When the Options Clearing Corporation changed its name to OCC in 2011, it reflected the clearinghouse’s growing suite of non-options services. One of those products is the clearing of securities lending transactions. That business continues to boom and appears to have much more growth ahead.
In 2015, 1.4 million transactions took place with OCC and the average daily loan value was more than $155 billion, up 16 percent from a year earlier. The program began in 1993, but only took flight in the last four years. It’s still just a fraction of the stock loan business, which gives OCC belief it can grow substantially from here.
“Frankly, this is the rare case where we have market participants coming to us seeking to have us rapidly expand the service rather than typically we’re trying to go out and sell them on a solution,” said Scot Warren, OCC’s executive vice president, business development. “There is a pretty significant level of demand and engagement with market participants trying to evolve to the next generation of clearing service.”
When the program started, its purpose was rather different. Initially, the service was all about providing access to the securities lending market for smaller clearing firms and prop shops who did not have adequate enough credit otherwise. While OCC’s credit still plays a role in deciding to engage (participants have lower indemnification costs when exposed to AA rated credit like OCC’s, for example), the capital efficiencies of having CCP cleared securities lending transactions are the primary reason for the program’s explosive recent history. (The four year growth rate of OCC’s securities lending business is 1000 percent, albeit from a low basis.)
“The capital charge for bilateral stock loans range from 20-100 percent versus the capital charges on a CCP cleared item at 2 percent,” said Warren. “So, there are pretty compelling capital efficiency reasons why people want to move as much of their stock loan business into a cleared environment.”
Furthermore, while OCC is a for-profit organization, participants view it as a better solution because it operates as an industry utility with different commercial interests than a public CCP. The current fee structure is $1 for each side of the transaction, although Warren expects that to change with prices that vary depending on whether the participant is the lender or borrower.
Despite the clear demand for OCC to keep expanding this business, there are a few hurdles to overcome. Much work with regulators needs to be done to figure out who can really participate in securities lending with a CCP, since some of the current rules did not consider that stock loans would be cleared. To engage these new participants, OCC needs to develop a new risk model, as well as change their own rulebook and update their technology to accommodate those new participants.
The good news is that OCC’s experience with regulators regarding this matter has thus far been positive, Warren said, as cleared stock loans enhance the safety of the market.
OCC also clears loans that originate from the alternative trading system AQS. And while OCC is open to clearing other alternative trading systems like AQS, whose transactions are anonymous, the demand is for more bilaterally cleared stock loans so that lenders and borrowers can build and maintain their relationships with each other.
Near-term, the OCC will continue working with an industry consortium on how to process order flow and manage inherent risk, all while making certain the shift from bilateral to cleared stock loans is not an invasive prospect for market participants. Once they are confident in their solution, the trips to the regulators will begin in earnest to open the cleared stock loan market further.