Japan: Opportunities and risks
18 February 2020
Japan is not a new market but it represents a wealth of untapped opportunities for those seeking a specials-driven securities lending arena
Image: Shutterstock
March 2020 was to mark the 17th annual conference on Asian securities lending by the Pan Asia Securities Lending Association and the Risk Management Association, but sadly, this was not to be.
Due to the World Health Organization declaring the coronavirus outbreak a global emergency, the event will now be held in Tokyo, Japan in 2021. In an increasingly risk-averse world, this seems like an eminently sensible decision – and so, the rest of the world’s markets have been forced to wait another year to gain some valuable exposure to the fascinating market that is Japan.
Japan cannot be described as a “new market” by any stretch of the imagination, but that certainly does not mean the market is devoid of opportunity. There is more to securities lending activity in the world’s third-largest economy than the recent decision of the Government Pension Investment Fund (GPIF) to cease lending – a move that has gained a significant amount of attention and provoked some heated debates on the pros and cons of securities lending and its association with short selling. It should be remembered that this decision only affected the overseas equity holdings of the GPIF; domestic equities were not being lent by the fund prior to this decision.
Looking at the nation’s market overall, there is a significant gap between Japan and the world’s two largest economies. By GDP, Japan is a little more than one-third the size of China, the next largest economy, and less than one quarter of the largest, the US. Statistics for the securities lending market show an even greater mismatch.
Based on a snapshot of activity, Japan has just 16 percent of the total number of active securities compared with the US. In terms of balances, Japan is just 6 percent of the size of the US, or about 1/16, and less than 4 percent, or 1/25, of the global market volume overall. However, despite the market appearing to punch below its weight in terms of active securities and balances, it does appear to outperform in returns. Recent statistics show Japanese equities demanding a weighted average intrinsic fee of 85bps from borrowers, whereas US equities were generating rates of just over 61bps. Figure one shows this same comparison over time, indexed to the fourth quarter of 2015, but against global equities rather than just the US.
The plot lines show two general trends of note: first, Japanese equities show greater volatility and are somewhat more prone to spikes than the rest of the world, although it is recognised that the larger sample will be dampened, relatively speaking, as a result of a much greater diversity of securities. Second, since the middle of 2017 at least, the intrinsic loan rates achieved by Japanese equities outpaced global equities on all but a few occasions.
This higher fee average concentrated on a small set of securities would tend to support the notion that Japan is a market dominated by ‘specials’, rather than general collateral (GC) activity. While there may be crowding, risks associated with the size of the market, the rates would certainly appear attractive to those that can lend into that space, especially if they are seeking higher intrinsic rates and avoiding the lower returning GC business. Figure two shows the total on-loan balances, again indexed to October 2015. The plot lines for Japanese equities versus global equities excluding Asia reflects the same spikes in volumes characteristic of a more volatile specials-driven market.
From a regulatory standpoint, there have been several moves recently to review the securities lending market in Japan, including around transparency. The Tokyo Stock Exchange has suggested that sharing the short selling data it holds could help investors gain trading opportunities and understand the short selling market better. This approach, suggesting that short selling data can help investors make better-informed decisions, could be viewed as contrary to the position of GPIF, which would certainly seem to be against short selling in any situation.
However, concerns around the opacity of the market would have been likely increased by the recent publicity surrounding the actions of GPIF. As the world’s largest pension fund, at some $1.4 trillion of assets, its decision certainly carries some weight, but given the levels of supply globally, the direct effects, and therefore any intended curtailment of short selling in assets it holds, may be less than hoped for.
What is more important is the indirect effect, as other asset managers are prompted to consider their own strategies considering GPIF’s action. A quick search on the internet around this issue returns a multitude of articles and comments from analyst and funds responding to GPIF’s action. This is not an isolated event, of course. This action is, according to GPIF, directly related to the desire to comply with the fund’s environmental, social and governance (ESG) objectives, and is part of a wider change in the tone of the markets globally. Recently, the International Securities Lending Association founded its Council for Sustainable Finance and, on 6 February, the European Securities and Markets Authority (ESMA) issued its Strategy on Sustainable Finance. ESMA is aiming to undertake its regulatory and supervisory roles under the umbrella of its sustainable finance objectives. These objectives include increased transparency, analysis of the financial risks of climate change and reporting on the risks of investing in green bonds and other ESG-compliant products, among many others.
Given that ESMA’s remit stretches right across the investment chain from issuers to investors, it seems likely that the securities finance industry will come in for yet more analysis and action. SFTR will surely bring about a significant increase in transparency across the securities finance market, but the question remains as to what that data will be used for and how that might combine with the rollout of ESG objectives aimed at improving the sustainability of finance.
