Asia
16 February 2016
A difficult end to 2015 has not deterred securities borrowers and lenders in Asia, where certain markets enjoyed significant growth and offered new opportunities
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The Asian market had a volatile year in 2015. How has the securities lending industry fared?
Madalin Prout: Based on data from FIS’s Astec Analytics, 2015 was a particularly flat year for securities lending in the majority of the Asian markets, despite the market volatility. The majority of developed markets finished the year with volumes on loan either flat or slightly down on where they started, with Japan and Singapore being the exceptions. Three names stand out as notable trades in 2015—Hanergy Thin Film Power Group, Samsung C&T and Celltrion Inc—together accounting for nearly 20 percent of the 2015 securities lending revenues generated from Asian securities.
Andrew McCardle: The first half of the year was a good year for Asia with there being a lot of profit to be made in a few securities in particular. The year started with the outlook for China being very positive, and the PASLA conference in Shanghai was very informative. Then, in the middle of the year with markets moving as they did, China was no longer as far forward as it had looked. One particular revenue-driving security, 566 HK, also hit a difficult patch as the stock was suspended by the Hong Kong exchange.
David Raccat: The securities lending industry did well, and better than other regions in terms of growth. According to Markit data, revenues from securities lending activity in Asia were up 21 percent year on year to a record $672 million in fees. That number is small when compared to other markets such as the US ($4.2 billion), but when you look at growth and then further potential, the Asian region is key. Hong Kong continues to be a strong performer with continued corporate activity, but South Korea has again returned to the top of the table and we have noticed a strong increase in this market.
Dane Fannin: The Asian securities lending market still appears to dominate others in the region. In particular, the Hong Kong equity lending market continued to be an important revenue stream for clients, given exposure to China via the dual listed H-shares listed on the Hang Seng index, which created arbitrage opportunities.
Over time, there has been a shift in risk appetite with the market volatility caused by uncertainty over the Chinese economy, lowering demand for these securities. However, these Hong Kong equity lending market impacts were offset by increased demand in other jurisdictions, notably South Korea. The South Korean securities lending market has seen an increase in directional strategies and increases in revenue to clients that hold such securities.
The Asian hedge fund industry continues to thrive, and this has also helped increase volumes across the board.
Ariel Winiger: 2015 was generally a good year for the securities lending industry. According to Markit, outstanding securities lending balances on Asian equities have increased by about 30 percent year on year while the average securities lending fees across Asia Pacific are above 1 percent.
The average fee level has been volatile throughout the year and reached 1.5 percent in March and April, mainly driven by China related demand in the Hong Kong market where average fees peaked at 3 percent.
Paul Solway: Asia has nine active markets open to securities lending—ranging from Japan to New Zealand—with no two markets being the same in terms of liquidity, structure, flows or industry dependence. Whether consumer or producer, the primary or downstream drivers of investment activities across each of the markets always makes lending in Asia fairly dynamic.
During the first half of 2015, securities lending fared well across the region, and indeed most of the year’s revenue was generated during the first six months of 2015. Hong Kong and Japan somewhat dominated in Asia with Hong Kong being the primary driver of 2015 lending revenue as it continued to be the main link into corporate issues coming out of China, which currently does not allow foreign investors to engage in securities lending. Japan was not as volatile as Hong Kong, but its size in terms of loan balances drove significant revenue.
Volatility also helped boost securities lending activity in a number of the smaller Asian markets. As money flowed out of the emerging markets and into the US during the summer months, there was a significant uptick of borrowing in South Korea, Malaysia, Singapore and Thailand.
Paul York: The volatility we witnessed throughout Asia in 2015 certainly proved beneficial in terms of promoting strong returns within our securities lending programme. From a purely State Street Asian perspective, there were positive like-for-like annual returns in every single country that we operate in, bar one, which was extremely pleasing. From a macro client perspective, we continue to see new entrants into Asian markets, which are both highly encouraging and beneficial in terms of adding new liquidity to core and emerging market supply. It’s these markets in particular where we can generate strong income streams on behalf of our customers.
