Getting connected: regulatory change through 30 years of the ISLA conference
27 June 2023
Securities finance veterans from Kaizen Reporting and London Reporting House reflect upon the past 30 years, where regulatory requirements have paved the way for incredible growth in the securities lending and repo markets
Image: stock.adobe.com/yj
The first ISLA conference was pioneered in 1992 in Gleneagles, a fertile ground for laying the foundations of today’s trillion-dollar securities financing markets. Similar to the 1992 Stereophonics hit, the securities lending industry really was getting “Connected”. It also marked the year of the first International Capital Market Association (ICMA) General Master Repurchase Agreement, as the concept of robust, legally enforceable contracts for repo and securities lending transactions were successfully ported from the US, where they had been in place since the 1980s.
Explosive growth
The establishment of a community and a legal basis for securities financing transactions (SFT) to take place were key components of the success of the securities lending and repo markets. Without it they would not exist, nor would the explosive growth we have witnessed over the past 30 years have happened. The confidence this industry thrives on is dependent upon the legal and regulatory framework in place across the world’s major financial markets.
As a barometer of the SFT market, we have approximately seen 1000 per cent growth in the European repo market since 1992 to a current size of €10 trillion.
Despite regulation, or perhaps because of regulation, beneficial owner, client and market counterparty confidence is such that volumes have exploded, markets have opened up and flexibility, as well as adaptability, has been the name of the game.
Innovation from regulation
Opinions are changing and, while it is unlikely that regulation will ever be seen as more than a burden, it is hard to deny that it can be associated with innovation, the adoption of standards and best practices, and far greater market data utilisation than was ever previously possible. This innovation has taken many forms, from the widespread use of CCPs — therefore limiting counterparty risk — to use of triparty agents for collateral optimisation or agent lenders facilitating far greater buy-side asset utilisation.
Together, with changes on the standards front — for example, the adoption of legal entity identifiers (LEIs), unique trade identifiers (UTIs), ISO 20022 and ISO codes for benchmark rates — we have seen greater transaction definition, reduced operational burden, increased settlement efficiency and greatly enhanced portfolio, collateral and financing optimisation.
Trade associations’ partnerships
The work of trade associations, such as ISLA, is paramount in partnering with the industry and its regulators through good and bad times to ensure that the legal and regulatory framework evolves and that the markets continue to grow and prosper. Invariably, throughout this period, the regulatory burden has only ever grown larger. Firms have been forced to establish how meeting regulatory requirements has become an integral part of their businesses. This has presented questions such as “how can the adoption of standards and best practices, and the data contained within reports, be used to our best advantage?”. The trade associations have certainly stepped up, progressing hand-in-hand with firms to meet the ever-growing regulatory brief. They are at the forefront of innovation, making regulation compatible with meeting the complex needs of investment firms, agent lenders, beneficial owners, fund managers and market utility and infrastructure providers.
Pre 2008: markets open up
Before the global financial crisis in 2008, engagement between the industry and regulators tended to be driven by the desire to open up new markets for lending and repo. The focus was primarily to ensure that an appropriate regulatory, legal, tax and operational regime was present to allow business to take place. By 2008, while already large, these were much more nascent markets. Indeed, even the unsecured lending market was still very buoyant in pre-Northern Rock times.
1994: first Overseas Securities Lending Agreement
The year 1994 was significant for ISLA, with the launch of the first Overseas Securities Lending Agreement (OSLA). This, the precursor to the General Master Securities Lending Agreement (GMSLA), was key to creating enforceable contracts, netting and in resolving disputes. This was closely followed by the Gilt-Edged Securities Lending Agreement (GESLA) in 1995, bringing the benefits of securities lending to the UK market.
The US pioneered repo agreements with the Securities Industry and Financial Markets Association (SIFMA) creating the Master Repurchase Agreement (MRA) of 1984, while ICMA’s Global Master Repurchase Agreement of 1992 brought repo as a tradable, contractually enforceable product across the rest of the world in the 1990s.
