Advances in collateral
23 January 2018
David Lewis, of FIS Astec Analytics, tracks the rise of ETFs and discusses their potential benefits to the securities lending collateral pool
Image: Shutterstock
Much has been said and written about the changing nature of the securities financing industry, its transition from the back office to the front, and, more recently, as it morphs into the enterprise-wide collateral management and financing function we increasingly see today. The industry has managed to do this through evolutionary adaptation and that capability is being tested further by a raft of new regulations coming into force.
Adaptation does not always come from reactions to external pressures; the market’s participants and their clients all along the transaction chain have repeatedly developed new ways of doing business to help expand and develop the services they delivers. Looking at new markets and products has often helped the market progress, such as, adding new markets as more mature markets decline in terms of revenues and opportunities. New parts of the Middle East, adding securities lending and shorting mechanisms, will bring those markets on line in the coming years.
As far as new product developments go, adding new possibilities for revenue generation and/or costs savings can also help develop the business. Most recently, talk has been about increasing the use of exchange-traded funds (ETFs) as collateral, with announcements from agents, such as Citi, regarding plans to accept ETFs as collateral in their securities lending business.
Falling margins and incomes are driving the business to look for opportunities to improve efficiencies and cut costs, as well as capitalise on new or previously underused pools of assets.
The development of ETFs as collateral potentially delivers on all these fronts. Collateral flexibility and diversity are key to ensuring assets can be lent to borrowers working under their own balance sheet constraints, while maintaining margin requirements, especially as new regulations come into play. As has often been said, lenders cannot create borrowing demand, but they can make themselves attractive lenders. While lenders might be looking for enhanced earnings from collateral flexibility, borrowers may see such developments as ways lenders can avoid further downward pressure on earnings.
From the investors’ point of view, ETFs have certainly been on the rise. Almost $5 trillion of global assets under management are now believed to be invested in ETF products, growing by over $650 billion in the past 12 months. Blackrock has stated that it expects these values to double by 2022. As with equities and bonds, the values in issue are not necessarily available to lend. While the announcement from Citi is certainly welcomed, more momentum will be needed before ETFs become a more widely accepted asset class. This concept not only has to be sold to the underlying lending clients who must get comfortable with accepting the assets as collateral, understanding and accepting that they can bring collateral diversification and counterparty risk mitigation, but also those same investors have to be happy to lend them out. With a growing demand to manage collateral efficiently across the globe, on an enterprise rather than local level, flexibility on acceptability, with the ability to use an extended range of assets, will be a distinct advantage. Those organisations unable to manage their collateral on an enterprise scale will be left behind.
Figure one shows two plot lines, running from January 2014 to the middle of January 2018. The blue plot line shows availability by value, which followed a relatively flat trajectory from 2014 toward the middle of 2015, before rising toward the end of 2016. Over that period, the value of ETF assets globally, broadly speaking, increased by two-thirds. Since January 2017, however, availability of ETFs, by value, jumped by more than 110 percent. Over the past four years, availability in ETF assets grew, in total, by over 250 percent. Asset prices advanced significantly over the same period of course, but as a comparison, the S&P500 ETF Trust advanced only 55 percent.
What is more striking from Figure one is the red plot line, showing ETF balances on loan, by value. While the plot line is clearly not smooth, and indeed, when we look at the lending pattern of individual ETFs, it is often binary rather than graded, the loan balances for ETFs has grown little over the last five years. In January 2014, borrowing volumes were just under $45 billion, with the highest peaks over the period seen in June 2014 and 2015, when balances exceeded $75 billion. This figure was nearly reached again in September 2017, but otherwise has struggled to break $65 billion across much of the last two years. As with availability, this value pattern must also be taken in the context of asset prices across the S&P500 ETF increasing by 55 percent.
With ETF trades now being reportable under the second Markets in Financial Instruments Directive, the perception that ETF liquidity is low may be dispelled. This has been quoted as one of the reasons why certain market participants have been reluctant to be more active in lending ETFs or taking them as collateral. While this may well be a factor, the rising market availability shown in Figure one suggests that there is significant supply and capacity already available that is not yet being put under any real stress. This indicates that while the opportunity appears to be there, it has yet to be taken up. The move from Citi is an important step and, if more follow, expect this to be a growing area in our ever-changing and developing market.