Order flow last year was extremely buoyant in high revenue generative markets such as Hong Kong and Japan. Here we witnessed a good eclectic mix of demand side strategies, particularly in the quantitative, long/short and event-driven space. It was also encouraging to see resurgence in markets that had arguably been underperforming in 2014, namely Australia, South Korea, Singapore and Thailand.
Darren Measures: There was volatility in the Asian markets in 2015—as much, if not more than, the rest of the globe. However, the demand and interest in securities lending has held up well across both developed and emerging markets across the region. On the demand side, Hong Kong has had a very positive year and South Korea and Taiwan were also very strong. In Japan, demand for dividend names was positive as always and we saw directional interest from the technology sector in particular.
On the supply side, international lender sentiment towards Asian markets represents one of the strongest areas of revenue generation with many lenders seeking ways to capture additional earnings even in the more hands-on markets of Taiwan and Malaysia. For Asia-based lenders, our emphasis on education and building long term relationships has been very positive. We saw new lenders bringing assets to market, existing lenders modifying their parameters, and strong desire for third party (non-custody) programmes.
Asian-based lenders have been quite adept at looking at opportunities arising from the new environment and have used this to capture additional returns from structured and term trades.
Francois Maury: The securities lending business has been relatively lacklustre during the past year. We see a few main trends having a material impact. The overall compression of margins in a world of high liquidity is not favourable, while the hedge fund world appears to have struggled in the second half of 2015, particularly smaller funds that strive to differentiate themselves to keep the interests of investors.
The second part of the year, however, provided opportunities on very select names and exchange-traded funds (ETFs), especially on those tracking China. However, most clients remained on one side only and unwinding/de-risking was the mood.
Has there been any notable difference in the development of the securities lending industry in each of the Asian countries? Were you surprised by which countries did best or struggled?
McCardle: I think everyone was a little taken aback about how China suddenly became much less important in the securities finance industry in the second half of 2016. Obviously, everyone is still very keen to see China truly emerge. In the first few months of 2015, it seemed that this might be the year for China, but now it is less certain as to when it will become a market for securities borrowing and lending.
Another noteworthy issue in the region in 2015 was when the Indonesian market announced that it would be instituting a requirement for securities borrowing and lending to be collateralised in the Indonesian rupiah, which meant that there may be less interest in this market from securities finance participants than was hoped for. It was a good year in Japan, Hong Kong and South Korea, with these making up the lion’s share of revenue.
Solway: In 2015, Hong Kong and Japan dominated the securities lending market in Asia, which was consistent with 2014 trends. One notable and pleasant surprise was South Korea returning to its number three spot in the Asian securities lending marketplace, according to our data. South Korean regulators eased the daily bandwidth in which stocks could move intra-day while refraining from any other restrictive measures. As a result, investor confidence returned, demonstrated by decent South Korean quant flow throughout the year, combined with some deep special plays in sectors such as pharmaceuticals, shipping and chemicals, and South Korea produced balances and returns that were stronger in 2015 than they were in the previous year.
The nascent but usually subdued Malaysian securities lending market also did very well in 2015 compared to 2014. We began to see activity and significant returns from the middle of the year, and this was driven by emerging market macro demand, for example, US dollar strength, emerging market exit, falling oil prices and political uncertainty. Between the beginning of 2015 and year-end, Malaysian loan volumes grew by a factor of five and returns grew by a factor of 3.5, according to Markit.
Measures: Generally across the emerging market countries, the supply of securities has increased, leading to greater liquidity in the market while spreads have held up. In the developed market countries, the spreads have come under pressure as supply has increased. The countries that have historically been strong performers in the last few years—Hong Kong, Taiwan and South Korea—continued to generate excellent returns in 2015. As we look at the outbound flow of investments from the emerging market countries, we see a greater accumulation of international equities coupled with a desire to capture additional returns from lending.
Raccat: The Hong Kong market is very much linked to what has happened in China and has become the third biggest market worldwide. Directional demand (all sectors affected) keeps increasing significantly whereas liquidity can vanish very quickly. Hong Kong ETFs are extremely popular and have generated impressive revenues for some of them. Scrip arbitrage has also been very active in 2015 with more and more companies offering this optional dividend programme. South Korea’s shipping industry has suffered quite a lot. Some names (like in Hong Kong) have been trading specials for years. All industries linked to oil are massively targeted by short sellers.
