A year in review
05 February 2019
Sam Pierson of IHS Markit reveals that last year’s securities lending revenues delivered the best post-crisis return
Image: Shutterstock
Best post-crisis annual lending revenues
Emerging market demand, global credit uncertainty and central bank tightening were the primary drivers of revenue for securities lending last year. These narratives included trade conflicts, the potential turning of the credit cycle and the coordinated effort to reverse quantitative easing and increase rates. The US market diverged from other equity markets in the middle of the year, resulting in pain for US short sellers, as well as a decrease in borrow demand, particularly in specials, during the summer and autumn. However, as valuations entered a downtrend in Q2, the demand for emerging markets soared with total borrow balances reaching a post-crisis peak in June. It was the best year ever for emerging market equity lending, delivering over $1 billion in revenue for the first time. It was also a banner year for lending exchange-traded funds (ETFs), which delivered $398 million in 2018 revenue, an increase of 15 percent compared with 2017 and the best year on record. Overall, it was the best year since the financial crisis with total securities lending revenue coming in at $10.7 billion last year.
Equities
Asia was the bright spot for equity lending, with demand for emerging market equities surging along with increasing demand for shares of Japanese firms. Revenues in North America were held back by a lack of specials demand, however, there was one bright spot discussed below. Overall equity lending revenues were $8.2 billion last year, which includes all ETFs and American depository receipts.
The uptrend in revenues for Japanese equities extended through 2018, with each quarter reflecting an improvement over its 2017 comparable, for a total of $878 million. The rate of increase is slowing, however, as the 23 percent year-on-year improvement in revenues was lower than the prior two years. Specials demand was consistently in the $3 billion to $4 billion range through the first three quarters before tapering off to $2.7 billion in December.
Demand for Hong Kong equities was robust, and the $388 million in 2018 revenues are equivalent to an increase of 24 percent compared with 2017, as demand for shares of Chinese firms soared, reaching a post-crisis peak of $34 billion in early June.
Revenues for South Korea reached a post-crisis peak with Celltrion delivering 23 percent of the country’s $483 million in revenue. Shares of Celltrion rallied in 2017, which led to declining borrow demand and fees. Last year represented a return to form, coming off the back of 2014 to 2016 when the firm delivered more than 30 percent of all revenues for South Korean equities.
Revenues for the Americas were subdued by a lack of specials demand and challenging returns for short sellers. Total revenues declined 3 percent year-on-year to $3.1 billion. Cannabis was the hot sector for region in 2018, delivering $230 million in lending revenue, up from $106 million in 2017. That is equivalent to 7.4 percent of all North America equity lending revenue. The top stocks were Tilray, Canopy Growth, Aurora Cannabis and Aphria, which combined for $177 million of the total revenue. The sector is likely to deliver again this year, as Canada moves closer to full legalisation of Cannabis derivatives along with more retail coming online, the lure of which will likely continue to attract investors on the long and short side. Tilray was the standout from a revenue perspective, delivering $59 million in revenue in less than half the year as the result of eye-popping fees.
At the mid-point of last year, Tesla appeared as a golden egg-laying goose, with the equity lending fee in the 200 to 300 basis points range on a balance greater than $10 billion, while the 5.3 percent 2025 bond was among the most revenue generating corporate issues. The firm’s Q2 and Q3 earnings reports failed to produce a lasting decline in valuations, which resulted in lower fees and borrow demand across the capital structure in the latter half of 2018. Given the volatility of the equity shares, whose price chart bore some resemblance to a cardiograph, long holders who stuck around for the 7 percent 2018 return could be said to have earned it. The road ahead for the firm, and borrow demand for its securities, is anything but certain: Tesla investors, and drivers, are reminded to keep both hands on the wheel at all times in 2019.
European equities delivered $2.1 billion in 2018 revenue, an improvement of 13 percent compared with 2017, though still 5 percent below 2016’s total. Balances and revenues improved relative to 2017 for the first three quarters before balances fell with the broader market in Q4 as new demand failed to materialise. Popular themes for borrow demand included consumer stocks, particularly retailers. EU special balances averaged between $2.5 to $3 billion, with the Spanish equities seeing the largest increase in specials balances during last year.
Corporate bonds
Borrow demand for corporate debt also increased throughout 2018, with increased demand for IG USD credits the most notable change in the first half of 2018, with an increase in demand for Euro credits notable in H2. Total revenue for corporate bond lending revenue reached $733 million last year, the highest level recorded since at least 2006.
