Basic HTML Version
For those remaining in the business, there are two
sets of issues that must be resolved. What is their
strategy going to be in regards to indemnification
and how are they going to manage with the new
counterparty concentration limits.
Survey participants offered up several solutions
for how to handle indemnification and ideas on
how to reduce counterparty exposures through
new intermediaries such as centralized clearing
counterparties. What came through most clearly
in the interviews, however, was that the thinking
around these topics is still in its early stages and
that there is not yet a sense of urgency around
resolving these issues.
New Economics of Lending Require Strategy
around Indemnification
Views diverged on the real value of indemnification.
Several lenders and even some asset owners argued
that in a well-run lending program, there was little
need for indemnification since each individual
transaction was fully collateralized. Others argued
that few asset owners would be able to make the
case to their boards to incur the risks of lending
without the guarantee. Some of these participants
argued that the cost of indemnification could be
priced into transactions, so long as it was a relatively
small expense while others argued that margins were
already so low that any attempt to further cut into
that return would make the economics of being in
lending programs untenable.
This sets up a difficult situation because there needs
to be a sufficient pool of supply in lending programs
to provide liquidity. If this supply becomes too low,
the economics of running the program become
strained. This need becomes even more critical as
the lending book will need to be spread out across
a broader set of counterparties to stay in alignment
with counterparty credit limitations. This reality is
encouraging many agent lenders to consider the
relative value of clients on their platform and to favor
larger asset owners that can have more of a material
impact on their business, giving them a larger pool of
lendable supply to spread out across the market.
The broad sentiment expressed in the survey was
that at least some agent lenders are likely to choose
to withdraw or significantly scale back their lending
programs.
Multiple Options on How to Handle
Indemnification Emerge
Chart 26 summarizes the main strategies survey
participants articulated for how they see the
challenge around indemnification playing out.
Today’s current state captures indemnification solely
as an implicit cost of doing business and not as part
of the explicit costs covered by the stock lending fee.
Due to the Basel III requirements and the change in
risk weightings associated with determining the costs
Section V: Agent Lenders Strategize Options for
New Regulatory Landscape
Faced with these new regulatory considerations, many agent lenders are being forced to
re-evaluate their business models in preparation of the new rules taking effect.
“ Indemnification is so tied into the board levels at
the funds and at the administrators. All boards
have indemnification tied into their decision to lend
so the administrator would be taking an enormous
amount of career risk,” — Agent Lender
“ If regulations come out as they are proposed, it will
make this business more expensive. Supply will get
a bit smaller and there will be a tipping point on
whether it makes sense to lend. If prices increase,
it will force some lenders to take a hard look and
decide if they want to continue,” — Agent Lender
“ I think we are going to see some agent lenders push back on
extending indemnification,” — Asset Owner—Money Manager
“ With a robust collateral policy, there is less need for
indemnification. In a way, you are signing up for a collateral
schedule and this gives you a set of assets you are forced to
deal with,” — Asset Owner—Money Manager