There is still an impressive list of Japanese companies raising cash. It’s probably the most active market in terms of flow.
Fannin: The most notable advancement in development was the Shanghai-Hong Kong Stock Connect scheme, offering offshore investors a means to invest directly in designated Chinese shares. However, the securities lending rules within the framework create some challenges for offshore participants, but they are nonetheless an important milestone in the development of the Chinese securities lending market. We believe market participants remain optimistic that progressive development of the Shanghai-Hong Kong Stock Connect scheme could open up a significant opportunity for securities lending, and result in incremental revenue streams for clients.
In other Asian jurisdictions, development of securities lending markets has been relatively muted. In Taiwan for example, a number of punitive rules pertaining to settlement and execution of trades that continue to constrain some securities lending activity, not the least of which is the daily quota applied to short selling volume. However, overall market development in Taiwan and other jurisdictions nonetheless remains encouraging.
Maury: The widely anticipated opening of China’s stock lending market didn’t materialise in 2015. To a lesser extent, we could say the same about Taiwan’s efforts. We believe, however, that the positive direction towards a more open environment is making significant inroads and hope to see further progress in 2016. Japan is resisting to a certain extent in this volatile environment and, indeed, we find that clients occasionally forget that it is still a tremendously big, albeit not ‘exciting’ market.
Prout: Despite starting from a low base in terms of volumes on loan, the Malaysian securities lending market looks to be firmly on a growth trajectory with volumes more than doubling from the start of the year. This growth is being noticed by local firms, many of whom are looking to enter the market or expand their securities lending activity.
In Hong Kong, there is a clear trend of the local entities of Chinese securities houses entering the securities lending space. They bring new sources of inventory to this established market, often holding securities that are hard to find elsewhere.
Winiger: The most noticeable change we observed was in the demand for South Korean equities where the overall securities lending market balances reaching $10 billion for the first time in July 2015, with a high average fee level of 3.25 percent, according to Markit.
Nevertheless, Taiwanese equity lending balances are also doing well with more international supply coming to market. Balances stood below $7 billion at the start of 2015, reaching almost $10 billion in the summer before ending the year at about $8 billion. Fees have reduced though because of the increased supply over the last few years. They are still at an attractive 1.8 percent, but down from the 3.9 percent of three years ago.
The main country to mention is Hong Kong. With fee levels going up in the first half of the year, comparable with the high demand seen in 2012, lenders were pleased to see their revenues soaring compared to 2014. Some of the Hong Kong-listed ETFs also traded at very high levels. CSOP’s FTSE China A50 ETF, 2822 HK, traded at an average of 13 percent in 2015 and was, together with China AMC’s CSI300 ETF, 3188 HK, and BlackRock’s iShare FTSE China A50 ETF, 2823 HK, among the most actively sought after ETFs in Hong Kong.
Which of these would you still consider to be ‘emerging’ and which are now developed? Are there any new Asian countries likely to develop a securities lending industry?
Measures: There are obviously many ways to categorise the divisions between emerging and developed market, but one safe proxy is the MSCI index definitions. These would put Japan, Australia, New Zealand, Hong Kong and Singapore in the developed bucket, and Taiwan, South Korea and Malaysia in the emerging bucket. Indonesia, Philippines and Vietnam are markets on our watch list for the creation of a non-domestic stock borrow loan model, with perhaps Indonesia the one closest. China and India have securities borrowing and lending activities but these are either limited to domestic entities and/or have challenges that are inhibitive for non-domestic lenders.
Maury: As does the overall economy of Asia, the future of securities borrowing and lending in the region relies heavily on China. Indeed, the pressing question is whether we are going to see the emergence of a securities borrowing and lending market on the mainland.
Furthermore, clients are looking at Thailand, Indonesia and Malaysia. We believe interest for those Southeast Asian economies will progressively deepen as the various foreign exchange regulations loosen. However, we anticipate this to be a slow evolution.
Meanwhile, enthusiasm for Taiwan seems to be wavering as the securities borrowing and lending market failed to materialise in 2015, as many clients expected.
