BNY Mellon is exploring the possibility of adding principal sec-lending capabilities to its agency securities financing business, with the aim of alleviating liquidity and credit mismatches between prime brokers and beneficial owners of securities.
Having traditionally operated as an agent lender, BNY Mellon would be following up its move last June to fold its sec-lending business into a new division called global collateral services, when it shifted agency lending out of its asset servicing unit.
Expanding into the principal model would likely entail warehousing more risk on the balance sheet than as an agent lender representing beneficial owner clients and holding no positions on book.
The firm is looking at options to play the role of a liquidity “bridge”, providing global broker-dealers with high-quality collateral, says Sean Greaves, managing director of global securities lending in Hong Kong. Their need for what he describes as "enhanced borrowing" has been made more acute by long-term liquidity requirements such as those under Basel III, he adds.
Moreover, lenders of securities under Ucits IV liquidity requirements must demonstrate their ability to satisfy short-term redemption obligations, says Greaves, leading them to be more conservative in their term lending activities.
BNY Mellon says such divergence in interest and capabilities between lenders and borrowers creates an opportunity for it to play a role in principal sec-lending, swapping less liquid, lower-grade securities that broker-dealers provide as collateral for high-quality government bonds or treasuries that are often demanded by the more conservative asset owners.
While sec-lending is a low-risk activity, practitioners must carefully manage the various sources of risks, including reinvestment, market, counterparty, regulatory and operational risks, said Dominick Falco, BNY Mellon’s managing director, at the Pan Asia Securities Lending Association in March in Hong Kong.
In fact, BNY Mellon would not be alone should it seek to reposition its agency sec-lending business, which it claims has an inventory of $3 trillion worth of lendable securities.
Others, such as custodians from RBC Investor Services to State Street, are offering what they describe as ‘enhanced custody’ services that see them directly lend to hedge fund clients without the intermediation of prime brokers or other securities firms, as reported.
However, not all market participants are convinced there is an opportunity for any additional service providers in this area.
Broker-dealers are already doing such “financing trades” in which they would trade collateral among themselves so they would have eligible securities acceptable by the end beneficial owners, says a Hong Kong-based head of equity sec-lending at a prime finance unit of a global broker-dealer.
Another sec-lending banker suggests expansion into principal sec-lending comes with the caveat of a potential conflict of interest, if a bank were to house principal and agency-lending desks under one roof, or without proper firewall and segregation.
“As an agency lender, you always keep arm’s length from your own principal lending business to ensure you transact based on the maximum interests of clients,” says the banker. “If these are housed under the same legal entity, clients will get concerned about your actual mandate.”
But BNY Mellon indicates that any plans for principal sec-lending that come to fruition would be supportive of its client base of prime brokers.
A feature on securities lending and collateral management will appear in the May issue of AsianInvestor magazine.