Imagine if the securities lending industry was a public company, SEC-LEND PLC. Would it be a growth stock or a value stock? Is it the next Amazon, GSK or WalMart, or is it the next GE, Kodak or Nokia?
Let’s look at the fundamentals – for the last decade its potential market has been growing steadily (the value of listed equities globally more than trebled from $25tn to $80tn) yet its client base ($2tn on loan) and gross revenues ($8-10 billion in yearly lending revenues) have largely been stagnating in the past decade. What would you do with SEC-LEND PLC? Would you buy it? Sell it (we can potentially facilitate the borrow)? If this was indeed a public company, wouldn’t analysts and investors ask why such a potentially lucrative offering wasn’t growing, expanding its reach and fulfilling its potential?
While securities lending has served the incumbents well for the last forty or so years, focus and resources have been spent on complying with new regulations and growing the lending pools with whatever anyone can pour into them. This has yielded partial success, with almost $20tn (mostly GC) in lending pools, but limited success bringing in the right supply to the market and growing theon-loan market, which has been stagnating at around $2tn. Make no mistake; increasing the former doesn’t necessarily increase the latter or guarantee success. It is akin to Airbnb making a million rooms available in Newcastle. A great achievement, but does the rental market really need it?
Looking at the graph below, one cannot ignore the worryingly slow growth of the on-loan versus the stellar growth of its underlying base (taking global equities market cap, ex-China, as an indicator)
Throughout the last decade, there have been some improvements – incumbents have ensured that securities lending has become a more stable and secure practice. But let’s face it, today it is still a closed, complicated and opaque ecosystem so new participants can be forgiven for not wanting to step forward to play a part in what is a potentially lucrative practice.
Nowadays, change is happening faster than ever before and no matter how well you’re doing things, if you keep doing them the same way you’ll soon be left behind. Sogoing back to SEC-LEND PLC with its stagnating revenues – how can we, as an industry, help it grow and push it up the path of progress? How do we attract a wider audience and increase engagement? How do we make SEC-LEND PLC the new Apple Inc?
Tech solutions have of course answered the call and automation has replaced many manual processes. Focus and resources have been poured into complying with the new raft of regulation and optimising collateral management, while trying to fix the age-old issue of clunky legacy systems.
However, this digitisation is largely not client facing and we must recognise that digitisation does not create value by itself; rather, it is a means to an end. Clients rarely care what is actually under the bonnet. YES in securities lending too!
In this digital age, we should accept that client behaviour is dramatically changing. From leisure services, to insurance and high finance, client expectations are rising rapidly.
Our industry can learn a lesson from successful fintech and insurtech firms. The likes of Revolut, Starling Bank, Transferwise, Stripe and Lemonade, among many others, have understood that digital capabilities which focus on client experience and the savvy use of data, must be at the heart of their business model in order to deliver a standardised solution with a strong value offering and engaging client experience. They are all heavily regulated,yet it hasn’t stopped them from religiously focusing on simplification, alignment of interests, reduction of friction while being as transparent as possible. With these companies you don’t get just a great app, you get an offering that exudes simplicity, engagement and transparency. They jump the end-user through the hoop of complexities associated with opening a bank account, buying insurance, making cross-border payments, taking business loans and much more. Unconvinced? Sceptical? Just ask their millions of clients.
Yet securities lending continues to be riddled with complexity. Have we ever stopped to ask ourselves what clients really want and what they need? Do lenders really need ten collateral schedules? Do borrowers really care about getting the cheapest borrow, or would they prefer to optimise its stability and visibility? Instead of simplifying and standardising our offering, we the industry, have created an array of different offerings to try and attract new participants, while substantially increasing the operational risk and cost-per-trade. Can this be a viable strategy in an era where standardisation and the commoditisation of offerings is inherent in most aspects of our lives?
Frank D’Agnese, State Street’s head of product and technology for securities finance, pointed out in a piece in the Securities Lending Times that every securities lending programme has its own set of client-driven parameters relating to commercial terms and conditions.
“Imagine rolling some portion of these parameters out to clients to give them the power to control key aspects of their lending programme directly,” he suggests.
