UCITS | UMR
During the month of April, it has been encouraging to see the progressive return of face-to-face conferences and events. Whilst there continues to be heated political debate here in the UK about the role of remote or hybrid working, it is clear from two events that I had the opportunity to be a part of recently, that there is a huge pent-up demand to see friends and colleagues in a physical setting.
The two events I attended – the first a smaller client-led event organised by Citibank in Madrid, and the second the much larger annual Euroclear Collateral Conference were quite different in so many ways, yet some of the same issues came up during the various discussions.
The securities lending market in Spain has been problematic for some time, with the absence of the transposition of the relevant Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive into local legislation, meaning that locally domiciled funds find themselves unable to participate. Whilst this has consequences for the ability of these funds to deliver incremental alpha in the form of lending revenues, it also raises questions about overall market liquidity. How can the European Union deliver on its ambitious Capital Markets Union agenda, if its fourth largest economy in unable to effectively deliver and support market liquidity? Interestingly, this same issue came up in a different context at the Euroclear Collateral Conference a few days later, where the panel that I moderated reflected on how post-Brexit market fragmentation could lead to collateral inefficiencies, with collateral being marooned in the wrong place as firms have to manage multiple collateral pools.
Recently, a globally-recognisable institutional investor spoke to me about the idea of facing what they described as a ‘technical default’, whereby they would have sufficient collateral to cover margin requirements across the business, but could fail to deliver collateral or margin as it was stranded elsewhere. As collateral management becomes evermore complex across both markets and products, they felt that their operational risk in this area is increasing significantly. Without looking to solve this almost self-inflicted problem in this piece, the answer may well lie in the work that we are seeing several member firms and others doing on tokenisation of collateral assets.
Another theme seen across the two events, was how the impact of the rolling implementation of Uncleared Margin Rules (UMR), especially on smaller institutional investors, is driving change in our markets. As previously discussed, the impact of UMR is forcing institutional investors to think about securities lending more as a financing or liquidity tool to underpin their need to deliver and manage collateral in the context of their derivatives business, rather than a simple stock lending business. Whilst there has always been a so-called financing element in our markets, there is no doubt in my mind that the liquidity squeezes seen in early 2020 combined with the needs of UMR, have led to a realisation by many institutional investors that they can’t always rely on traditional sources of liquidity during periods of stress. Discussions in both Madrid and in London at the Euroclear event tended to support that view.
Inevitably, both events spoke extensively about the sustainability agenda, and how it is reshaping how we think about lending and what this means for our community. At its core, the challenge we face is how we bring a values-based ethos such as this, into a world that essentially conforms to rules. The problems we face are further compounded, or at least in the short term, by the absence of clear guidance from regulators and policy makers. Consequently, the market is looking for reference points or foundations upon which they can develop standards to allow the market to grow and flourish. Much of the work we have been doing at ISLA in this area, notably on issues such as voting and collateral provide those common points around which the market can coalesce.
Whilst we have debated these points before, what I noted for the first time in both locations was a growing realisation that in order to deliver on these ambitious objectives, we need to adopt a level of pragmatism. Extreme views at either end of the sustainability debate will not deliver the solutions that we all need. A good example here might be our thoughts on collateral and its purpose. First, I think we would all agree that collateral is there primarily as a mitigant against loss in the event that the lent securities are not returned. In this regard therefore, collateral needs to be taken on that basis and not necessarily be reflective of the loan assets or the ethos of the fund. Anyone lending emerging markets equities is unlikely to take equivalent securities as collateral, yet I hear many calling to do exactly that with ESG portfolios. Clearly there will be certain asset classes that would not be suitable in the context of the lender, but the nature of the collateral needs to be balanced against what it is there to achieve.
As we look forward to the remainder of 2022 and onto 2023, it is vitally important that ISLA remains close to this debate and these changes, and responds to the developing needs of our members and wider stakeholder community.
Part of that response is in our own events and conferences. On the back of a very successful webinar series during the first half of the year, I am delighted to see that our Events team are actively working to deliver our flagship European conference in Vienna this June, and the Annual Post Trade Conference in London in October. I am also delighted to see the return of our regional briefings and roundtables, with the announcement of Zurich on 17 May. Earlier this year, Fredrik Carstens joined the Association to lead our wider advocacy efforts across Europe. As part of that work, he has already engaged with many local regulators and market participants to understand how we can support specific markets through our work. More locations and dates will be announced in due course.
To conclude, there is no doubt that we as individuals and as an industry adapted very well to the challenges of remote working and virtual engagement during the pandemic. There is clearly a need however, perhaps a social one, to start meeting face-to-face once again where circumstances and restrictions permit. Whilst I believe that hybrid working is now a permanent feature of our daily lives, it is certainly refreshing to see social gatherings return, or opportunities where we can meet and exchange ideas in an in-person setting.
Andrew Dyson
