Zürcher Kantonalbank
Lukas Meier
20 June 2024
Switzerland is often seen as both within, and without, its broader European counterparts. Lukas Meier, head of Cash & Collateral Trading at Zürcher Kantonalbank, looks at the Swiss securities lending market, key regulations and its unique differences
Image: Lukas Meier
Could you perhaps start by giving us an overview of the current Swiss lending market? How does it differ from other similar markets in Europe or the US?
One of the defining characteristics of the Swiss securities lending market is the dominance of the principal model. Unlike the agency model predominant in markets like the US and the UK, the principal model in Switzerland allows institutions to lend securities in their own name. This model simplifies the lending process and enhances efficiency, as the borrowing counterparty only needs to establish documentation and a credit line with a single entity to access a large pool of securities.
The Swiss intermediaries acting as principal have a long history as retail aggregators. The principals pool many small holdings of securities and lend the combined size under their own name and faces the market using their own operational setup.
Are there any interesting differences you see in the market between agent lenders and principals, or fundamental differences to either model that is unique to the Swiss market?
According to data from S&P Global, the global lendable pool of assets across all securities was US$35 trillion at the beginning of the year, with only US$2.9 trillion being on loan. Naturally, this ratio varies significantly across different asset classes and HQLA-level. However, it shows that fostering a strong demand side is a dominant force for any lending programme. Except in the case of a few specials, borrowers can pick who to trade with, and will choose counterparts that are attractive on more factors than just price. With that in mind, the limitations and considerations of borrowers are very important when deciding on how to bring assets to the market.
Each of the two models offers advantages and disadvantages, which vary depending on the specific setup, entities and assets involved. One of the selling points of the agency model, from the perspective of the lender, is a better fee split. The principal model, on the other hand, also offers several advantages that can work in the favour of the beneficial owner. Each situation must be assessed individually to choose which one is better suited.
Some of the key aspects to consider include:
Flexibility — The principal model offers greater flexibility in setting the terms of lending transactions, including establishing a broad, market-friendly collateral schedule. This adaptability can be crucial when responding to market conditions and borrower requirements promptly and effectively, bridging differing levels of risk appetite.
Cross-product integration — The principal model provides a path to merge different products into the market. Principals can potentially transact in a variety of product types, ranging from repo, securities lending and borrowing (SLB), and total return swaps (TRS), while always borrowing securities as part of a securities lending transaction from the underlying client. This cross-product offering allows for optimised returns for programme participants by taking advantage of various market opportunities.
Counterparty risk and RWA impact — The principal model involves a single counterparty, which reduces the complexity associated with dealing with multiple counterparties as seen in the agency model. By assuming the credit risk of the borrower, the principal can potentially provide greater security for the lender, particularly if the principal itself is a better rated entity. On the other hand, the singular credit risk and the lack of counterparty diversification can be seen as a negative.
The principal model has the potential to transform and improve the risk-weighted asset (RWA) footprint for borrowers, particularly in situations where direct trades with beneficial owners themselves create a punitive risk weighting. With the upcoming Basel Endgame regulation, this consideration becomes even more pronounced. Basel Endgame, part of the Basel III reforms, introduces stringent capital requirements and a standardised method for calculating RWAs, emphasising capital efficiency and risk management. Hence, principals can potentially offer a more favourable RWA profile, reducing capital charges associated with credit risk and making transactions more cost-effective and attractive.
What are the most significant pieces of regulation for the Swiss securities finance market right now? What changes do you expect in regulation, or the impact that regulation will have, in the coming years?
Although the Central Securities Depositories Regulation (CSDR) is a European regulation, it impacts internationally active Swiss financial institutions similarly to its European counterparts. Our high level of operational efficiency aligns well with CSDR’s goals, and essentially makes us a more attractive lender.
In contrast to the CSDR regulation, the Securities Financing Transactions Regulation (SFTR) does not have a direct impact on Swiss counterparties, as it focuses on transparency and reporting requirements within the EU.
A more significant change in Switzerland’s regulatory landscape is the revision of the liquidity ordinance by FINMA under the too-big-to-fail (TBTF) regime. This was introduced at the beginning of 2024, gearing up throughout the year to reach 100 per cent implementation at the beginning of Q4. This regulation is aimed at ensuring that systemically important banks hold sufficient liquidity to absorb shocks and cover needs in restructuring or liquidation scenarios. It applies specifically to Switzerland’s Domestic Systemically Important Banks (D-SIB) and Global Systemically Important Banks (G-SIB).
The TBTF regulation makes a clearer distinction across product and client types regarding their liquidity value. It forces banks to attract longer financing tenors due to their more beneficial treatment in terms of regulatory liquidity. Optimisation of funding instruments are crucial as banks contend with these stricter liquidity requirements and have other limiting factors to contend with as well. This change in the regulatory landscape impacts the supply/demand-dynamics in the securities finance market.
There is a growing move towards digitisation and automation. How is ZKB approaching this, and what do you believe are the key areas or technologies that will come into play?
While the securities lending market has made progress in terms of automation and transparency, it remains less automated than other financial sectors. Factors such as differing collateral schedules, counterparty risks, limits, RWA considerations, lifecycle management, and restrictions on efficient trading systems add complexity.
We aim to streamline and automate post-trade processes using prevalent technological vendors as much as possible. For trading, we pursue a dual approach: advancing automation while leveraging the expertise of our traders. This balanced strategy allows us to enhance efficiency and maintain high service levels, adapting to technological advancements without losing the human touch that is crucial in complex market environments.
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