Given the scale of outstanding debt, it is unsurprising that USD denominated corporate issues delivered the most revenue for the asset class last year, $436 million in total, an increase of 8 percent compared with 2017. However, it is notable that Euro-denominated issues posted the largest increase, both in percentage and absolute terms, with total revenues coming in at $186 million, a 40 percent year-over-year increase. Breaking returns out by credit rating, non-investment grade bonds delivered 63 billion of all revenue, up from 61 percent in 2017. The Q4 average corporate on-loan balances were $198 billion, the highest on record, as credit spreads widened amid the global sell-off. The broad global increase in demand augurs well for lending opportunities in the asset class for 2019.
Government bonds
The demand for government bonds was robust, however, the uptrend lost momentum, with a 10 percent increase in average balances for last year compared with 2017 (which had bettered 2016’s average by 30 percent). Average fees also increased, driving $730 in total revenue for 2018, an increase of 13 percent year-over-year. There was an upswing in demand for Italian government debt, which delivered $51 million in 2018 revenue, the highest level recorded. Emerging market government bond loan balances were up 11 percent in 2018 to $17.7 billion, however lower fees had a depressing impact on revenues. There was a spike in fees for US treasuries into the last days of the year, however, the impact was much smaller than at year-end 2016.
Wrap up
After 2017, a year best defined by low volatility, 2018 was a marked divergence—a benefit for asset owners that securities lending revenues delivered the best post-crisis return. By way of comparison, total revenues for 2008 were $13.2 billion, but not having to go through a financial crisis to achieve last year’s $10.7 billion seems a fair tradeoff. The average global revenues over the last 10 years have been $8.8 billion and the trend higher over the last two years has primarily been driven by increases in Asia and government bond demand.
The road ahead looks bright, with demand trending higher on the margin for US specials at the end of the year, while demand for emerging markets equities remains stable, despite declining valuations and corporate bond demand is trending higher. The rate of increase for Asia and government bond lending revenues is slowing, however, both still boasted impressive growth last year. On the heels of the best annual lending revenue since 2008, there’s cause for optimism looking ahead. Many of the demand drivers for last year are at least as relevant coming into the new year, which should make for a fruitful set of opportunities for this year.
Emerging market demand, global credit uncertainty and central bank tightening were the primary drivers of revenue for securities lending last year. These narratives included trade conflicts, the potential turning of the credit cycle and the coordinated effort to reverse quantitative easing and increase rates. The US market diverged from other equity markets in the middle of the year, resulting in pain for US short sellers, as well as a decrease in borrow demand, particularly in specials, during the summer and autumn. However, as valuations entered a downtrend in Q2, the demand for emerging markets soared with total borrow balances reaching a post-crisis peak in June. It was the best year ever for emerging market equity lending, delivering over $1 billion in revenue for the first time. It was also a banner year for lending exchange-traded funds (ETFs), which delivered $398 million in 2018 revenue, an increase of 15 percent compared with 2017 and the best year on record. Overall, it was the best year since the financial crisis with total securities lending revenue coming in at $10.7 billion last year.
Equities
Asia was the bright spot for equity lending, with demand for emerging market equities surging along with increasing demand for shares of Japanese firms. Revenues in North America were held back by a lack of specials demand, however, there was one bright spot discussed below. Overall equity lending revenues were $8.2 billion last year, which includes all ETFs and American depository receipts.
The uptrend in revenues for Japanese equities extended through 2018, with each quarter reflecting an improvement over its 2017 comparable, for a total of $878 million. The rate of increase is slowing, however, as the 23 percent year-on-year improvement in revenues was lower than the prior two years. Specials demand was consistently in the $3 billion to $4 billion range through the first three quarters before tapering off to $2.7 billion in December.
Demand for Hong Kong equities was robust, and the $388 million in 2018 revenues are equivalent to an increase of 24 percent compared with 2017, as demand for shares of Chinese firms soared, reaching a post-crisis peak of $34 billion in early June.
Revenues for South Korea reached a post-crisis peak with Celltrion delivering 23 percent of the country’s $483 million in revenue. Shares of Celltrion rallied in 2017, which led to declining borrow demand and fees. Last year represented a return to form, coming off the back of 2014 to 2016 when the firm delivered more than 30 percent of all revenues for South Korean equities.