Having achieved this primary goal of establishing legal frameworks, legal documentation and standardised contracts, the global financial crisis meant that attention was turned to controls and supervision.
2006: ALD goes live in the US
Even pre-crisis, attention had already turned to Agent Lending Disclosure (ALD), following concerns raised by the US Securities and Exchange Commission (SEC) in 2003 about broker-dealer counterparty, concentration and credit exposures with the beneficial owner clients of agent lenders.
Prior to ALD, without access to principal exposures, regulatory capital requirement calculations were imprecise and inefficient. ALD went live in the US in 2006 and was subsequently adopted in Europe in 2008, helping to optimise balance sheets, regulatory capital and liquidity buffer requirements.
2008: global financial crisis hits
The global financial crisis of 2008 was a significant inflexion point for the engagement between regulators and the securities finance industry. Post-crisis, regulators adopted a much more proactive approach to the product, especially given that securities finance was perceived to be a key component of the so-called ‘shadow banking’ industry.
Regulatory initiatives have focused on two key themes:
Investor protection and treating customers fairly. This means:
• making sure that market participants have the necessary capacity and authority to conduct business on behalf of their underlying beneficial owner clients.
• ensuring that these clients have a proper understanding of the activity being conducted on their behalf.
• ensuring a sufficiently transparent regime when it comes to the revenue being generated by this activity.
An example of this type of regulation is the ESMA guidelines for Efficient Portfolio Management (EPM) activity, which includes securities finance — first published in 2012.
Measures to identify, monitor and ultimately limit systemic risk posed by securities finance transactions as part of the broader ‘shadow banking’ industry. Much of these stemmed from the work of the Financial Stability Board (FSB) in the years following the crisis.
An example of this type of regulation is the introduction of minimum haircut floors for securities financing transactions, brought in as part of the Basel framework for regulatory capital requirements.
2020: SFTR goes live
The Securities Financing Transactions Regulation (SFTR), published by the European Securities and Markets Authority (ESMA) in 2015 and implemented in 2020, has proved quite pioneering, despite delays. Published just one month after the seminal FSB document “Standards and Processes for Global Securities Financing Data Collection and Aggregation”, and while overblown and under-defined, it has become a beacon of how to capture all SFT activities for regulators in one place.
Upcoming US regulation
US SFT data collection is set to be made up of four distinct datasets for cleared repo (direct from DTCC), triparty (direct from BNY Mellon), securities lending (proposed to be submitted to the SEC via FINRA), and uncleared bilateral repo to the Office of Financial Research (US Treasury Board).
Greatly delayed implementation has also meant that the US authorities have been forced to openly admit the holes in their data set, amid the regional banking crisis they are currently experiencing. On uncleared bilateral repo reporting, the Federal Register stated that it was, “a critical blind spot in a market that plays a key role in financial stability”.
Short selling concerns
In the context of impending US SEC securities lending reporting there have been concerns about short selling. This remains a politically charged issue when evaluating its impact on underlying equity markets, the perceived lack of a level playing field and the effects played out on retail investors’ saving, stock portfolios and pension funds.
Throughout history, short sellers have often been made the scapegoats when markets fall sharply. Often, the knee-jerk reaction of regulators is to ban short selling in the hope that this will somehow support asset prices and stop (or at least limit) these falls. The problem is that short selling bans simply do not work. Since 2008, there have been several instances where they have been introduced and there have been numerous academic studies into their impact. The overwhelming conclusion of these studies is that short selling bans have no effect on the underlying market price. In fact, the only discernible impact was to damage market liquidity and widen bid or offer spreads to the detriment of all market participants.
