobering moment to understand what those fails look like and the magnitude of the numbers. What I think it also really enforces is we must work on things together, that will effectively not change that behaviour but identify the reasons for the underlying fails. It will be increasingly important to bear in mind that if you have a high level of fails in your business, you’re going to get absolutely hammered by the regulators.

We know that the UK regulators are looking at a version of CSDR that’s not going to be as hard as elsewhere. And we know that they’re not keen on doing anything on mandatory buy-ins. However, they all quite like fines. And they will point you to the US Treasury market 10 years ago, they put in huge fines and it miraculously righted itself. The real killer around fines is around recalls and getting them back early enough from your clients to cover the cash sale on the other side. And the other one is many outward legs fail because the collateral doesn’t show up.

Kiely: On that, I was speaking to my operations department about this last week; we often see borrowers who are returning assets that have not been specifically recalled and the loan hasn’t come back, and you just roll it, roll it, roll it, roll it, as the client hasn’t asked for it back. They’re still getting paid and they’re happy enough, but the borrower is going to get fined for this. Anything that speeds up the efficiency of the market is great, but I do think some institutions are going to need almost an army of individuals to reconcile this process. And that concerns me.

Andrew Geggus, BNP Paribas: it’s a little bit of the carrot and stick sometimes. But I would prefer to be investing in figuring out how to create better efficiencies as we don’t like fails in the market. No one does, it doesn’t help anybody. But having to build out a way of dealing with fines coming in and how we implement them, pass them onto clients, where that sits, different account structures as opposed to building out a way of having simultaneous settlement in the future or a network of technology that we can touch on later around settling at the exact same time and removing that risk...

Dyson: I think they’re going to be significant. The other thing I would say is that if you’re identified as a firm that is persistently causing fails, you will get a visit from your regulator. Because even if your point is well made about how we should be investing into things that add value to our clients, when you talk to the regulator community, they don’t care about that. They just think that a market that has a high level of fails is unacceptable.

Daswani: I would like to remind everyone of something quite interesting. I’ve always thought that there’s no mention of this internally, when CSDR comes up. We still consider Taiwan and Korea like new markets - and Malaysia too to some extent – of some significance that we brought into securities lending. The main point is that you can have a zero fail in that market. And we deal with it, and we lend securities, we make money and we have zero fails. We call them emerging markets, but we are moving somewhat in that direction. Our industry works very well with lending securities and not having fails. I don’t see CSDR as a threat, I see it as bringing further efficiency for us all.

Singh: My view is that it’s a little bit more than just… I think 10% is a fact but when you look at CSDR, it goes a bit beyond what the end of day outcome is. It’s what you do intraday as well that’s become more important. You may have STP from a technology standpoint, going front to back, but then you need to start having to cancel some things out afterwards. I think there’s an element of process. But there’s also an element of actually allocating costs as well. When those fines start coming in, where are they going to sit? We talked about borrowers taking some of them, but this might not be possible. What happens when someone says: we think it’s yours. And you say no, it’s not. Just as we have all said, it’s all actually trying to achieve the right thing. For me, it’s more about the amount of time spent resolving something that involves us as agent lenders, and our buy-side clients as well.

Matthew Chessum, Abrdn: From my perspective, I completely echo what Sunil says. We already lend and buy in markets; we already lend in markets where there are fines in place. Anything that involves tightening up processes and making operational flows more efficient, I’m all for. As a beneficial owner, there’s nothing more irritating than having failing sales on the back of a securities lending transaction, because a borrower is returning to the wrong SSIs, or something’s been dumped in the wrong account, and it’s takes too long to resolve. Anything that helps focus the mind to get loans back on time, I think is positive. And like I say, we already lend in many markets where there are automatic buy-ins, and where these penalties do already exist, and we transact in them a lot more efficiently than in those markets where they don’t exist.

I don’t think that we should be too scared of it. I think the reconciliation is going to be a bit of a nightmare, because from my understanding, a lot of custodians can’t distinguish between a securities lending transaction and a normal buy and sell transaction. I can imagine a lot of chasing, going around the houses to find out where the credit or the debit sits at the end of the day. But I think we’re going to have to wait and see, it’s going to be a case of waiting until those credits and debits come in, and then seeing where they can be allocated. I think it comes down to buffer management, and ensuring the SSIs are correct first time around.

Martin Aasly, NN IP: I can echo that. We’re quite curious to see how this is going pan out, how frequent this is this going be. But certainly, a lot of processes have had to change. It’s important to have accurate and timely information flows between the lending parties, custodians, lending agents, it’s more important than ever. And our fear going into the CSDR was - and I think this is of systemic importance as well - that we would have to become a lot more cautious about what assets we make available to lend. The logic is that if securities go lower, there will be less liquidity, and the knock-on effect will mean a further reduction in liquidity, which reduces market efficiency. In general, this is just the wrong way to go. And to be fair, I think that’s also where monetary buy-ins would have a really big impact. And we’re glad that’s been put aside. We were hoping indefinitely, but I hear from Andy that’s not going to be the case.