Winiger: I would categorise the region as follows. First, you have the established countries of Japan, Hong Kong, Australia, Singapore and New Zealand. The second category contains the two big emerging markets that have been operating for many years now and are becoming more mainstream, South Korea and Taiwan. Then you have two smaller emerging markets in Thailand and Malaysia. The latter revised its rules only a few years ago to accommodate securities lending flows better and has shown good balance growth over the past year.
Then you have two markets that officially offer a securities lending market, the Stock Connect and India, but in reality the rules are not practical and there has been little to no volumes. The next Asian securities lending market to open up is supposed to be Indonesia, which is expected to go live as early as this year.
Raccat: Thailand, Malaysia and Indonesia are still emerging. We all hope to see a proper mechanism in place on the Chinese onshore market. The current set up via the Shanghai-Hong Kong Stock Connect doesn’t work. But for the moment, Japan, Hong Kong, Australia, Taiwan and South Korea will be the key markets for many more years to come.
York: I suppose it depends on how you define ‘developed’ versus ‘emerging’ but I think with so many idiosyncrasies within multiple jurisdictions throughout Asia, it’s imperative for any country wishing to gain ‘developed’ status to incorporate a fluid working capital markets framework that offers high levels of liquidity and encompasses meaningful regulatory bodies. In Asia, it’s not uncommon to have a ‘workable’ structure for securities lending, but it’s certainly not as liquid or fluid as participants would perhaps like them to be. Taiwan, South Korea and Malaysia, for example, are all viable and working structures, but they are not arguably as fluid as, say, Japan, Hong Kong or Australia.
Obviously, all eyes are on China right now in terms of how looks to develop its securities lending capability. As it currently stands, the model is simply unworkable from an offshore agency perspective and, until that changes, China will remain stifled in terms of both market participation and liquidity.
That said, through organisations such as PASLA, the industry had some excellent dialogue with both the Shanghai Stock Exchange and Hong Kong Stock Exchange last year. Participants remain positive in their commitment to working closely with them in order to help formulate a more workable framework that will better serve Chinese market and foreign institutional investors going forward.
McCardle: The emerging and developed markets have not really changed in 2015. Some people see South Korea becoming more developed, with the focus and level of trading in the market, but I still believe that it is more likely to have three levels of market development in Asia. South Korea and Taiwan can be seen as developing, somewhat ahead of emerging, but not fully developed yet.
Fannin: Asia continues to boast an impressive landscape of untapped emerging markets that offer attractive return profiles for securities lending participants. Most notably, the industry is acutely focused on developments pertaining to the Shanghai-Hong Kong Stock Connect initiative in respect of the ability to lend and borrow Chinese inventory. The launch of a Shenzhen-Hong Kong Stock Connect platform is also widely anticipated and it is thought that this would be an important milestone for index providers to include China in various global indices at some point. This would ultimately serve as a critical source of supply for the purposes of securities borrowing and lending via the Stock Connect schemes.
Other jurisdictions, such as Indonesia, continue to progress developments of their offshore securities lending frameworks. Indonesia, having previously engaged its counterparts in South Korea to facilitate creating a robust securities and lending offshore market, is hopefully anticipating a model that will closely resemble the successful one established in South Korea. From a demand perspective, Indonesia promises an attractive demand profile, given its changing economic backdrop.
Prout: Although still making changes to their operating models to support securities borrowing and lending activity, South Korea and Taiwan can broadly be considered emerged markets in Asia. Malaysia is a key emerging market in the region that appears to be gaining momentum with both local and international players. Other markets that have signalled an intention to develop securities lending activity include Indonesia, the Philippines and Vietnam, but any development in these markets is likely to be cautious and gradual.
Solway: One could consider markets open for 10 or more years to be developed or mature by nature, depending on local regulations that may restrict access and therefore liquidity. In Asia, this would include Hong Kong, Japan, South Korea, Singapore, Australia, New Zealand and Thailand. Taiwan continues to lag a number of markets due to regulations that constrain the freedom of investment that is enjoyed elsewhere. Malaysia, which opened up three years ago, continues to grow both in terms of supply and demand. Both of these markets are still considered by many as still emerging.
