Securities lending 2019 snapshot
07 January 2020
IHS Markit’s Sam Pierson breaks down the highs and lows of global lending revenues last year
Image: Shutterstock
It is neither the best nor the worst of times for securities lending, which means there is the opportunity for movement in either direction as we look ahead to 2020. Before we turn the page, however, we review the year that was 2019. At the end of 2018, things looked rather bleak for capital markets and securities lending revenues were soft given the decline in asset values which reduced loan balances.
That makes Q4 2018 a relatively easy year-over-year (YoY) comparison, which Q4 2019 improved on by 3.8 percent with $2.4 billion in revenues. That put the total for 2019 at $10.1 billion, a decline of 6.3 percent relative to 2018 (see figure 1), while the yearly revenue comparison is less favourable, the underperformance was primarily concentrated in the first half of the year.
It was a mixed year, to say the least, for equity lending revenues. North American equities were the stand-out, led by recent initial public offerings (IPOs) and cannabis-related firms. The impact of cannabis was such that 2019 was the best year on record for Canada equity lending, with revenues jumping 30 percent YoY. That joy was not widely distributed – excluding the impact of cannabis Canada equity, revenue was down 25 percent YoY. In the US, revenues were similarly concentrated in relatively few equities, which really didn’t take off until Q3.
For the first half of the year, US equity revenue was down 18 percent, however, based on surging fees for Beyond Meat and some other recent IPOs in Q3, revenues were up 11 percent for the year. The YoY outperformance for North America equities was greater in Q4 than in Q3 (49 percent versus 43 percent respectively), however, that was owing to the easy comparison in Q4 as North America equity revenues fell 14 percent sequentially. It’s also important to note the significance of corporate action related trades, particularly exchange offers. In Q1, the Eli Lilly exchange offer made LLY shares the most revenue generating for the quarter. In Q4, Danaher Corp was the most revenue-generating US equity (see figure 2) as a result of its exchange offer for shares of Envista.
It was a challenging year for deriving lending revenue from EU equities, with each quarter seeing a YoY decline and the total revenue of $1.7 billion reflecting a 20 percent YoY decline. That makes 2019 the lowest revenue observed for EU equities in the last decade. There were some opportunities to generate significant lending returns such as Casino Guichard in France and a few UK firms relating to concern over Brexit. The overall trend was toward lower balances, down 17 percent YoY, as well as lower fees, down 3 percent YoY.
Asia equity lending revenues declined by 8.7 percent YoY, with only Q1 posting gains relative to 2018. The general theme was decreased hard to borrow loan balances in emerging markets set against increasing balances in the lower fee developed markets, most notably Japan but also including Australia. One stand-out against the broader trend was South Korean pharmaceutical firm HLB, which delivered $38 million in Q4 revenues as the share price and lending fees surged while shares on loan remained constant. South Korean equity revenues increased 4.4 percent YoY to $130 million, of which 29 percent was from lending shares of HLB.
Corporate bond lending revenues continue the slide from the post-crisis peak in Q2 2018. That comes mainly as the result of lower fees as balances were essentially flat YoY, down 0.7 percent, while fees declined 17 percent. There were some opportunities to generate lending returns, for example, the energy and opioid-related issuers. However, the strong performance of the credit market and increase in lendable assets kept a lid on overall revenues. The $604 million in corporate bond lending revenues reflects a decline of 17 percent YoY, though it’s worth noting that 2018 was the best year on record, with 2017 and then 2019 ranking second and third most, respectively.
Government bond lending revenues continued the slide from post-crisis peak revenues in Q1 2018. The narrative in the latter portion of 2019 concerned more about the funding of long positions in a function similar to the repo market. The spike in UST repo funding costs on 17 September spilled over into securities lending, as the rebate for cash collateralised funding transactions increased to more than 400bps. Subsequent accommodation by the Federal Reserve precluded similar funding stress at year-end. With increased issuance of US treasuries and increased holdings on broker-dealer balance sheets, the need to borrow in high-quality liquidity assets has declined, putting pressure on revenues from traditional securities loans. US government bond lending revenues fell by 20 percent YoY, with ex-US government bond revenues falling 21 percent.
Conclusion:
Part of the narrative in recent years has been the push towards efficiency on the part of broker-dealers, which has resulted in greater amounts of broker-to-broker loans and internalised borrows.
There has also been an increased presence on the part of retail brokers, in part the result of fully paid lending programmes for retail investors gaining popularity. These sources of lendable assets have reduced the demand for the traditional agency lending model; we see revenues from agency lending down 12.6 percent YoY in 2019. These additional sources of borrow have added market share, howev, the majority of securities loans still come through the agency pipeline. The pressure on agency utilisations, along with a mandated lack of collateral flexibility for some beneficial owners, has caused a general shift in focus toward intrinsic value lending. The resulting increase in fee level and volatility for hard to borrow securities has, in turn, challenged borrowers. Hedge fund frustration with borrow cost variability has led to greater use of synthetic products. In theory, those products would be hedged in the underlying, although, there is also the possibility of hedging synthetically. A consideration of securities lending revenues is therefore incomplete if it excludes the growing alternative sources of lending revenue.
With the opportunities and challenges of 2019 in the rearview, the future looks bright for securities lending. There has been an emerging dialogue on corporate governance which is vital to beneficial owners, though it’s worth noting that agents have actively managed lendable assets around corporate action record dates over the last decade per academic research, so it’s still important, but not new.
The increase in lendable assets continues, largely as the result of asset appreciation though there has also been a consistent increase in accounts reporting to IHS Markit since the low point in 2013. From 2008, the high point in securities lending revenue, to the low point in 2010, and up to the present much has changed and yet the core remains: The generation of lending revenues by beneficial owners, the funding of securities by asset owners and the provision of borrow to short sellers. Here’s to another decade of growth and prosperity for all capital market participants!
