T+1 woes persists in the securities-lending industry as shorter settlement puts the squeeze on participants.
Unease persists in the securities-lending industry as the transition to T+1 continues, driven by concerns over heightened information leakage risks and the necessity for substantial technological upgrades
Earlier this month, Bloomberg Intelligence released research indicating that accelerating settlement cycles and the subsequent squeeze of securities borrow/lend processes could leave asset owners footing an eye-watering $24 billion bill, $17 billion of which is attributed to information-leakage expenses.
Under the new T+1 regime for North American markets, lenders must initiate loan recalls by 11:59 p.m. on the trade date, which is 15 hours earlier than the previous practice of 3:00 p.m. the following trading day, with European and Asian participants facing the tightest time constraints.
Consequently, security lenders will have a shorter window to recall loaned securities, and borrowers will have less time to return them for settling a sale. According to Bloomberg, this accelerated process could potentially lead to information leakage, alerting custodians and borrowers alike to investors’
intentions to sell.
Gerard Walsh
Gerard Walsh, global head of capital markets client solutions at custodian Northern Trust, says information leakage is a problem the industry has been puzzling over for the past six months with no clear solution in sight. The bank is actively striving to eliminate all manual processing in the stock loan flow and expedite the recall process. However, Walsh emphasizes that there may be a necessity for the industry to send recall notifications 24 hours in advance to ensure settlement.
“That’s an information leakage window of 24 hours that doesn’t exist at the moment. If we send a note to the traditional market who are shorting stock, they know something’s up. They know they’ve got a signal from the market as to what someone is doing, particularly if the loan is at scale. I don’t know the workaround for that and I’m not entirely sure there is one. I think it just becomes a known risk with market practices and market structure,” Walsh says.
Compressing the securities recall process could cause trades to fail.
Reducing failed trades in a compressed settlement environment and identifying/resolving hidden inefficiencies in settlement processes are key operational challenges ahead of T+1, according to Darren Crowther, head of securities finance and collateral management solutions at Broadridge Financial Solutions. To address this, he says, firms should focus on the cause of failure and aim to get settlement right the first time.
“Ensuring the demand to recall is identified as quickly as possible and subsequently instructed to borrowers is a key challenge that businesses are looking to solve. This involves technology improvements, automation of processes, and realigning resources to match the extended recall window,” Crowther notes.
However, replacing legacy processes with new technology requires an extensive amount of time and initial capital investment. Large, complex, and legacy technical platforms exist throughout the securities lending chain. Modernizing these platforms is often easier said than done.
Tom Poppey
Tom Poppey, head of product strategy for securities lending at Brown Brothers Harriman (BBH), observes that the operational challenge morphs into a technical one.
“From our perspective, we are working with our clients to have them send us their sale instructions and their recall instructions on a more immediate, preferably real-time basis,” Poppey says. However, not all clients have the bandwidth for wholesale technology upgrades.
As well as Bloomberg, many securities lending participants anticipate temporary disruption and a period of elevated fails in the short-term as organizations adapt to the new world order. However, Broadridge’s Poppey doesn’t agree about the scale of information leakage risk. He points to existing protections within the security lending industry today to prevent information leakage—such as anonymizing the client associated with recall securities.
“I’m not disputing that there is going to be more of an operational challenge, but I struggle to understand why there’s greater information leakage because again, all this exists today,” Poppey adds.
Need a Reprint?