Industry leaders from the Asian securities lending sector discuss the region’s outperforming revenue, the effects of the coronavirus on behaviour and which markets will lead the pack in 2020
Asia’s securities lending revenue outperformed on the global stage in 2019. What drove this trend and can we expect it to continue this year?
Mark Snowdon: 2019 was a mixed year for securities lending, with a feeling of continued buoyancy despite the headwinds that slowed growth in comparison to 2018. Political and economic uncertainty, driven by Brexit and international trade tensions, contributed to a general lack of conviction globally, resulting in reduced demand particularly in the equities space. This was evidenced by a 14 percent drop in year-on-year revenues for Asia Pacific (APAC) equities, according to DataLend.
The securities lending industry in APAC continues to be optimistic, despite the impact of slower demand and lower fees. Key developments are expected to take place regarding new markets and different approaches which will affect the lending industry throughout 2020 and onwards.
Jansen Chua: We welcome the development of the Asian markets from a lending perspective and note that there have been positive signals from the Philippines who recently approved implementing guidelines on securities lending. China continues to take promising steps towards market liberalisation; recent index inclusion has further increased investor interest. However, the ability for offshore securities finance to fully participate remains contingent on significant regulatory and market infrastructure change.
Simone Broadfield: Last year brought with it geopolitical unpredictability, global economic policies that led to trade-war tensions and sustained localised political protests. The combined volatility of these macro events impacted lending activity across Asia Pacific. Spread compression and a reduction in balances across equities were a notable trend towards the latter part of Q4.
Nevertheless, there were still significant opportunities available to generate alpha across equities assets within agency lending programmes, most particularly across longer term directional shorts in Australia, Hong Kong and South Korea. IPO assets entering the discretionary lending pool in Hong Kong, equities undergoing corporate activity in Japan and continued demand for flexible trading structures commanded a premium, particularly the last as balance sheet optimisation continued to be an ongoing focus for the market. The fee compression and balance reduction seen across equities were offset by increased opportunities within the fixed income space.
Demand for upgrade structures showed no sign of abating as 2020 began, with the main beneficiaries being those clients holding desirable risk-weighted asset ratings and a flexibility in terms of trade tenor and collateral parameters, such as the ability to accept Korean treasury bonds.
As 2020 Q1 began, the theme of fee compression across equities showed indications of continuing; however, the slower start is now moving into a period of increased market volatility as the impacts from coronavirus begin to emerge, leading to directional short opportunities and an anticipated recovery across APAC equity lending markets.
To face the challenges that the unpredictable market conditions may bring, agent lenders need to respond rapidly to the evolving needs of the securities lending market. The focus will be less on traditional lending, although that remains a fundamental part of revenue generation, and will shift towards customised trading solutions and continued diversification of product offerings.
Brian Leung: Asia’s outperformance compared to its peers was largely driven by an increase in specials activity, particularly in Hong Kong where demand surged on the wave of the escalating US/China trade war and continued macro geopolitical uncertainty which drove end-users to increase China exposure. This was boosted by the fact that the Hong Kong market saw multiple high-profile capital raisings.
Similarly in Japan, strong corporate deal activity and increased focus by activist investors on Japanese-listed companies’ corporate governance kept the Japanese market thriving. 2020 should see similar trends, as macro challenges are set to continue. Discerning lenders should be on the lookout for more corporate deals and be able to maximise their securities lending returns on the back of those transactions.
One of the big stories that came from Asia in 2019 was Japan’s GPIF decision to partially pull out of lending. How big a shock was this and what is the impact on the market in Asia and afield?
Chua: While the decision was not communicated widely before the announcement, it was well-known that Japan’s Government Pension Investment Fund (GPIF) holds a view on environmental, social and governance (ESG). There was also an internal opinion that the lack of transparency around securities lending trading activity did not support good governance. Despite the size of their holdings, the impact on the market appears to have been muted as most borrowers have been able to cover their exposure to this lender adequately.