2023: market turmoil
Indeed, calls for a short selling ban have been heard as recently as early 2023, in the wake of the demise of the Silicon Valley Bank, following the Gamestop debacle and market turmoil in the US bank sector. There remains a fine balancing act between promoting securities financing market business growth and in strengthening the regulatory framework to mitigate systemic risks, protect less sophisticated investors and ensure markets remain well regulated, liquid, fair, sustainable and orderly. Trade associations such as ISLA continue to play a crucial advocacy role in helping to steer regulators towards sound, evidence-based decision making and policy that promotes growth and does not stifle innovation
Explosive growth
The establishment of a community and a legal basis for securities financing transactions (SFT) to take place were key components of the success of the securities lending and repo markets. Without it they would not exist, nor would the explosive growth we have witnessed over the past 30 years have happened. The confidence this industry thrives on is dependent upon the legal and regulatory framework in place across the world’s major financial markets.
As a barometer of the SFT market, we have approximately seen 1000 per cent growth in the European repo market since 1992 to a current size of €10 trillion.
Despite regulation, or perhaps because of regulation, beneficial owner, client and market counterparty confidence is such that volumes have exploded, markets have opened up and flexibility, as well as adaptability, has been the name of the game.
Innovation from regulation
Opinions are changing and, while it is unlikely that regulation will ever be seen as more than a burden, it is hard to deny that it can be associated with innovation, the adoption of standards and best practices, and far greater market data utilisation than was ever previously possible. This innovation has taken many forms, from the widespread use of CCPs — therefore limiting counterparty risk — to use of triparty agents for collateral optimisation or agent lenders facilitating far greater buy-side asset utilisation.
Together, with changes on the standards front — for example, the adoption of legal entity identifiers (LEIs), unique trade identifiers (UTIs), ISO 20022 and ISO codes for benchmark rates — we have seen greater transaction definition, reduced operational burden, increased settlement efficiency and greatly enhanced portfolio, collateral and financing optimisation.
Trade associations’ partnerships
The work of trade associations, such as ISLA, is paramount in partnering with the industry and its regulators through good and bad times to ensure that the legal and regulatory framework evolves and that the markets continue to grow and prosper. Invariably, throughout this period, the regulatory burden has only ever grown larger. Firms have been forced to establish how meeting regulatory requirements has become an integral part of their businesses. This has presented questions such as “how can the adoption of standards and best practices, and the data contained within reports, be used to our best advantage?”. The trade associations have certainly stepped up, progressing hand-in-hand with firms to meet the ever-growing regulatory brief. They are at the forefront of innovation, making regulation compatible with meeting the complex needs of investment firms, agent lenders, beneficial owners, fund managers and market utility and infrastructure providers.
Pre 2008: markets open up
Before the global financial crisis in 2008, engagement between the industry and regulators tended to be driven by the desire to open up new markets for lending and repo. The focus was primarily to ensure that an appropriate regulatory, legal, tax and operational regime was present to allow business to take place. By 2008, while already large, these were much more nascent markets. Indeed, even the unsecured lending market was still very buoyant in pre-Northern Rock times.
1994: first Overseas Securities Lending Agreement
The year 1994 was significant for ISLA, with the launch of the first Overseas Securities Lending Agreement (OSLA). This, the precursor to the General Master Securities Lending Agreement (GMSLA), was key to creating enforceable contracts, netting and in resolving disputes. This was closely followed by the Gilt-Edged Securities Lending Agreement (GESLA) in 1995, bringing the benefits of securities lending to the UK market.
The US pioneered repo agreements with the Securities Industry and Financial Markets Association (SIFMA) creating the Master Repurchase Agreement (MRA) of 1984, while ICMA’s Global Master Repurchase Agreement of 1992 brought repo as a tradable, contractually enforceable product across the rest of the world in the 1990s.
Having achieved this primary goal of establishing legal frameworks, legal documentation and standardised contracts, the global financial crisis meant that attention was turned to controls and supervision.
2006: ALD goes live in the US
Even pre-crisis, attention had already turned to Agent Lending Disclosure (ALD), following concerns raised by the US Securities and Exchange Commission (SEC) in 2003 about broker-dealer counterparty, concentration and credit exposures with the beneficial owner clients of agent lenders.