As to new countries developing a securities lending industry, all eyes are on China. Currently, foreign investors are not allowed to engage in securities lending in China and instead use the Hong Kong securities lending market as a proxy, where able. If China opens up securities lending to foreign investors, this will no doubt have a huge impact on the securities lending market in Asia.
How important is an active equity market to Asia’s securities lending industry?
Fannin: Generally, an active market would imply a strong supply of liquidity and large daily average trading volumes, which all are critical components to the level of securities lending demand. In the absence of sufficient liquidity, investors are unable to benefit from the advantages brought by securities lending through the various trading strategies. This is increasingly important as the various markets continue to grow.
York: Securities lending plays a pivotal role in providing both liquidity and settlement, not just in Asia but on a global basis. Furthermore, it reduces volatility and creates greater price discovery on exchanges and in bilateral markets. An active equity market is clearly a prerequisite to encouraging investment within any particular country, therefore creating a more fluid securities lending product offering. This in turn is likely to promote multiple investor strategies from which all market participants can benefit and engage.
Maury: The equity market’s health is essential to the securities borrowing and lending business. We need end-user clients, such as hedge funds and asset managers, to be active and successful in their trading to be the catalyst for securities lending markets. Furthermore, a lack of liquidity and light volumes do not favour the securities borrowing and lending markets We also believe that unhealthy market valuations are not conductive to the long term development of our businesses. Beyond liquidity, depth and market valuation, the securities borrowing and lending business requires healthy legal, regulatory and fiscal environments. There are complex legal environments in Asia, while stamp duties are another form of unfortunate restrictions to the business.
Measures: The two things go in lockstep: one of the hallmarks of an active market is a vibrant lending (short selling) market. The foundation of any successful securities lending market is the ease of conducting international investments, sufficient liquid stocks to trade in, securities borrowing and lending rules that can are viable for the international borrower community, and limited restrictions on short selling. Importantly, tax legislation needs to keep pace with market evolution so that loan transactions are not treated as sales activity. The more constrained and restricted a market, the less attractive it is for securities lending, which in itself limits liquidity in the equity/bond markets and makes the market more expensive for capital investments.
Winiger: An active equity market is very important. Securities lending is only a secondary market and depends on an equity market flows to generate the demand for short selling and hedging needs.
Solway: An active equity market is extremely important because consistent activity drives securities lending returns. The active and volatile equity market in 2015 demonstrated this relationship, as volatility drove earnings up significantly during the first half of the year.
The equity market’s volume, liquidity and transparency are also key considerations. Japan and Hong Kong are strong markets in terms of volume and liquidity, with the remaining markets perhaps less so.
Before participating in securities lending in Asia, investors need to be aware of the breadth and depth of the Asian equity market and know any nuances or limitations that may prevent them from completing their investment strategies during their desired time-frame.
With specific regard to transparency, Asia does very well. South Korea and Taiwan may not be as liquid as some other markets, but their securities lending platforms are among the most transparent of all markets globally.
Overall, the Asian equity market is very active, volatile and driven by fundamentals—all good characteristics for generating securities lending revenue.
Raccat: The cash equity market is the driving force of our securities lending industry. The ability to short sell a stock has a direct impact on our activity.
In Asia, many stocks in Hong Kong or Taiwan cannot be short sold at all, which can limit the utilisation rate of a long portfolio. Regular bans on short selling occur when stock markets tumble. Securities lending continues to suffer from a bad reputation.
Have the close ties that smaller Asian economies have to China been an advantage or disadvantage for securities lending participants and short sellers? Is this likely to change?
McCardle: In the first half of the year the economies linked heavily with China did see an advantage, but in the second half of the year, as China slowed, those countries also saw the downside to the relationship.
Fannin: Asia’s regional economies are directly or indirectly exposed to the health of the Chinese economy (as are most global economies). This may benefit or equally hinder the securities lending industry. With a slowing growth rate in China, directional demand has manifested in some jurisdictions most exposed to this theme, particularly those who maintain China as a key export trading partner (for example, within Australia, Singapore and South Korea).