Leung: GPIF’s decision to pull out of its securities lending programme was disappointing, however a keen securities lender would see it as an opportunity. It was only noted as a suspension and not a withdrawal from the industry as a whole, which implies they would be open to re-entering the market at a future stage. It is widely proven with supporting empirical evidence that securities lending and short selling play a vital role to properly-functioning and efficient markets. The impact of their suspension is more psychological than economical. While overall lendable supply has dipped as a result from their absence, the rates (particularly on specials and a broader level) have not shifted significantly since the announcement.
Do you foresee other Asian funds following suit to GPIF?
Leung: From our discussions with existing clients, they acknowledge GPIF’s high profile departure has not gone unnoticed, but they have fallen short of questioning their own participation in lending as a whole as they are soundly aware of the benefits that a transparent, well-function securities lending programme can deliver. Dialogue and communication with clients are key at this stage, and we expect the industry as a whole to be able to deliver the right type of solution for each participant.
Chua: Investors are increasingly reviewing the relevance of ESG principles to securities lending programmes, particularly how certain aspects (proxy voting, short selling) align to their stewardship responsibilities. The divergence of views today amongst participants, however, speaks to the lack of a uniform standard. Many investors understand that it is not a binary decision and it is possible to have effective ESG goals and still participate in securities lending. We believe that this topic is likely to remain at the forefront of agent lender and beneficial owner discussions for 2020.
2020 will see big moves in Europe to harmonise markets and improve data quality and transparency under SFTR. Could a similar framework exist in Asia? Would you want it to?
Leung: Given Asia’s level of market sophistication in the region and that almost every major market has a requirement for reporting over-the-counter derivatives, it stands to reason that each market is watching this space very closely. They will be learning from Europe’s experience in implementing the Securities Financing Transactions Regulation (SFTR), how it impacts markets and market participants before making their own SFT reporting decisions based on best practices tailored for their own market idiosyncrasies. From previous experience, the more developed markets such in Japan as well as Australia are likely to take the initial lead, followed by Hong Kong and Singapore.
David Lai: Securities financing is employed in various degrees of volumes in each of the region’s markets, and four of the 10 biggest stock exchanges reside in Asia Pacific (based on market capitalisation in USD, May 2019).
Therefore, it would stand to reason that there will eventually be calls for a similar framework in Asia to facilitate greater harmonisation and transparency.
Since securities lending in some Asian countries has been more recently established than in other countries, we believe that having a similar framework would help to further educate the region on the role securities financing plays in today’s global marketplace and highlight the region’s growing importance to global securities financing.
Chua: SFTR is specific to one regulatory regime (Europe). So, it is unlikely to be replicated across Asia, which has multiple regulatory regimes to consider. While many would welcome the transparency that SFTR is bringing to the market, a much simpler version with fewer requirements would be the model adopted by Asian regulators.
What other challenges do you see on the horizon for the securities finance industry in Asia in 2020?
Chua: The emergence of the coronavirus in its latest form appears to be having a widespread impact on both social and investor sentiments. Geopolitical instability will continue to be a factor. With the US-China trade war still ongoing, tensions on the Korean Peninsula and the US election year are likely to materially impact the performance of stocks regionally. From a market perspective, the continued low interest rate environment will present a challenge to those investors reliant on returns from cash collateral. Continued regulatory implementation will add to the cost of running securities financing programmes.
Lai: One challenge for 2020 is to further expand the universe of acceptable collateral types. As demand for diversification continues to increase, along with the desire to utilise/monetise unencumbered assets, we are working closely with our clients and their counterparties to identify additional opportunities.
This follows the 2018 launch of international pledge in Asia Pacific, which our agency securities lending team completed independent of the industry initiative, and the 2019 introduction of expanded Korea collateral schedules to include Korean treasury bonds within our South Korean equity collateral programme.
Snowdon: While not necessarily a challenge, regulation is a fundamental part of every market players’ agenda. It is likely that both global and converging local regulation will continue to transform the industry, despite the fragmentation it has across APAC.
