Structural Changes Loom in Securities Finance

The future of EquiLend, a trading platform that has been at the heart of the securities lending market for more than 20 years, is being reassessed amid other anticipated changes in securities-finance market structure and operations.

They come in the wake of an August 2023 agreement by four of EquiLend Holdings’ then 10 owners – Goldman Sachs, JPMorgan, Morgan Stanley and UBS – to settle for $499 million a lawsuit accusing them of exercising monopoly control and charging excessive fees. Plaintiffs in the suit against the securities-lending agent banks included the Iowa Public Employees Retirement System, Orange County Employees Retirement System and Sonoma County Employees’ Retirement Association.

A previous, $81 million settlement was reached with Credit Suisse in 2022, before it was acquired by UBS. Another EquiLend owner, Bank of America, remains a defendant in the case. The other EquiLend owners are BlackRock, Northern Trust, State Street and National Bank of Canada, which in 2019 bought a 10% stake in the trading, post-trade and analytics platform.

Reuters reported at the end of September that EquiLend was “working with investment bank Broadhaven Capital Partners on an auction process, which is expected to draw interest from exchange operators, financial technology providers and private equity firms.”

EquiLend declined to comment on a possible transaction or its terms. At a relatively non-material cost to its megabank owners, the settlement could result in a clean slate for EquiLend, remake its governance and free it to pursue new technological and growth opportunities to serve what has historically been an opaque marketplace.

“Securities lending probably wasn’t high on the CEOs’ radar screens, unlike trading and other businesses where there are massive balance-sheet fluctuations,” commented James Angel, a professor at Georgetown University’s McDonough School of Business.

In settling, the banks did not admit to wrongdoing but agreed to governance reforms, including limiting each bank’s board seats, adopting a code of conduct to prevent collusion, and retaining “rotating” outside antitrust counsel to ensure that the firm maintained its independence.

“More Nimble and Competitive”

Strategic or resource-allocation reasons may be behind a decision by the banks to sell. “They know the business well and probably see the handwriting on the wall,” said Angel, referring to both the competitive and regulatory outlook.

Source: Securities lending market fact sheet at Orbisa.com.

As opposed to a joint venture, “a standalone enterprise can be more nimble and competitive, and given the changes in the securities lending world, nimbleness is essential to survival,” Angel added.

“If a sale left EquiLend with the ability to pursue commercial activities independently, it could turn into a significant player across all collateral markets, not just securities finance,” said Josh Galper, managing principal of Finadium, which tracks the securities lending market. “This could include a range of OTC derivatives products that have a collateral component.”

Regulations Pro and Con

In October, the Securities and Exchange Commission finalized Rule 13f-2, requiring institutional investment managers meeting certain thresholds to report positions and activities for equity short sales – which require borrowing securities that are later returned to their lender at a loss or gain – by the start of 2025.

The SEC concurrently adopted Rule 10c-1a, requiring securities-loan transaction information to be reported to, and published by, a registered national securities association (RNSA). This rule becomes effective in February 2024, and securities lenders and intermediaries must begin reporting the information 24 months later.

“Securities lending played a role in the 2008 financial crisis and, currently, the securities lending market is opaque,” SEC Chair Gary Gensler said in a statement. Fulfilling Dodd-Frank Act mandates, “adoption will promote greater transparency in the securities lending markets both to regulators and the public.”

Further stirring the pot, the Managed Funds Association, National Association of Private Fund Managers and Alternative Investment Management Association have sued the SEC, claiming that the agency was “arbitrary and capricious” in disregarding the short-selling rules’ interconnectedness and contradictions.

“The rules follow inconsistent approaches with broad extraterritorial scope and contain conflicting analyses and rationale, even though they both address similar markets. The rules will impair market efficiency and price discovery and harm market participants and investors,” AIMA CEO Jack Inglis said in a December 12 statement.

Data and Insights

In a report to Finadium clients, Galper said that in the view of industry participants, end-of-day reporting could result in better benchmarking and analytics services, with more details on supply and demand dynamics. It could also cause confusion for both retail and professional investors, he said, because bundling of data on security types and counterparties reduces its usefulness.

Rule 13f-2 reports could provide interesting insights, Galper stated. However, he agreed that Rule 10c-1a could lead to “over-transparency,” and potentially to a reduction in market participation, short squeezes, and short-selling funds’ reorganizing as family offices to avoid reporting requirements.

Galper also saw mixed benefits from the asset owners’ antitrust suit. Although transparency was an objective, he noted that transparency has already been significantly improved by the availability of more data services in the market than ever before.

Technological innovations may ultimately play a bigger transparency-promoting role than the legal processes. Vendors including Trading Apps, Provable Labs, Wematch and FIS have either launched or plan to launch securities-lending solutions that increase transparency and facilitate transactions.

The emergence of innovative service providers may be a factor in EquiLend’s owners’ decision to sell, which would free them to experiment with alternative approaches.

EquiLend itself, Galper said, might gain strategic flexibility without being beholden to its legacy owners.

Price Competition

Professor Angel sees more competition improving securities-lending transparency, further opening the market, and lowering the costs of searching for trades and better pricing. “In the end,” he said, “owners of securities should get a bigger piece of the pie.”

According to Reuters, a potential EquiLend buyer is the Euronext exchange. A Euronext rival, Deutsche Börse, partnered with fintech HQLAᵡ on a securities lending platform using distributed ledger technology (DLT). Having completed its first securities lending transaction 2018, HQLAᵡ in 2021 announced strategic investments from global heavyweights including BNY Mellon, Citi, Goldman Sachs and BNP Paribas Securities Services. Also in 2021, JPMorgan connected its agency securities lending business to the platform. (See Securities Lending and Repo Get the Blockchain Treatment.)

EquiLend in September announced a pilot of its own DLT solution, 1Source, that will retain a centralized record of securities-lending agreements between counterparties.