Modern Technology for the Complex World of Securities Finance
April 6, 2022
Securities Finance is an important piece of the global market, consisting of trillions in lendable assets and facilitating order and stability within our financial system. Securities finance also happens to be one of the fast-growing areas of our business here at Clear Street.
To learn more about securities finance and why it matters, I sat down with Madhu Subbu, who leads our Securities Finance engineering team.
Madhu oversees 11 engineers who are partnering directly with our Securities Finance trading team to develop a robust, proprietary technology platform that is cloud-native, scalable, and something that we believe will add considerable efficiencies to the market.
We had a great chat about security finance, repo, and how finance long-haulers and freshly minted engineers are teaming up at Clear Street to build a powerful platform to improve market access and efficiency.
Q: I often find that securities lending is not well understood, and yet it is an important function of the global market. So to start, can you explain what Securities Lending is and why it’s important?
MS: The Securities Lending market facilitates lending and borrowing of securities against collateral, and is typically a major function within prime brokerages. It is difficult to overstate just how large this market is. According to recent figures from the International Securities Lending Association, the market had approximately $650Bn of assets on loan in 2021 — and that’s in US Equities alone. As a prime broker, Clear Street provides our institutional clients with full service securities financing services.
We see the securities finance market as a key to the overall health and efficiency of the financial ecosystem. Securities financing allows market participants, like Clear Street’s clients, to take on short positions, hedge their investments, and even provide lubrication in event of a settlement failure. Yet, when we speak with colleagues across the industry, we find that the securities lending market is often misunderstood because of its role in short selling — a short seller typically has to borrow the security from a holder of that asset before going short.
It seems like short sellers often get a bad rap in the general press, but the reality is that short selling is a critical mechanism for price discovery and liquidity in the cash equities market. Efficient price discovery benefits all market participants, including the holders of that asset, as it serves as a secondary source of income. Moreover, short sellers’ diligence and analysis can provide key signals for discovering and exposing fraud in traded companies, whether it is faking an electric truck progress or a massive fraud like Wirecard.
So in short (forgive the pun), securities finance is an essential part of a healthy market. And it is therefore troubling to me to see how today’s securities finance market is burdened with heavy cost structures, outdated technology, and inefficient organizational designs. Clear Street is creating a nimbler and more agile firm, offering more favorable cost structures, more efficient growth through innovation, and higher quality of returns for asset owners and stakeholders compared to what we have seen elsewhere in the market.
Q: Let’s dig into that. What is Clear Street’s role in the securities finance market? Can you tell me about our Securities Finance team?
MS: As I mentioned earlier, securities finance is typically a key business area at a prime brokerage like Clear Street. As a broker, we represent our clients in the market to help them access securities that would otherwise be difficult to access (i.e., hard to borrow).
Despite its importance, securities finance is an area of the financial services industry that has only seen limited innovation. Like much of today’s capital markets infrastructure, it is dependent on antiquated technology such as mainframes, which can create data challenges for clients. We’re working to change that. There is a hunger among our clients for data, transparency, easy-to-use APIs, access, automation, and insights.
I am personally head of our Securities Finance Engineering team, which means I have the privilege of working alongside a fantastic lending team that represents our clients across all areas of securities finance, including stock loan, repo, collateral management, and treasury. Veteran practitioners averaging 25+ years in the business sit side-by-side with younger minds, including top engineering and quantitative talent, who see the opportunity to digitize many of the processes with a fresh perspective.
The technology and the business teams are truly integrated at Clear Street as compared to other firms I have seen. When technology and business are siloed, as they are at many other broker-dealers, a lot of information gets lost in translation. We have managed to avoid that problem. When you know what to build and how, you can build great products that are a joy to use and beneficial for both our customers and the firm.
Q: So I have to ask then: what are you building?
MS: Clear Street is building what we consider to be the most efficient and modern securities finance platform on the street. We have assembled a team of tested technologists, data scientists, and subject matter experts that bring a lot of experience to the table. This is an exciting opportunity for us because we get to apply all the lessons we’ve learned throughout our careers building technology at large prime brokers to create something new, something that we believe will be better.
What’s special about Clear Street is we’re building this from scratch, from the ground up. When you don’t have legacy systems bogging you down you can build a truly scalable and efficient platform that can ultimately help us service our customers the best way possible.
Q: And what do Clear Street customers want?
MS: Clear Street’s prime clients are looking for a seamless customer experience. They are looking for timely access to high quality inventory with reasonable pricing, while not having to worry about the legwork that goes into arranging a short sale. Our hedge fund clients often express frustration with the lack of transparency, fragmented access, poor supply, and high cost–all areas we are solving for. In that respect you are in very good hands with Clear Street Prime.
Q: That’s certainly exciting. Could you go into more detail about how you’re thinking through the platform build-out? Anything we can preview to our readers today?
MS: The best way to answer that is to first give you some of my own background. My career is rooted in computer science, more specifically in algorithm design. I joined Credit Suisse in 2009 following graduate school at Carnegie Mellon University during the peak of the financial crisis. At that time I was fascinated by financial contagion and systemic risk, and I was developing techniques to simulate the spread of contagion in a financial network.
My work led to more opportunities in the prime services business. I worked on various problems, including inventory/collateral optimization and balance-sheet efficiency. This experience led me to the realization that all banks are marketplaces internally. I later started the firm Enigmatch, where I developed an efficient multi-party, multi-criteria auction mechanism that could fully automate many OTC markets, including securities finance.
When I met the Clear Street Securities Finance desk, we realized that there was an excellent synergy between Enigmatch’s technology and Clear Street’s market expertise. Today we are using Enigmatch’s technology to build out, arguably, the most efficient broker-dealer platform ever built, while also developing an all-to-all marketplace for stock loan.
Q: That’s great. And how will this build-out solve issues facing the market today?
MS: I would start from my understanding of the perspectives of each stakeholder in a lending transaction. From the lenders and lending agents’ point of view, the focus has always been maximizing returns while minimizing risk and cost of administration of the program. For borrowers, the primary concern is access to high-quality, stable sources of inventory at a reasonable price, along with ease of access. With our technology and market expertise, we believe we can create a win-win scenario for both lenders and borrowers.
More specifically, our platform will de-silo key inputs and leverage advanced analytics and machine learning to optimize the balance of inventory, collateral, and margin against customer demand–with the goal of more liquidity, better economics, and reduced systemic risk.
We are solving a complex problem within a complex market–it’s a challenge, but an exciting one. Every day we are pushing the boundaries of how we can improve the experience for our clients on our platform, providing them with enhanced access to modern, tech-driven resources in order to make them more competitive within the marketplace. I look forward to continuing to share updates on our progress.
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