April 2020 sees the first phase of SFTR go live. SFTR is a global regulation that mandates enhanced reporting of securities lending transactions for in-scope entities. This should help the industry better prepare for imminent challenges and better position market participants for a more flexible and efficient future.
Regulators introduced Resolution Stay Protocol requirements following the global financial crisis, in order to ensure benefits for the securities lending industry. Further requirements will be put in place to ensure the benefits of lending continue to accrue, whilst delivering a higher chance of positive resolution should a borrower default occur in the future.
Alongside growing cost pressures and lower yields, another challenge is the continued rise of responsible investing, which is the integration of ESG factors into investment processes and decisions.
Sustainability is a core element of ESG investing. It is also a benefit that a securities lending programme brings to capital markets generally, and to investors’ returns specifically. Incorporating their securities lending programmes with ESG principles is important to investors as they become more involved in expressing their values through voting. On the surface, securities lending can appear to run counter to ESG principles, as when a security is on loan the investor loses the right to vote. However, securities lenders have been successfully balancing the returns from securities lending with the requirement to exercise good governance for many years.
In partnership with a supportive, client-focused securities lending agent, the right balance is achievable, and will come from an agreed approach between the agent and the asset owner or manager using technology, market insight and strong relationships with borrowing counterparties.
Leung: The COVID-19 outbreak has provided a stark reminder to ensure that participants have strong business continuity procedures and technology in place, such that securities lending programmes and client experience will not be affected adversely due to the pandemic. We have seen a reduced trade flow in some of the major markets since then, and while we foresee it is a temporary lull, we have yet to see how it will impact the wider securities lending industry as a whole.
Several Asian markets took steps to further develop their securities lending and short selling markets in 2019. How important have these developments been in improving the overall region?
Snowdon: In Australia and Japan in particular, borrowers are looking to reduce the number of intercompany transactions by using a domestic entity to borrow local securities, rather than their European or US entity. This trend is expected to continue in the region, and will allow increased opportunities to expand distribution and generate additional revenue for lenders.
The trend of lending to non-traditional borrowers is growing in APAC, as we are increasingly seeing hedge funds borrow directly from lenders which offer opportunities for clients who want to utilise a different risk-reward profile, thus causing disruption to the usual value chain.
The Pan-Asia Securities Lending Association (PASLA) has been liaising with regulators and authorities to develop a working offshore model and increase usage of the operational, yet seldom used, onshore model. The upcoming model is expected to be a simplified bilateral one that is more transparent and inclusive.
Leung: With Philippines adding new short selling rules and Indonesia looking and potential CCP models, it is important the PASLA community continues to bring more countries into the fold. Each come with their own unique regulatory challenges which the PASLA committee has been working in partnership with regulators and industry bodies to overcome.
The elephant in the room continues to be China and its gradual easing and opening of its financial markets, particularly in providing a viable SBL framework that international investors can take part in. Industry players must be nimble and reactive to any possible (and sometimes sudden) changes the CSRC will announce as the onshore market has been under the microscope for the past few years given its potential and presents a significant opportunity.
Lai: We have seen encouraging steps on short selling, from revised guidelines to new approvals. Individual regimes also issued clarifications on various functions including collateral valuation and tenors.
These updates are encouraging as they allow for the increased understanding of the role that securities lending plays in the region’s markets. We continue to see new entrants which is encouraging and can be partly attributed to the increased information about, and understanding of, the role securities lending plays in regional markets.
Every year, the developing markets of Asia are catching up with the more established markets. Which Asian markets do you expect to shine in 2020?
Broadfield: Although Japan is an established market, we see significant enough growth opportunities to warrant a continued focus and expansion of our lending product in the market across all lendable asset classes. The Hong Kong lending market has been heavily impacted by the macro factors mentioned earlier; however, we remain positive that we will see a recovery and a return to increased activity. South Korea consistently offers high returns, in spite of increased onshore supply, and we expect this to continue throughout 2020.
