In recent years, we have seen new beneficial owners coming to market with greater appreciation for securities lending programs. What’s in the cards for them as the landscape evolves?
By lending securities to selected parties, asset owners and investment managers can get exposure to a relatively low risk product to potentially generate extra returns on their portfolio. While securities lending can be used to offset custody costs and generate additional liquidity, most lenders use it primarily as a yield play. An effective securities lending program will consider the beneficial owner’s risk and return objectives in determining the loan type, distribution model and collateral options.
“In securities lending, only a certain percentage of securities are capable of generating decent revenue, so a targeted approach is warranted. It used to be that beneficial owners would evaluate borrowers and select who to lend to, but the opposite is now more often true, with borrowers looking more closely at the jurisdiction and asset composition of the lender as well as other aspects of the securities lending program they are offering,” said Paul Solway, Head of Securities Finance, Asia Pacific at BNY Mellon Markets.
Beneficial owners need to consider how to structure their loans, working via a central counterparty, agency or acting as principal facing counterparties directly. They also have to decide whether the loan should be on overnight, open or term basis. If the latter, various structures are possible: ‘bullet’ lending for a fixed term or ‘evergreen’ contracts that automatically reset at predetermined intervals. Extendable structures are becoming more popular. The loaned securities’ asset class—equity, fixed income or both—also comes into play as well as the collateral that is accepted.
While the US remains the world’s largest equities market, prime brokers and agent lenders have welcomed the opening up of new markets in Asia for securities lending since the turn of the century: first Korea, then Taiwan and more recently Malaysia. Asia is seen as the engine of global demand, a region that continue to grow in corporate and economic activity. With the newer rules and regulations in Asia's emerging markets, Asian equity owners have become more comfortable with lending securities. (Figure 1)
Figure 1: $2.16 billion Global Revenue in Securities Lending in Q1 2019
The partial-open markets of China and India do not yet allow offshore lenders to take advantage of opportunities there, though this could be changing with developments such as China’s recent move to allow certain domestic funds to lend stocks to brokers via the state-owned China Securities Finance Corporation, which signals the start of something new.
Fixed-income securities lending is growing globally, alongside a relative drop in equity lending, as banking regulations encourage institutions to hold more high-quality liquid assets (HQLA). Government bonds, US Treasuries, Japanese Government Bonds and Australia’s Commonwealth Government Securities are all being actively sought after. Stricter liquidity rules also encourage longer term borrowing, with evergreen and fixed-term loans both on the rise and less on overnight lending. (Figure 2)
“Economists argue that collateral scarcity is not the issue, but rather that HQLA is being held in the wrong place. Securities lending corrects this by bringing the high-quality layer around on a temporary basis,” Mr. Solway said.
Figure 2: Value of loans in Equities and Fixed Income (June 2015-July 2019)
From a securities lending perspective, efficiency and transparency are paramount: technology can contribute to an error-free trade and help meet more arduous regulatory requirements.
“There’s a lot of focus on lifecycle efficiency that automation can bring. Data and technology can also drive risk mitigation, replacing person-to-person communications with machine-to-machine communications which greatly reduces issues downstream,” said Andrew McCardle, Head of EquiLend Asia, which offers securities finance trading, market data and clearing services across the region.
Another key factor is that beneficial owners, prime brokers and agent lenders today have access to a level of data that would have been impossible five years ago—and at volumes that are daunting even with modern data management tools—but the data required by each user group varies.
“The fundamental issue with data is how to use it. There is no perfect source of data that can identify the best decision with one simple calculation; there are only datasets that can be interpreted to discern information. It is up to us in the industry to educate people on what data shows and help them understand what they want their data to do,” Mr. McCardle continued.
New technology breakthroughs, like artificial intelligence, distributed ledgers and blockchain, have huge potential, but the time to market for such attention-grabbing technology is far longer than the current buzz suggests.
As the securities lending space in Asia evolves, the role of intermediaries will inevitably change. Two major trends are reshaping the product: the better use of data enabling greater transparency to examine liquidity verses return; and the disparity between Asia’s nine active markets, Japan, Hong Kong, Singapore, Korea, Taiwan, Thailand, Malaysia, Australia, New Zealand which means buy-side firms have to build underlying systems and workflows that allow them to adapt to market differences; and as a consequence they may also consider a more proactive program managed by themselves.
Ultimately, it all comes down to risk versus reward. Some institutions are not lending because they consider it to be too risky; others would argue that they need securities lending to stay ahead of the curve. The classic approach retains its value: build a diverse and balanced lending portfolio by drawing on custodial expertise and using technology with the right operational controls, compliance systems and reporting access in place. Get the basics right – walk before you run!
The views expressed herein include external speaker and may not reflect the views of BNY Mellon. This does not constitute legal, tax, accounting, investment, financial or other professional advice on any matter and does not constitute a recommendation by BNY Mellon of any kind.
Any references to dollars are to US dollars unless specified otherwise.
This material may not be reproduced or disseminated in any form without the prior written permission of BNY Mellon. Trademarks, logos and other intellectual property marks belong to their respective owners.
Neither BNY Mellon nor any of its respective officers, employees or agents are, by virtue of providing the materials or information contained herein, acting as an adviser to any recipient (including a “municipal advisor” within the meaning of Section 15B of the Securities Exchange Act of 1934, as amended, “Section 15B”), do not owe a fiduciary duty to the recipient hereof pursuant to Section 15B or otherwise, and are acting only for their own interests.
The Bank of New York Mellon, member of the Federal Deposit Insurance Corporation (FDIC).
Asset Servicing Global Disclosure
©2019 The Bank of New York Mellon Corporation.
Head of Securities Finance, Asia Pacific
Paul is Head of Securities Finance, Asia Pacific, within BNY Mellon’s Markets. Reporting to the Global Head of Agency Lending, he is responsible for the oversight of trading and risk of Securities Lending and Financing across Asia. In his role, Paul also has responsibility for coordinating and liaising within Markets, to leverage BNY Mellon’s global products and relationships in order to enhance Securities Lending and Financing revenues for our clients.View Profile