Prior to ALD, without access to principal exposures, regulatory capital requirement calculations were imprecise and inefficient. ALD went live in the US in 2006 and was subsequently adopted in Europe in 2008, helping to optimise balance sheets, regulatory capital and liquidity buffer requirements.
2008: global financial crisis hits
The global financial crisis of 2008 was a significant inflexion point for the engagement between regulators and the securities finance industry. Post-crisis, regulators adopted a much more proactive approach to the product, especially given that securities finance was perceived to be a key component of the so-called ‘shadow banking’ industry.
Regulatory initiatives have focused on two key themes:
Investor protection and treating customers fairly. This means:
• making sure that market participants have the necessary capacity and authority to conduct business on behalf of their underlying beneficial owner clients.
• ensuring that these clients have a proper understanding of the activity being conducted on their behalf.
• ensuring a sufficiently transparent regime when it comes to the revenue being generated by this activity.
An example of this type of regulation is the ESMA guidelines for Efficient Portfolio Management (EPM) activity, which includes securities finance — first published in 2012.
Measures to identify, monitor and ultimately limit systemic risk posed by securities finance transactions as part of the broader ‘shadow banking’ industry. Much of these stemmed from the work of the Financial Stability Board (FSB) in the years following the crisis.
An example of this type of regulation is the introduction of minimum haircut floors for securities financing transactions, brought in as part of the Basel framework for regulatory capital requirements.
2020: SFTR goes live
The Securities Financing Transactions Regulation (SFTR), published by the European Securities and Markets Authority (ESMA) in 2015 and implemented in 2020, has proved quite pioneering, despite delays. Published just one month after the seminal FSB document “Standards and Processes for Global Securities Financing Data Collection and Aggregation”, and while overblown and under-defined, it has become a beacon of how to capture all SFT activities for regulators in one place.
Upcoming US regulation
US SFT data collection is set to be made up of four distinct datasets for cleared repo (direct from DTCC), triparty (direct from BNY Mellon), securities lending (proposed to be submitted to the SEC via FINRA), and uncleared bilateral repo to the Office of Financial Research (US Treasury Board).
Greatly delayed implementation has also meant that the US authorities have been forced to openly admit the holes in their data set, amid the regional banking crisis they are currently experiencing. On uncleared bilateral repo reporting, the Federal Register stated that it was, “a critical blind spot in a market that plays a key role in financial stability”.
Short selling concerns
In the context of impending US SEC securities lending reporting there have been concerns about short selling. This remains a politically charged issue when evaluating its impact on underlying equity markets, the perceived lack of a level playing field and the effects played out on retail investors’ saving, stock portfolios and pension funds.
Throughout history, short sellers have often been made the scapegoats when markets fall sharply. Often, the knee-jerk reaction of regulators is to ban short selling in the hope that this will somehow support asset prices and stop (or at least limit) these falls. The problem is that short selling bans simply do not work. Since 2008, there have been several instances where they have been introduced and there have been numerous academic studies into their impact. The overwhelming conclusion of these studies is that short selling bans have no effect on the underlying market price. In fact, the only discernible impact was to damage market liquidity and widen bid or offer spreads to the detriment of all market participants.
2023: market turmoil
Indeed, calls for a short selling ban have been heard as recently as early 2023, in the wake of the demise of the Silicon Valley Bank, following the Gamestop debacle and market turmoil in the US bank sector. There remains a fine balancing act between promoting securities financing market business growth and in strengthening the regulatory framework to mitigate systemic risks, protect less sophisticated investors and ensure markets remain well regulated, liquid, fair, sustainable and orderly. Trade associations such as ISLA continue to play a crucial advocacy role in helping to steer regulators towards sound, evidence-based decision making and policy that promotes growth and does not stifle innovation
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