Revenues for the Americas were subdued by a lack of specials demand and challenging returns for short sellers. Total revenues declined 3 percent year-on-year to $3.1 billion. Cannabis was the hot sector for region in 2018, delivering $230 million in lending revenue, up from $106 million in 2017. That is equivalent to 7.4 percent of all North America equity lending revenue. The top stocks were Tilray, Canopy Growth, Aurora Cannabis and Aphria, which combined for $177 million of the total revenue. The sector is likely to deliver again this year, as Canada moves closer to full legalisation of Cannabis derivatives along with more retail coming online, the lure of which will likely continue to attract investors on the long and short side. Tilray was the standout from a revenue perspective, delivering $59 million in revenue in less than half the year as the result of eye-popping fees.
At the mid-point of last year, Tesla appeared as a golden egg-laying goose, with the equity lending fee in the 200 to 300 basis points range on a balance greater than $10 billion, while the 5.3 percent 2025 bond was among the most revenue generating corporate issues. The firm’s Q2 and Q3 earnings reports failed to produce a lasting decline in valuations, which resulted in lower fees and borrow demand across the capital structure in the latter half of 2018. Given the volatility of the equity shares, whose price chart bore some resemblance to a cardiograph, long holders who stuck around for the 7 percent 2018 return could be said to have earned it. The road ahead for the firm, and borrow demand for its securities, is anything but certain: Tesla investors, and drivers, are reminded to keep both hands on the wheel at all times in 2019.
European equities delivered $2.1 billion in 2018 revenue, an improvement of 13 percent compared with 2017, though still 5 percent below 2016’s total. Balances and revenues improved relative to 2017 for the first three quarters before balances fell with the broader market in Q4 as new demand failed to materialise. Popular themes for borrow demand included consumer stocks, particularly retailers. EU special balances averaged between $2.5 to $3 billion, with the Spanish equities seeing the largest increase in specials balances during last year.
Corporate bonds
Borrow demand for corporate debt also increased throughout 2018, with increased demand for IG USD credits the most notable change in the first half of 2018, with an increase in demand for Euro credits notable in H2. Total revenue for corporate bond lending revenue reached $733 million last year, the highest level recorded since at least 2006.
Given the scale of outstanding debt, it is unsurprising that USD denominated corporate issues delivered the most revenue for the asset class last year, $436 million in total, an increase of 8 percent compared with 2017. However, it is notable that Euro-denominated issues posted the largest increase, both in percentage and absolute terms, with total revenues coming in at $186 million, a 40 percent year-over-year increase. Breaking returns out by credit rating, non-investment grade bonds delivered 63 billion of all revenue, up from 61 percent in 2017. The Q4 average corporate on-loan balances were $198 billion, the highest on record, as credit spreads widened amid the global sell-off. The broad global increase in demand augurs well for lending opportunities in the asset class for 2019.
Government bonds
The demand for government bonds was robust, however, the uptrend lost momentum, with a 10 percent increase in average balances for last year compared with 2017 (which had bettered 2016’s average by 30 percent). Average fees also increased, driving $730 in total revenue for 2018, an increase of 13 percent year-over-year. There was an upswing in demand for Italian government debt, which delivered $51 million in 2018 revenue, the highest level recorded. Emerging market government bond loan balances were up 11 percent in 2018 to $17.7 billion, however lower fees had a depressing impact on revenues. There was a spike in fees for US treasuries into the last days of the year, however, the impact was much smaller than at year-end 2016.
Wrap up
After 2017, a year best defined by low volatility, 2018 was a marked divergence—a benefit for asset owners that securities lending revenues delivered the best post-crisis return. By way of comparison, total revenues for 2008 were $13.2 billion, but not having to go through a financial crisis to achieve last year’s $10.7 billion seems a fair tradeoff. The average global revenues over the last 10 years have been $8.8 billion and the trend higher over the last two years has primarily been driven by increases in Asia and government bond demand.
The road ahead looks bright, with demand trending higher on the margin for US specials at the end of the year, while demand for emerging markets equities remains stable, despite declining valuations and corporate bond demand is trending higher. The rate of increase for Asia and government bond lending revenues is slowing, however, both still boasted impressive growth last year. On the heels of the best annual lending revenue since 2008, there’s cause for optimism looking ahead. Many of the demand drivers for last year are at least as relevant coming into the new year, which should make for a fruitful set of opportunities for this year.
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100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