Figure 1
Figure 2
That makes Q4 2018 a relatively easy year-over-year (YoY) comparison, which Q4 2019 improved on by 3.8 percent with $2.4 billion in revenues. That put the total for 2019 at $10.1 billion, a decline of 6.3 percent relative to 2018 (see figure 1), while the yearly revenue comparison is less favourable, the underperformance was primarily concentrated in the first half of the year.
It was a mixed year, to say the least, for equity lending revenues. North American equities were the stand-out, led by recent initial public offerings (IPOs) and cannabis-related firms. The impact of cannabis was such that 2019 was the best year on record for Canada equity lending, with revenues jumping 30 percent YoY. That joy was not widely distributed – excluding the impact of cannabis Canada equity, revenue was down 25 percent YoY. In the US, revenues were similarly concentrated in relatively few equities, which really didn’t take off until Q3.
For the first half of the year, US equity revenue was down 18 percent, however, based on surging fees for Beyond Meat and some other recent IPOs in Q3, revenues were up 11 percent for the year. The YoY outperformance for North America equities was greater in Q4 than in Q3 (49 percent versus 43 percent respectively), however, that was owing to the easy comparison in Q4 as North America equity revenues fell 14 percent sequentially. It’s also important to note the significance of corporate action related trades, particularly exchange offers. In Q1, the Eli Lilly exchange offer made LLY shares the most revenue generating for the quarter. In Q4, Danaher Corp was the most revenue-generating US equity (see figure 2) as a result of its exchange offer for shares of Envista.
It was a challenging year for deriving lending revenue from EU equities, with each quarter seeing a YoY decline and the total revenue of $1.7 billion reflecting a 20 percent YoY decline. That makes 2019 the lowest revenue observed for EU equities in the last decade. There were some opportunities to generate significant lending returns such as Casino Guichard in France and a few UK firms relating to concern over Brexit. The overall trend was toward lower balances, down 17 percent YoY, as well as lower fees, down 3 percent YoY.
Asia equity lending revenues declined by 8.7 percent YoY, with only Q1 posting gains relative to 2018. The general theme was decreased hard to borrow loan balances in emerging markets set against increasing balances in the lower fee developed markets, most notably Japan but also including Australia. One stand-out against the broader trend was South Korean pharmaceutical firm HLB, which delivered $38 million in Q4 revenues as the share price and lending fees surged while shares on loan remained constant. South Korean equity revenues increased 4.4 percent YoY to $130 million, of which 29 percent was from lending shares of HLB.
Corporate bond lending revenues continue the slide from the post-crisis peak in Q2 2018. That comes mainly as the result of lower fees as balances were essentially flat YoY, down 0.7 percent, while fees declined 17 percent. There were some opportunities to generate lending returns, for example, the energy and opioid-related issuers. However, the strong performance of the credit market and increase in lendable assets kept a lid on overall revenues. The $604 million in corporate bond lending revenues reflects a decline of 17 percent YoY, though it’s worth noting that 2018 was the best year on record, with 2017 and then 2019 ranking second and third most, respectively.
Government bond lending revenues continued the slide from post-crisis peak revenues in Q1 2018. The narrative in the latter portion of 2019 concerned more about the funding of long positions in a function similar to the repo market. The spike in UST repo funding costs on 17 September spilled over into securities lending, as the rebate for cash collateralised funding transactions increased to more than 400bps. Subsequent accommodation by the Federal Reserve precluded similar funding stress at year-end. With increased issuance of US treasuries and increased holdings on broker-dealer balance sheets, the need to borrow in high-quality liquidity assets has declined, putting pressure on revenues from traditional securities loans. US government bond lending revenues fell by 20 percent YoY, with ex-US government bond revenues falling 21 percent.
Conclusion:
Part of the narrative in recent years has been the push towards efficiency on the part of broker-dealers, which has resulted in greater amounts of broker-to-broker loans and internalised borrows.
There has also been an increased presence on the part of retail brokers, in part the result of fully paid lending programmes for retail investors gaining popularity. These sources of lendable assets have reduced the demand for the traditional agency lending model; we see revenues from agency lending down 12.6 percent YoY in 2019. These additional sources of borrow have added market share, howev, the majority of securities loans still come through the agency pipeline. The pressure on agency utilisations, along with a mandated lack of collateral flexibility for some beneficial owners, has caused a general shift in focus toward intrinsic value lending. The resulting increase in fee level and volatility for hard to borrow securities has, in turn, challenged borrowers. Hedge fund frustration with borrow cost variability has led to greater use of synthetic products. In theory, those products would be hedged in the underlying, although, there is also the possibility of hedging synthetically. A consideration of securities lending revenues is therefore incomplete if it excludes the growing alternative sources of lending revenue.
With the opportunities and challenges of 2019 in the rearview, the future looks bright for securities lending. There has been an emerging dialogue on corporate governance which is vital to beneficial owners, though it’s worth noting that agents have actively managed lendable assets around corporate action record dates over the last decade per academic research, so it’s still important, but not new.
The increase in lendable assets continues, largely as the result of asset appreciation though there has also been a consistent increase in accounts reporting to IHS Markit since the low point in 2013. From 2008, the high point in securities lending revenue, to the low point in 2010, and up to the present much has changed and yet the core remains: The generation of lending revenues by beneficial owners, the funding of securities by asset owners and the provision of borrow to short sellers. Here’s to another decade of growth and prosperity for all capital market participants!
Figure 1
Figure 2
NO FEE, NO RISK
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
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
