What are the benefits of a more centralised approach?
Nicholas Gant: The move to more centralised clearing enhances the ability to manage collateral effectively across asset types. Each of the past two year-ends has seen a squeeze in the liquidity of the repo market, which has made efficient management of capital even more important.
William Gow: From the agency lending side, the breakdown of silos and the bringing together of different asset classes—of equity and fixed income—allows for far more efficient balance sheet management and better management of scarce resources. That’s particularly important when treasurers and counterparty banks need high-quality liquid assets to cover their liquidity coverage ratios (LCR).
We see more and more collateral upgrade and downgrade trades. That’s really where the market is from an agency lending standpoint, and the merging of different asset classes has made a significant difference to efficient management.
But, while we see a movement in that direction, I don’t think everybody has broken down these silos yet. It comes down to politics and people not wanting to give up their profit and loss; there has to be a firm-wide push to make these synergies work.
Gant: Traditionally, while the equity and fixed income divisions would have some similarities, they were seen as distinct and separate parts of a bank. Some of our peers have the prime brokerage department within the equity division, while others have it in fixed income. That means other influences can get in the way of what should be a practical decision.
Gow: Positioning prime brokerage as a separate division on its own enables collaboration; prime brokerage can do joint ventures with either fixed income or equity teams, or anyone else in the bank.
Gant: We decided to adopt this centralised approach in 2014, chiefly motivated by the centralisation of risk and optimisation of collateral across asset classes. Now each function that you would associate with a prime brokerage is in one area. With all the prime brokerage-focused activity in one division, we can be nimble and add extra pieces if it suits the client.
How has Societe Generale tackled the transition?
Gow: The agency lending side used to sit within our securities division. Bringing that into the prime brokerage has enabled us to invest in and develop the platform. This is valuable. In addition to sourcing mandates from our custodian, we are very focused on third-party and non-traditional agency lending, adding collateral and inventory optimisation to our offering for our clients. It is just looking at things slightly differently.
Gant: We all have dialogue across all teams on a daily basis just to see what we can optimise between us. I am agnostic as to whether we are providing our customer with a principal solution or an agency solution. The idea is that we have multiple offerings and then choose the one—or ones—that are most appropriate to give an individual client a better experience.
If you look at the historic model, prime brokerage was the liquidity provider for the client. The regulatory shift has brought a reduction in the capacity for all banks to provide liquidity. We are here to provide liquidity, but can also provide other solutions so clients have access to liquidity and can efficiently use scarce resources through a mix of agency and principal offerings.
What new initiatives are addressing the changing demands of the European securities lending market?
Gant: The 2016 year-end spike in the repo market was very well documented and very severe. 2017 had a much more orderly year-end, but that had been flagged well enough in advance.
The International Capital Market Association (ICMA) posed the question of what would happen if there was a sudden market shock. One institution made the point that it had 14 liquidity sources during the month, but this dropped to four at the month end. That is enough, but what happens if that four drops down to two? They wanted to ensure some future-proofing of their liquidity. As part of our suite of products, that’s something we felt we should be offering our clients.
Historically, client repo market activity was governed by multiple global master repurchase agreements (GMRA) between clients and their liquidity providers—typically the banks—who could then partially or fully hedge these repos with other banks either bilaterally or through central counterparties (CCPs) such as LCH and Eurex. The buy side did not have access to the deep liquidity pools and balance sheet netting opportunities available when trading into the CCP. However, this is now possible through a sponsoring model, and Societe Generale sponsors clients into the CCP, thus allowing them to reduce administration and increase liquidity.
How has increased disintermediation contributed to the markets’ evolution?
Gant: We see disintermediation as an opportunity. In general, there is a requirement to make maximum efficient usage of scarce resources—at bank and client level. The most efficient possible management of the collateral process and the inventory is part of that. If we are offering both agency and principal, that allows the client to maximise their return on their collateral pools as well as their usage of their collateral pool.
Gow: Banks in many respects are contributing to disintermediation themselves by promoting agency platforms. It’s effectively taking flow off the balance sheet so by default they are disintermediating that connectivity. But banks still want to have that client relationship, and an agency model is an efficient way of maintaining that.
Electronic platforms can allow clients to trade directly themselves, but banks will provide a service, which involves more heavy lifting, the back-office outsourcing functionality.
In reality, banks aren’t going to be completely cut out of the picture. Clients still need banks and like the credit intermediation that banks offer. And banks, although often much maligned, still have very good technology—and the resources to be able to service that technology.
Gant: Maybe the role of the bank is slightly different to what it was 15 or 20 years ago. The cost of capital has risen over the past 20 years, and I would be surprised if it goes down again. From the bank’s viewpoint, it’s about making the best use of the resources available, providing the services that are the best fit for the customer, and embracing the opportunity that comes from a change in market practices.
Are there any particular challenges that come from conducting business across international markets?
Gant: All challenges come down to mindset. You can look at anything as a challenge, but if you’re nimble enough and your DNA and mindset are built around providing solutions for your clients, then it’s not so much a challenge as an opportunity to provide something for our clients.
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International Securities Lending Association
Sejal Amin
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