Minutes of the Securities Lending Committee meeting – November 2022

Minutes

Item 1 – Introductory Remarks

The Chair confirmed the minutes to the previous meeting were available on the Bank of England website.

The Chair welcomed to the Committee Farrah Mahmood from ISLA, Sonia Shah from Citi, Amar Amlani from Goldman Sachs who all attended as part of the Bank’s Meeting Varied People initiative; Tim Smollen from MUFG and Sunil Daswani from Standard Chartered were welcomed as new members of the Committee.

The Chair led thanks to Matt Brunette of Norges Bank for his contributions to the Committee and noted that he had now stood down from the Committee.

Item 2 – Recent Market Trends and Observations

The Committee began by noting that 2022 was a satisfactory year for securities lending. Datalend reported record volumes, although demand for general collateral gilts decreased. Agent banks also decreased business due to the cost of capital usage for indemnified lending versus returns.

Utilisation has been focussed on sub-10 year gilt issues with increased demand following the market disruption in September / October. An increased number of queries from beneficial owners arose during the LDI crisis as they queried the level of flexibility in their lending contracts in the event they needed to recall their securities. This led to some temporarily ceasing lending.

Despite the recent record months in terms of volumes, Risk Weighted Asset constraints remain a problem for many of those in the industry. In particular the interaction with Basel 3/4 is coming more into focus.

The Committee then turned to a discussion on the levels of fails seen in the industry. Post the mini-budget, there was an increase in securities lending fails on returns and resulting CSDR penalties. The Committee noted CSDR penalties are bigger than expected – and not washing through the system as easily as anticipated. Levels of fails remain high, which means the level of penalties remain high, particularly in Europe. There is discussion around increasing the level of fines, but other avenues need to be explored, such as allowing partial settlements. Fails are largest by volume in the equity space, but are most common in corporate bond lending, though settlement rates have fallen across all products. The Committee noted that this problem has existed in the industry for years, and CSDR penalties have not made a large improvement thus far. The Committee discussed some potential drivers for high levels of fails which included: technical issues, liquidity of the underlying security and deliberate fails. The Committee noted that technological improvements were clearly the most important way to improve this issue, due to reliance on rigid archaic systems. The Committee noted that better investment was therefore needed, and that the trend of managing books to zero balances might have to be reviewed so firms could carry cash buffers to account for fails.

The Gilt sell-off saw many more enquiries from LDI funds that are looking at actively reviewing their funding models – and asking how to access greater liquidity. This has been seen particularly noticeable in the peer to peer lending space.

The Committee noted that the provision of indemnities might be expected to drop in the future. It costs around 13bp for agent lenders to provide indemnities, and investor understanding of these indemnities is not that strong. It may be that in future firms other than banks will provide these indemnities.

Item 3 -Tokenised Collateral

The Committee received a presentation outlining the basics of tokenised collateral. Tokenised collateral is a bond or equity moving as an object token, on a public or private block chain network. There are two methods of tokenisation: native and nonnative. Native tokenisation requires more legal structural change whereas non-native tokenisation fits more readily within current legal frameworks but requires improved additional development to be compatible with reporting requirements.

Tokenisation, it was suggested, may be able to resolve the issue of collateral fails. Settlement speed can be improved potentially to T+0, although intraday cash movements can be difficult due to segregated cash deposit accounts. The lack of digitalised cash further compounds the problem. It was felt that the main challenge has not actually been the technology but rather the regulatory and legal uncertainty around this form of ownership making compliance difficult. ISLA is in the process of issuing a paper which highlights the main challenges of regulatory and legal certainty of new owner records. Client money rules and asset rules add further complexity. Corporate actions remain a challenge for lenders and beneficial owners.

Item 4 – Basel 4 : Implementation of the Output Floor

It was noted that Basel 4 will require changes to risk calculations and minimum haircuts. Some members felt that the EU position on implementing output floors may increase the capital requirements particularly for unweighted corporates, pension funds, sovereign wealth funds and mutual funds. This might impact unrated funds in the EU who may be disadvantaged resulting in borrowers sourcing securities outside of the EU. This reduces transparency and impacts liquidity. ISLA is proposing to the EU that banks should be allowed preferential risk weighting up until 2032 and to use international standards to determine if counterparties meet high quality liquidity requirements. In addition, ISLA will propose use of 60% risk weighted assets (RWA) rather than 100% RWA for unrated counterparties. Further discussion will centre on using a credit benchmark to alleviate risk weighting or using clearing houses and CCPs.

Eurex have been considering increased collateral for pledge in comparison to title transfers. In June, EU collateral reported under SFRT showed 16% under pledge for title whilst the UK showed 18%. This was an increase from 12% previously and is a result of the Basel framework. There is concern that within the unrated UCITS, where pledge is not possible, this may result in reduced availability from lenders due to the cost of implementation.

Item 5 – Environmental, Social and Corporate Governance (ESG) in Securities Lending Markets

Due to lack of time the Committee agreed to bring back this agenda point at the next meeting, with a particular focus on greenwashing and understanding how this issue has progressed in a busier, more volatile environment.

Item 6 – Diversity and Inclusion

Thanks were given to two members of the Committee who spearhead the Women in Securities Finance group. The Committee were reminded to only join diverse industry panels.

ISLA continues work on D&I to ensure the right training is in place and to develop policies including participation and code of conduct at events. They are working on promoting inclusion of younger talent at events and will work to shift the culture away from the use of sub-groups comprising existing members to a more inclusive approach. Maintaining the D&I panel in the middle of the day at the main Conference saw good support.

It was noted that retention rates for women have decreased in recent years in the sector, and decreased even more with ethnic minorities. It was agreed that creating allyship and sponsorship programmes can support career paths and identify role models.

AOB

The Chair noted that Sovereign Wealth Fund representation would continue to be beneficial to the Committee since Matt Brunnette has stood down from the Committee. Members were invited to make recommendations.

Attendees

Nina Moylett, Chair M&G

Tim Smollen MUFG

Amar Amlani, JP Morgan

Farrah Mahmood, ISLA

Sonia Shah, Citi

Andy Krangel, Citi

Sunil Daswani, Standard Chartered

Godfried de Vidts, ICMA

Harpreet Bains, JP Morgan

Krishan Chada, Morgan Stanley

Andy Dyson, ISLA

Ina Budh-Raja, BoNYM

Johanne Armita, Goldman Sachs

James Day, State Street

Tim McLeod, Blackrock

Simon Dunderdale, M&G

Habib Montani, Clifford Chance

Jamie Anderson, HSBC

Ben Meaden, Aviva Investors

Alan Barnes, FCA

Apologies

Jessica Pulay, DMO

Jack Skinner, DMO

Jo Whelan, DMO

A Jacobs-Dean, AIMA

Tanja Hauenstein, Credit Suisse

Devi Aujeet, Barclays

Bank of England

Jon Pyzer

Tom Baines

Kirstine McMillan