Figure 1
Figure 2
Due to the World Health Organization declaring the coronavirus outbreak a global emergency, the event will now be held in Tokyo, Japan in 2021. In an increasingly risk-averse world, this seems like an eminently sensible decision – and so, the rest of the world’s markets have been forced to wait another year to gain some valuable exposure to the fascinating market that is Japan.
Japan cannot be described as a “new market” by any stretch of the imagination, but that certainly does not mean the market is devoid of opportunity. There is more to securities lending activity in the world’s third-largest economy than the recent decision of the Government Pension Investment Fund (GPIF) to cease lending – a move that has gained a significant amount of attention and provoked some heated debates on the pros and cons of securities lending and its association with short selling. It should be remembered that this decision only affected the overseas equity holdings of the GPIF; domestic equities were not being lent by the fund prior to this decision.
Looking at the nation’s market overall, there is a significant gap between Japan and the world’s two largest economies. By GDP, Japan is a little more than one-third the size of China, the next largest economy, and less than one quarter of the largest, the US. Statistics for the securities lending market show an even greater mismatch.
Based on a snapshot of activity, Japan has just 16 percent of the total number of active securities compared with the US. In terms of balances, Japan is just 6 percent of the size of the US, or about 1/16, and less than 4 percent, or 1/25, of the global market volume overall. However, despite the market appearing to punch below its weight in terms of active securities and balances, it does appear to outperform in returns. Recent statistics show Japanese equities demanding a weighted average intrinsic fee of 85bps from borrowers, whereas US equities were generating rates of just over 61bps. Figure one shows this same comparison over time, indexed to the fourth quarter of 2015, but against global equities rather than just the US.
The plot lines show two general trends of note: first, Japanese equities show greater volatility and are somewhat more prone to spikes than the rest of the world, although it is recognised that the larger sample will be dampened, relatively speaking, as a result of a much greater diversity of securities. Second, since the middle of 2017 at least, the intrinsic loan rates achieved by Japanese equities outpaced global equities on all but a few occasions.
This higher fee average concentrated on a small set of securities would tend to support the notion that Japan is a market dominated by ‘specials’, rather than general collateral (GC) activity. While there may be crowding, risks associated with the size of the market, the rates would certainly appear attractive to those that can lend into that space, especially if they are seeking higher intrinsic rates and avoiding the lower returning GC business. Figure two shows the total on-loan balances, again indexed to October 2015. The plot lines for Japanese equities versus global equities excluding Asia reflects the same spikes in volumes characteristic of a more volatile specials-driven market.
From a regulatory standpoint, there have been several moves recently to review the securities lending market in Japan, including around transparency. The Tokyo Stock Exchange has suggested that sharing the short selling data it holds could help investors gain trading opportunities and understand the short selling market better. This approach, suggesting that short selling data can help investors make better-informed decisions, could be viewed as contrary to the position of GPIF, which would certainly seem to be against short selling in any situation.
However, concerns around the opacity of the market would have been likely increased by the recent publicity surrounding the actions of GPIF. As the world’s largest pension fund, at some $1.4 trillion of assets, its decision certainly carries some weight, but given the levels of supply globally, the direct effects, and therefore any intended curtailment of short selling in assets it holds, may be less than hoped for.
What is more important is the indirect effect, as other asset managers are prompted to consider their own strategies considering GPIF’s action. A quick search on the internet around this issue returns a multitude of articles and comments from analyst and funds responding to GPIF’s action. This is not an isolated event, of course. This action is, according to GPIF, directly related to the desire to comply with the fund’s environmental, social and governance (ESG) objectives, and is part of a wider change in the tone of the markets globally. Recently, the International Securities Lending Association founded its Council for Sustainable Finance and, on 6 February, the European Securities and Markets Authority (ESMA) issued its Strategy on Sustainable Finance. ESMA is aiming to undertake its regulatory and supervisory roles under the umbrella of its sustainable finance objectives. These objectives include increased transparency, analysis of the financial risks of climate change and reporting on the risks of investing in green bonds and other ESG-compliant products, among many others.
Given that ESMA’s remit stretches right across the investment chain from issuers to investors, it seems likely that the securities finance industry will come in for yet more analysis and action. SFTR will surely bring about a significant increase in transparency across the securities finance market, but the question remains as to what that data will be used for and how that might combine with the rollout of ESG objectives aimed at improving the sustainability of finance.
Figure 1
Figure 2
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