Is this so far-fetched that we need to imagine it? Should it not serve as the bedrock for our offerings?
Sharegain has taken a long and hard look at the industry. We took stock (no pun intended) and looked at it from a twenty-first century lender’s point of view. We questioned why the securities lending industry was not working as it should be, and why the size of the industry is not double, or even triple its current size. We thought about how we can make it more accessible, more inviting and effortless, and strived to understand why more investors were reluctant to benefit from a new stream of revenues with relatively minimal risk. We saw that today’s investors have little time and lack the resources to engage with this directly, and the information is not forthcoming. What investors crave is simplicity, control and efficiency, and we vowed to stop at nothing to provide this.
On an industry level, how can we remain relevant in the era of digital disruption? Naturally, the industry must use more automation to reduce risk, streamline processes and provide that slick client experience. The utilisation of technology to replace all the labour-intensive processes must be integral to our conversations. But automation has a much wider role to play. For example, one of the biggest issues holding us back as an industry is the onboarding process. Today one can open a bank account with a challenger bank in a matter of minutes, going through the entire AML/KYC process, even for business accounts. Yet onboarding in our industry is usually a traumatic experience for all stakeholders. It is a labour-intensive and lengthy process, which can take weeks.
Should we, as an industry, stop to think how we can cut out all this high-friction? Think how different it would be if a potential lender could start lending his Specials in just a matter of minutes? How appealing will securities lending look then?
At Sharegain we have a few ideas, and would welcome the opportunity to lead an industry-based tech solution to free up this bottleneck.
In terms of future technologies, naturally we laud all the work done by market participants and other technology companies who have taken on the challenge of implementing Distributed Ledger Technology (DLT) to free up dramatic bottlenecks and enhance collateral mobility and real-time settlement. Both are crucial to the success of our industry. But make no mistake, while the adoption of an industry-standard solution for realtime settlements is certain, it’s still years away. The race today between different market players to tokenise collateral and experiment in real-time settlements on blockchain feels to us like the early days of the internet, when global companies were trying to build an internet of their own! From the early interbank payment systems, to XBRL (eXtensible Business Reporting Language), to Open Banking, the financial services industry has proven adept, if not always especially speedy, at creating industry standards, and solving problems together. These have often been imposed by regulators, sometimes to unblock competitive barriers, but the outcome has usually been to create new markets and to expand opportunities.
A look to the wonders of blockchain brings into discussion the evolving role of custodians in the age of decentralised ecosystems. Their role will certainly change, but they play an important part in the industry and we can’t see them going away anytime soon. We do envisage capital markets with custodians and CSDs having a key part in a hybrid solution, running fully-permissioned, semi-centralised environments which enable the public to both access and read information, but leave the safeguarding and editing of their ledgers to our trusted custodians and CSDs.
We also see the rise of the new asset class – cryptocurrencies – as a major growth engine for our industry. As more institutional money dips its toes into the crypto world, the need to facilitate crypto-lending in a regulated environment will rise and we will be there when the tide turns.
In terms of Artificial Intelligence and Big Data, the most evident use-cases involve Machine Learning for predictive analysis and better pricing of loans; NLP for communication with clients and counterparties, as well as analysing news and corporate events. However we at Sharegain believe that while AI can create efficiencies, there aren’t enough use-cases warranting an industry wide use of AI at this stage. For the next few years, securities lending is facing much larger fundamental challenges that, once solved, will outshine any efficiencies created by AI. SFTR, for instance, can significantly improve data quality and enable the industry to enhance its offering through data with minimal use of AI.
The challenges to our industry are clear. If we want to take our market to new heights, with numerous new usecases we haven’t even thought of, we firstly need to change our mindset and relentlessly focus on simplification and customer experience. We must also use transparency as a currency and combine the power of collective action to free up industry bottlenecks. Such powerful combination will future-proof our industry, open it to new participants and enhance its legitimacy and longevity.
So what does the future hold for SEC-LEND PLC? The stakes are high, the road is long and the challenges are many, but in the words of the great Warren Buffett: “The most common cause of low prices is pessimism – some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces.”
This article was originally posted at the ISLA’s Securities Lending market report