For 2020, we would say that it is less about which market will shine and more about how the traditional agency lending product will evolve to meet client needs.
Snowdon: Since China A-Shares were added into MSCI benchmark indexes in 2018 and the number of these shares subsequently increased in 2019, China has stood out as one of the key opportunity markets for the securities lending industry. Both borrowers and lenders look to leverage opportunities in China, such as the development of links between onshore and offshore exchanges via Stock Connect. Hong Kong, however, faces various restrictions on who is authorised to engage in securities lending and therefore, the activity is only minimally utilised in the market. Although it is currently allowed under Stock Connect, only exchange members are permitted to participate, eliminating some of the largest asset holders such as custodians and asset owners.
The Australia market looks set to continue to grow in 2020, with Australian superannuation funds currently managing around AU$2.7tn of assets. As these assets grow and the industry consolidates, many superfunds have started to consider securities lending as an integrated investment solution. Securities lending is seen as a means to achieve increased returns with low risk, during a period of increased regulations and rising cost pressures.
Leung: In 2020, we expect the major players in Japan, Hong Kong and South Korea to continue punching above their weight, however, it will be nascent markets like Philippines and Indonesia, where if a viable market structure is achieved for international investors, can present significant first mover advantages for participants who are best equipped to capitalise on lowly tapped markets such as these. Beneficial owners will be well aware of which service provider is able to differentiate themselves with innovative ways to access new markets.
Chua: In absolute terms, returns are likely to be highest in Japan and Hong Kong. The Korean market continues to show higher returns than the previous years.
Several Asian markets have seen the introduction of emerging technology, such as blockchain, for securities lending. How big a part can technology play in developing interest in SBL and help interconnections across Asia?
Chua: The potential for technology to increase efficiency and enhance returns is enormous. However, some fundamental issues (such as market liquidity, infrastructure and regulatory environment particularly for cross-border investments) remain the same with several regional markets. These issues will continue to detrimentally impact the growth of securities financing activities in such markets.
Lai: Technology is critical to efficient markets, and securities lending is no exception. Whether it’s at a client level, with better performance and analytic tools, or an industry/infrastructure level, with emerging technologies that can improve the flow of data, information and governance, we continuously seek better execution and access to data that supports transparency and liquidity.
Snowdon: Advanced technology is transforming financial markets globally, and the Asian securities lending industry is no different. Technology provides the opportunity to enhance entire lifecycles, from trading strategies through to operational efficiencies.
There is a potential for blockchain technology to drive both small-scale benefits for lenders and borrowers, and major industry-wide improvements. We expect the practical application of technology to strengthen competitive advantage for performance, efficiency and better client experiences.
With our experience and expertise in pioneering blockchain technology, we believe it has the potential to drive major industry-wide improvements and could significantly change the securities lending market. Blockchain and distributed ledger technology will allow automation so people can focus on the tasks that will bring the real value to the client. This will provide potential opportunities to achieve industry cost-efficiencies across the value chain. As confidence continues to grow in the technology sector, future opportunities are likely to develop in a wide range of areas.
Leung: Blockchain has already had a tremendous impact on the financial industry and the securities lending industry is no exception. Having a ledger that tracks the lending of securities that has been transferred multiple times between counterparties is ideally the most elegant solution which could in theory reduce costs, increase efficiency and execute transactions instantaneously between two parties.
The announcement of Deutsche Boerse’s partnership with HQLAx to develop a blockchain-operated solution for the securities lending market also signifies the growing shift towards this technology. Asia is definitely watching this space closely, where similar to regulatory changes, it is expected the more developed markets to follow first, given their market structure and sophistication.
We have also observed individual firms in markets like Korea and Malaysia experiment with their own blockchain solutions. The potential for this technological breakthrough is huge, though one should temper timeline expectations given historical lead-times for rolling out market developments in the region and it the regulators’ historical trend as followers instead of innovators.