Davis: Sunil mentioned trading in Taiwan and Korea, and the mandatory buy-ins and zero fails attached to those markets. The point that was just mentioned about the industry embracing mandatory buy-ins and getting through it needs to be approached with caution. The kind of volumes that we have in the European markets today compared to Taiwan are very different. If mandatory buy-ins do come in across the board then that opens up a whole new agenda. Are we talking a more aggressive style of buffer management in addition to a strain on liquidity? Definitely one to watch as this regulation continues to evolve.

Geggus: This could have a knock-on effect as well for the rest of the industry if borrowers are struggling to get something back. It’s not a simple case of, well, they might only be 40% utilised in the market, because if 60% has been held back for buffer management internally, then suddenly that’s an active 100% utilisation.

Kiely: Matt - how significant a barrier to entry do you think that is for certain funds? Do you think there’s a real danger or a percentage that will just say: ‘this is too much hard work; lending is not for me?’

Chessum: Definitely. I think asset pools need now need to be of a certain size to be able to justify the amount of oversight needed to ensure that you’re running an efficient securities lending operation. Reputational risk is massive for the buyer side. But, you don’t want to be in a position where you’re not fully in control of what you’re doing, especially in the new world of ESG, and of some of the assets that you’re looking to include in the lending programmes.

Kiely: We saw that when SFTR kicked in, several self-lenders or smaller agent lenders, just said: I’m out, because I do not have the resource for this. Is it right that it’s almost pushing the activity towards a smaller number of big players?

Chessum: You’ve got all this European regulation coming in while UCITS are losing their attractiveness because they’re more tied to this regulation. That makes it more difficult.

Kiely: Interestingly, the Bank of England stock lending committee minutes the other day showed that UCITS are going to be lobbied re their restrictions. Because for a long time now, the availability of assets from UCITS funds has been three times the percentage of on-loan assets from UCITS funds.

Dyson: We’ve tracked the availability of UCITS funds in programmes versus the proportion of on-loan balances. There’s 45% of all funds in programmes in Europe, or similar structures, yet they represent somewhere between 15 and 20% of on-loan balances. In a like-for-like standardised world, it should be the same. There’s no reason why it shouldn’t be. And primarily the reasons UCITS don’t lend as much as other people is there’s restrictions around collateral and term.

We estimate by looking at the SFTR data that up to 90% of loans in Europe could come from entities that are outside of Europe. My suspicion is that’s a bit high. We did a straw poll three or four years ago, and it came out about 70%. What that means is for all of you lending securities, you’re lending on behalf of a client who falls outside the reporting regime on the loan side of the trade.

I was talking to a gentleman who runs a cash equities exchange in the Netherlands. He told me something I was staggered about: 90% of participants are non-European on that cash exchange in Amsterdam. This tells me that, in Europe, there’s a lot to do about raising that awareness of what capital markets do. And the reason it’s 90% is, we’re not in that number anymore. Because think about where most stocks trade: they trade primarily in the London market, because that’s where the liquidity is.

Dolce: I think that what we’re trying to mention is clearly that the behaviour will change. Where we are making a lot of money is not within UCITS. I’m part of a beneficial owner looking after UCITS funds, and clearly the concern is that they’re very difficult to monetise, you cannot go term.

On the collateral side, the liquidity part, I’m not sure you can accept corporate bonds so that keeps you on the equity side, government bonds and cash. To summarise what we said: we will get the constraints from the pledge plus the collateral plus those from the UCITS. I think the UCITS funds will be making less and less money if we continue like that, especially if you’re a small asset manager.

We were saying: maybe people will stop doing securities lending. This is quite funny, because three years ago, people were trying to manage in-house securities lending, thinking they would be able to handle it, but SFTR told them no. The good part from my perspective for SFTR and now we can build on it for CSDR is the fact that we can improve our operational setup, middle, back, and automation too.

Singh: Look at the equity market where things weren’t electronic front to back. Purely from a securities lending point of view, look at the concentration that’s led to in the prime brokerage space. In the US, there are more broker-dealers. If you look at Europe, who are you lending to? There are circa four counterparties. Why do you need an agent to do that? If you’re a large asset owner, I think the four sales team should go out and say: we split it into four. I’m kind of saying something that works against me. I worked on the prime brokerage side but I’ve asked myself that question. And it’s quite interesting to see. If you keep going down this path, keep trying to look at the minutiae and trying to cover off the detail…

Kiely: Two words why that won’t happen: credit intermediation.

This article is part of the Beneficial Owners Guide 2022, which is available here.