Figure One
Adaptation does not always come from reactions to external pressures; the market’s participants and their clients all along the transaction chain have repeatedly developed new ways of doing business to help expand and develop the services they delivers. Looking at new markets and products has often helped the market progress, such as, adding new markets as more mature markets decline in terms of revenues and opportunities. New parts of the Middle East, adding securities lending and shorting mechanisms, will bring those markets on line in the coming years.
As far as new product developments go, adding new possibilities for revenue generation and/or costs savings can also help develop the business. Most recently, talk has been about increasing the use of exchange-traded funds (ETFs) as collateral, with announcements from agents, such as Citi, regarding plans to accept ETFs as collateral in their securities lending business.
Falling margins and incomes are driving the business to look for opportunities to improve efficiencies and cut costs, as well as capitalise on new or previously underused pools of assets.
The development of ETFs as collateral potentially delivers on all these fronts. Collateral flexibility and diversity are key to ensuring assets can be lent to borrowers working under their own balance sheet constraints, while maintaining margin requirements, especially as new regulations come into play. As has often been said, lenders cannot create borrowing demand, but they can make themselves attractive lenders. While lenders might be looking for enhanced earnings from collateral flexibility, borrowers may see such developments as ways lenders can avoid further downward pressure on earnings.
From the investors’ point of view, ETFs have certainly been on the rise. Almost $5 trillion of global assets under management are now believed to be invested in ETF products, growing by over $650 billion in the past 12 months. Blackrock has stated that it expects these values to double by 2022. As with equities and bonds, the values in issue are not necessarily available to lend. While the announcement from Citi is certainly welcomed, more momentum will be needed before ETFs become a more widely accepted asset class. This concept not only has to be sold to the underlying lending clients who must get comfortable with accepting the assets as collateral, understanding and accepting that they can bring collateral diversification and counterparty risk mitigation, but also those same investors have to be happy to lend them out. With a growing demand to manage collateral efficiently across the globe, on an enterprise rather than local level, flexibility on acceptability, with the ability to use an extended range of assets, will be a distinct advantage. Those organisations unable to manage their collateral on an enterprise scale will be left behind.
Figure one shows two plot lines, running from January 2014 to the middle of January 2018. The blue plot line shows availability by value, which followed a relatively flat trajectory from 2014 toward the middle of 2015, before rising toward the end of 2016. Over that period, the value of ETF assets globally, broadly speaking, increased by two-thirds. Since January 2017, however, availability of ETFs, by value, jumped by more than 110 percent. Over the past four years, availability in ETF assets grew, in total, by over 250 percent. Asset prices advanced significantly over the same period of course, but as a comparison, the S&P500 ETF Trust advanced only 55 percent.
What is more striking from Figure one is the red plot line, showing ETF balances on loan, by value. While the plot line is clearly not smooth, and indeed, when we look at the lending pattern of individual ETFs, it is often binary rather than graded, the loan balances for ETFs has grown little over the last five years. In January 2014, borrowing volumes were just under $45 billion, with the highest peaks over the period seen in June 2014 and 2015, when balances exceeded $75 billion. This figure was nearly reached again in September 2017, but otherwise has struggled to break $65 billion across much of the last two years. As with availability, this value pattern must also be taken in the context of asset prices across the S&P500 ETF increasing by 55 percent.
With ETF trades now being reportable under the second Markets in Financial Instruments Directive, the perception that ETF liquidity is low may be dispelled. This has been quoted as one of the reasons why certain market participants have been reluctant to be more active in lending ETFs or taking them as collateral. While this may well be a factor, the rising market availability shown in Figure one suggests that there is significant supply and capacity already available that is not yet being put under any real stress. This indicates that while the opportunity appears to be there, it has yet to be taken up. The move from Citi is an important step and, if more follow, expect this to be a growing area in our ever-changing and developing market.
Figure One
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