The volatility of regional exchange rates and the pursuit for export-led economies to remain competitive in this regard has also presented opportunities for revenue to be generated for clients who participate in securities lending.
Prout: Following the significant market volatility in the Chinese stock markets in the second half of 2015 and the public condemnation of short selling by the Chinese government, many short sellers, especially those in Hong Kong, scaled back their activities in the latter part of the year. This has clearly been a disadvantage for the prime brokers servicing these clients in the region as lower levels of demand from short sellers hit their bottom lines.
On the other hand, the close links with China seem to be working well for the local Chinese-owned brokers in Hong Kong. Their access to wealthy Chinese investors is allowing them to take advantage of the opportunities created by the investors’ demand to short international markets and the access to attractive inventories for their emerging securities lending programmes.
Raccat: One of the key challenge for securities lending participants is to offer stable inventory to the sell side. Demand is there and keeps increasing but thin liquidity available for short selling can refrain from entering into a deal. This is unlikely to change anytime soon. For example, many stocks in Hong Kong are held by investment vehicles not part of any securities lending programme. On top of that, it is fairly usual to see some funds pulling out temporarily from lending programmes in case of high volatility in the market.
Solway: In 2015, all of Asia’s securities lending markets felt the effects of the market volatility caused by China as it continues to open up its market to the rest of the world. Currently, foreign investors cannot participate in securities lending in China, but instead must use other Asian markets as proxies. Technology focused economies, such as Taiwan, South Korea and Japan, can serve as proxies for China as does Hong Kong, especially with the Shanghai-Hong Kong Stock Connect platform now in place.
China’s slow transformation from a production to a consumption economy, combined with is relative slowdown in GDP, has had impact on a number of sectors with commodities being hardest hit. An obvious market that in turn has been affected is Australia, where many mining companies, both large and small, saw earnings slump in 2015.
There is certainly potential for change. In Taiwan, the pro-Chinese KMT political party was recently replaced by the pro-independence DPP, party which may affect trade relations between China and Taiwan with potential knock-on effects for the rest of Asia. Such change and uncertainty ultimately attracts speculation both at the macro and micro level.
Maury: It is a relative disadvantage as non-Asian investors and clients often lack the breadth to focus on smaller economies, where we believe there could be interesting opportunities for them. Also, the flows are massively macro-driven with monetary policies playing a major role and somehow swamping more local factors.
If we dig further into the question, we can observe a pattern; local investors are focused on their own markets but very few are going into other Asian markets. Asia, in that respect, displays very little unity.
The link to China benefits the small number of sophisticated cross-border sellers in Asia (outside of Japan) because most of the sectors are somehow linked to the Chinese economy. This explains the short selling of sectors across Asia, such as the recent action in the commodities markets. In other words, excluding Japan, many Asia Pacific markets have benefitted from the Chinese market. Australia is a clear example.
The link does not favour autonomous development of smaller Asian markets, and sometimes penalises local long-term investors. From our perspective, this is not a positive environment and it is unlikely to change rapidly. One rebalancing factor for the longer term could be the expansion of India.
York: Naturally, one would expect both countries and companies alike with deeply integrated supply chains with China such as Hong Kong, Japan and South Korea to be more affected in terms of short side demand. In Europe, Germany is arguably most at risk as a producer of capital goods to China and large commodity exporters such as Australia also find themselves in the firing line, especially within the mining sectors and such like.
One way to amplify the trade effects would be through a massive depreciation of the currency in an attempt to revive Chinese export-led growth and that is what we have been witnessing over the last few months. That said policy makers have strengthened the yuan rate since early January. However, in doing so, the central bank has burned through more than $400 billion in foreign reserves to prop up the yuan since the surprise August devaluation, raising concern that the cash stockpile may soon fall below adequate levels.
Measures: The volatility in the local economies in Asia are always, to some extent, going to take their lead from how the dominant economies in the region are faring, especially China and Japan. However, each country has its own dynamic around balance and composition of trade, exposure to foreign exchange and trade reserves. Exposures to global pressures such as commodity prices and internal political pressures will affect how each country deals with the reverberations from changes in those economies. For example, an economy such as Malaysia is more likely to be driven by the price of oil and foreign exchange devaluations than by events in China, whereas Hong Kong will be materially more affected.
