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BNY Mellon to add ETFs to agency lending collateral list

BNY Mellon is set to add exchange-traded funds (ETFs) to its collateral list by the end of the year in response to client demands for greater flexibility when collateralizing securities lending transactions.

In a report for institutional customers in the US and the Asia Pacific published last week, Simon Tomlinson, global head of agency lending trading at BNY Mellon, said the process of adding ETF collateral lists to the agency lending business is already underway, with a view to accepting it this fall.

According to the report, the decision comes after the bank began to receive “questions from securities borrowers who want to know when ETF collateral will be accepted for its own agent lending business”.

The report also reviews the results of the bank’s survey which asked, among other things, if its buy and sell-side clients would be open to growing their currently very low levels of utilisation of ETFs as collateral as a way of increasing market liquidity.

The survey of 20 collateral provider clients by BNY Mellon Markets found that, by and large, firms use a negligible amount ETF collateral today. Many see their usage growing, however, especially if liquidity and circulation of the funds’ increases or they can find buy siders to accept the funds, the report noted.

Although the report acknowledged that the use of ETFs as collateral for securities financing transactions is on the rise, “convincing hundreds of clients to add ETFs to their collateral schedules will take time”.

The bank plans to leverage its new RULE tool, which can help clients with changes to their existing collateral schedules to include ETFs, to help speed up the process.

According to BNY Mellon, the adoption of ETFs as collateral has also been slowed by a lack of nuance in the regulatory oversight of ETFs.

Katy Burne, the report’s author and BNY Mellon’s content and communications strategist, described how one current sticking point is that regulators that determine what collateral can be pledged against derivatives currently treat Goldman Sachs Access Treasury (GBIL), an ETF that tracks an index comprised of US Treasury securities with less than one year remaining in maturity, no differently than an ETF containing Russell 2,000 stocks.

“When traders pledge $100 of collateral, the regulators guide the receivers of that collateral how to discount its value in case one side goes belly up. With the typical equity-like haircut for ETF collateral, the requirement today can be north of 15 percent,” she explained.

However, the bank now believes that there are several market forces that might increase the potential for ETF collateral use as institutions become more comfortable with how ETF baskets are built and dismantled. As well as this, collateral flexibility is becoming more important.

The report noted that if ETFs are mobilised as collateral then it is more likely funds’ liquidity will increase, thereby reducing market friction.

Additionally, for those jurisdictions and credit arrangements where cash collateral may be restricted, ETFs could be easier to move and manage than other assets, BNY Mellon noted.

The report comes a month after Goldman Sachs Asset Management selected BNY Mellon to provide asset services for its newly-launched European UCITS exchange-traded funds (ETFs).

BNY Mellon’s global head of business solutions for asset servicing, James Slater, remarked that the world is better piped to move equities than money market funds.

He commented: “The need to collateralise transactions is increasing and in some cases regulations restrict the use of cash.”

Robert Rushe, head of ETF services for Europe, the Middle East and Africa at BNY Mellon, noted: “Our appointment bears testament to the quality of our ETF-specific technology, our scale and our team of ETFs experts.”

“It also underscores our commitment to growing our ETF business in markets around the world.”

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