This extract is taken from the Securities Finance Times Collateral Annual 2021 (p.48)
Elisa Poutanen, sales lead at HQLAᵡ, describes how the Luxembourg-based company has built an agency securities lending model that enables agent lenders and their counterparties to reap the benefits offered by DvD settlement
In terms of our value proposition for market participants, HQLAᵡ was initially designed to enable capital efficient balance sheet management for banks. While our current production solution caters for upgrade transactions settling in tri-party environments, it is paramount for us to keep expanding the HQLAᵡ product scope and provide seamless access onto our platform for a wider community of securities financing market participants.
Through consultations with our strategic investors, partners, and clients, we have built a model that enables agent lenders and their counterparties to use and reap the benefits that our delivery-versus-delivery (DvD) settlement achieves. Our custody vs. tri-party model provides an opportunity for both agent lenders and borrowers to enter the flow with minimal operational and technical impact on their systems and to keep as many parts of their trading and settlement flows the same as they are today.
To onboard banks versus agent lenders on our platform, at least in the initial phases, much of the underlying value proposition will reside with the capital efficiencies that the operating model provides for the bank users. The simultaneous DvD settlement reduces intraday credit exposures by ensuring the ownership exchange of the principal and collateral legs takes place simultaneously. For the agent lenders, the value proposition can be characterised as being the lender of choice, enabling the agents to lend more securities out as the model is more capital efficient to bank borrowers.
For these specific flows, and in collaboration with two leading agent lenders, we have enhanced our current operating model to fit into the current agency lending market practice in which principal loan securities are settled through existing custody networks while the collateral leg settles through tri-party.
HQLAᵡ’s current operating model enables the segregation and transfer of ownership of baskets of securities via tri-party. Consequently, we are already well positioned on the collateral side to segregate the collateral for the agency lending flow. In our operating model, the trusted third party (TTP) holds the collateral account in the books of the tri-party agent of the borrower, either on behalf of the lender or borrower, as recorded by HQLAᵡ on the digital collateral registry.
From an operational perspective, there is little or no change for the borrower as a collateral giver. The TTP, in its role as commissionaire under our legal construct, can hold the collateral securities on behalf of the participants and report the ownership of the collateral based on digital collateral records (DCRs) on our digital collateral registry.
On the loan side, we have adapted our operating model to support the delivery of loan securities to the TTP via custody. After the loan securities have been delivered to the TTP by the agent lender and the change of ownership has been executed (DvD), the loan securities are immediately delivered onwards to the borrower. The key difference from the traditional agency lending flow for the loan securities is that the TTP acts as a neutral account holder in the flow on both collateral and principal securities sides and on behalf of both the agent lender and the borrower.
DvD is achieved by using a combination of the TTP’s ability to hold securities on behalf of the participants and the Digital Collateral Registry being able to record the simultaneous ownership exchange of the DCRs that represent the record of ownership of the loan securities and the collateral securities. For both the start leg and end leg of the trade, it is possible to define a precise moment in time for the ownership exchanges to take place, allowing borrowers finer control over their collateral optimisation, especially when intraday or time zone efficiency matters.
From an operational perspective, trades can be booked via any of the platforms that are currently supported by the agent lenders. The post-trade data flows for loan opening, returns and recalls, and triparty collateral required value (RQV) remain very much the same as today. No additional connectivity is required for the borrower to be able to take advantage of the operating model. All existing contract comparison, return services and RQV matching services remain the same.
Looking forward, we are analysing potential medium-to-longer term use cases for agent lenders and underlying beneficial owners, especially in the light of Uncleared Margin Rules and the requirement for the buy-side to collateralise margin exposures. One such use case is to enable beneficial owners to re-assign ownership of collateral received via DCRs on our platform in onward margin pledge obligations. This process could be facilitated by agent lenders connected to our platform, hereby enabling buy-side market participants to seamlessly re-deploy collateral via their existing agent lender relationships.
We are also working on enabling borrowers to benefit from even greater collateral mobility via the use of pre-collateralised DCRs, held in a “DCR Long-box” and instantly transferable at any moment from multiple custody or tri-party locations. This will help our clients to avoid issues related to having the right collateral in the right place at the right time. A DCR reuse feature will also allow our customers to mobilise DCRs received and held on ledger instantaneously in favour of the agent lenders, even outside of the settlement and tri-party collateral management same-day deadlines.
We are continuously adapting our services to include new product developments. We are intent on listening to input from our clients, prospective future clients and stakeholders to ensure we are providing significant solutions to address the market’s pain points — while remaining true to our guiding principle of being ‘designed by the industry, for the industry’.
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