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Item 1 – Bank of England Introductory remarks and minutes from last meeting
The Chair welcomed new Committee member Devi Aujeet.
The Chair welcomed Sara Almosawi, Andy Hill, Alexander Westphal, Joana Barata, Shikha Kalra, Victoria Robbins and Charlie Watson as part of the Bank’s initiative to make such meetings more diverse and inclusive.
The Chair confirmed that the minutes of the February 2021 meeting were published on the Bank of England’s (BoE) website.
The Committee had no comments to raise on the minutes from February’s meeting.
Item 2 – Recent market trends and observations
The Chair introduced a discussion on recent market conditions and trends. It was noted that the first quarter of 2021 has been notable for the securities lending market with increased volatility in February during the fixed income sell-off, the S&P reaching new highs and increasing revenues as a result.
Members discussed how the events of the first quarter have impacted securities financing revenue. For the repo market, the first quarter events had little impact on profit and loss (P&L), with the main driver in this being special repo trades, particularly in the US and Hong Kong. The Committee noted General Collateral (GC) lending rates are further decreasing given the current low interest rate environment. Spreads more generally are thin and the Committee noted the securities lending market as a whole is being squeezed in terms of rates and revenue.
Turning to equities, during 2020 participants positioned in outright directional trades were tending to perform well. Committee members had observed a change in behaviour in equities driven by the sizing in crowded short trades. The Committee discussed if hedging these types of trades had added additional volatility to the market. There was agreement that the squeeze on spreads in markets is leading to an increase in securities lending balances, particularly in fixed income and equities, as the market is seeking out returns.
Looking further ahead in 2021, the Committee discussed possible events which might widen spreads in the market. SLR not being rolled in the US in March was thought to have had an impact, and may have reduced available balance sheet size. The Euro area equivalent to SLR is due to happen in June and is thought it could have a similar impact. For fixed income in particular, expected rate rises in markets will aid widening spreads.
Item 3 – Future Landscape – Retail trading activity (Gamestop), Archegos
The Committee continued a previous discussion from the February meeting on the events involving GameStop and discussed any lessons learnt from both the Gamestop and Archegos episodes. In summary, a number of retail traders had targeted concentrated hedge fund short positions, leading to a dramatic increase in the share price of GameStop during January ($19 to $350).
For hedge fund short-sellers – danger of crowded shorts and increased market power of retail investors
For securities lenders – specials lending entails concentrated, idiosyncratic risk that needs to be managed.
Archegos defaulted on a number of margin calls with prime-brokers who had material and concentrated exposures, leading to a fire-sale of holdings by a number of prime-brokers.
The Committee reflected on the two events, with the main focus on firms’ risk processes and in particular whether adequate haircut and margin levels were applied. It also questioned whether if exposure to collateral delivered by counterparties was sufficiently diversified. Prime Brokers have accepted lower revenues and have taken lower collateral margins/less liquid collateral in the battle to gain market share for hedge fund business. It was highlighted one of the differences between losses of prime brokers in the Archegos event was the speed with which some of the prime brokers were able to liquidate positions compared to others. Speed to market was felt to be a large factor that impacted the liquidity of collateral held and should have implications for how lenders view the risk of pledge collateral versus title transfer.
For prime brokers – aggregate risk matters, remedy grace periods for Events of Default need to be reviewed, low margin trades do not compensate for tail risk (>$10bn in industry losses associated with Archegos).
For lenders – for certain trades (funding leveraged equity positions) the only effective hedge may be more collateral (from media reports the average shortfall for liquidating Archegos collateral was 28%)…”industry standard” haircuts are insufficient for this type of risk.
The discussion turned to the whether it was really possible to set appropriate haircut levels which were appropriate for stressed markets across different jurisdictions. A particular challenge was felt to be when valuations are based on UK end of day pricing but the US market is still trading. If there was a major US price move, UK loans may not be appropriately collateralised. One possible solution to the margining issue suggested was to move to using CCP’s to clear business, as this would ensure standard and real time valuations and margining, although it would not deal with the time differential issue (use of CCPs would also mean out-sourcing risk management and reduce diversification of collateral).
Members debated possible solutions to the issues around collateral concentration; it was noted that in a situation like Archegos it can be difficult to see how large the exposure to one firm can be. The Committee noted the difficulty given the lack of transparency in reporting by some types of counterparties. One possible solution discussed was for triparty agents to be required to set limits on collateral holdings rather than just counterparty specific limits.
The Committee discussed the role regulators should play following the recent events and it was felt that the regulators already had a role identifying if there is a systemic risk. The inconsistency in the reporting across jurisdictions was highlighted.
Item 4 – Environmental, Social and Corporate Governance (ESG) in Securities Lending Markets
The Chair opened the discussion on ESG with a particular focus on the role of tri-party agents in facilitating ESG collateral lending and in being in tune with beneficial owners policies.
It was felt that there is still much work to do in this space to enable this to happen. Members noted there are only two ESG indexes, and this lack of options creates challenges in being able to overlay an investment portfolio with an ESG measurement. This also presents challenges if you want to make any changes to collateral parameters as it will need to be completed at an individual level, rather than at the tri-party level. The Committee discussed how a common approach to ESG collateral schedules would make it easier to apply, and how helpful it would be if these were to come from tri-parties. It was noted there are currently no market standards for ESG, which could have an adverse impact on smaller lenders who may not have the ability to create bespoke schedules. Members agreed standardisation in ESG collateral schedules would be welcomed.
Item 5 – UK Money Markets Code
The Bank of England confirmed the updated Money Markets Code was published on the 21st April 2021. The Bank thanked the Committee for their assistance in updating the securities lending section of the Code and noted the main updates in the Code were on Diversity and Inclusion, ESG policies, working away from the usual location, and electronification of markets.
Members noted the updates made to the Code had been well received and it would be interesting to particularly see how Diversity and Inclusion (D&I) updates are added into future practices.
Item 6 – Diversity and Inclusion on Securities Lending Markets
The Chair invited any updates or thoughts for future meetings regarding D&I.
Members welcomed the enhancement on D&I in the Money Markets Code and noted where the Codes comment on working from home has helped with thinking for firms future plans.
Members noted the Bank’s Meeting Varied People event on the 21st April 2021was an excellent event which was well received. They would welcome comments from the Bank on how it continue to keep the momentum from the event going. The Bank noted the next steps will be to follow up with attendees on how to join the Bank’s market intelligence gathering function.
Item 7 – AOB
No further business was raised by the committee.