China has already experienced its first wobble of 2016, which automatically affects all of the Asia Pacific and even global markets. What are your predictions for the next 12 months?
McCardle: I think that people will continue to concentrate on Japan, Hong Kong and South Korea as the revenue drivers in 2016, but, as always, if there are opportunities in markets such as Malaysia, Taiwan or others, there will be activity there also. Asia is a region that is hard to predict, as we saw in 2015. Last year in particular showed that there are many influences in this region compared to others, as the regulatory environment is less aligned and, as we have seen, things such as elections have large impacts on the markets.
Prout: Since the beginning of 2016, FIS’s Astec Analytics has observed a 10 percent reduction in the available supply of Asian securities for lending. This is particularly notable in the Hong Kong market, which has seen the largest decrease of over 12 percent. The well documented sell off among long investors is likely to account for this, at least in part, and while this does result in supply constraints, the prolonged market volatility does create opportunities for the short side of the market.
Looking more broadly, the much discussed regulatory changes will continue to shape market activities in 2016, with further increases in the use of synthetic financing options likely as prime brokers seek to maximise their balance sheet efficiency. From a technology perspective, at FIS we are already seeing the effects of this as banks seek to optimise their IT infrastructure with multi-asset solutions that can simplify their IT footprint. Coinciding with this is a clear industry move towards hosted and managed services for their platforms, driven by firms seeking to take advantage of the expertise of their technology providers and benefit from operational efficiencies. We see both of these technology trends continuing throughout 2016 and beyond.
Raccat: Volatility will continue, consistent and stable supply will become more critical and in regards to China, we shall see. The regulators have surprised us in the past with their speed and pace of market change, but this may be slowed down in line with the economic environment. But you never know, the regulators may see securities lending for what it is—a market facilitator—and surprise us by reviewing market rules to attract more market participants.
Solway: Over the next 12 months, we believe market volatility will undoubtedly continue, fueling the type of activity that provides opportunities to lend securities. There is still a great deal of uncertainty in the market regarding regulation, currencies, commodities, and monetary and fiscal policy.
Similar to 2015, Hong Kong and Japan will continue to generate good returns, and macro trends (for example, the U.S. political situation) will likely influence the market. Currencies have a huge influence on markets and so drive volatility. It’s also worth remembering that weaker emerging market currencies will suppress securities lending earnings in US dollar terms.
On a country-specific level, I see the following. South Korea returned to the third spot in the Asian securities lending space in 2015, according to our data, and these high levels of activity are set to continue into 2016. In Malaysia, loan volumes grew five-fold above their 2014 levels throughout 2015, according to Markit, so in 2016 spreads may compress as additional new supply is added during the year. In Thailand, given that average borrow rates remain healthy due to limited supply, any new entrants to lending will likely see good returns in 2016.
Japan spreads were compressed due to broader supply being available in 2015, and this trend will likely continue in 2016, albeit on a healthy volume base. Negative interest rates are already a reality—the impacts of which are yet fully to be seen.
York: Being the second largest market in the world, China is always going to be a major cause for concern across all global markets if it continues to go through a period of correction. With ongoing weakening economic data, a devaluation of the yuan, falling commodity prices and growing concerns over aggressive credit expansion and the potential for bad loans—all of these issues weigh heavily on market sentiment.
A plethora of attempts have been made by the central bank to intervene within the capital markets in a bid to buoy mainland indices and artificially introduce restrictive selling practices, particularly on major shareholders. If this trend continues throughout the year, it will only serve as a selling proxy for China in markets such as Hong Kong, where investors look to bypass the ongoing intervention. This in turn is highly likely to induce further securities lending activity.
Hong Kong has long benefited from a unique blend of Chinese growth and a well-established currency peg to the US dollar. If China continues to slow down and the US Federal Reserve stays on the current path of raising rates, Hong Kong may face the possibility of a property and equity market downturn, again which would culminate in specific strong sector shorts for the securities lending market.
Maury: Overall, global equity markets have been expensive. Indeed, equities are very much in a bull market, so it is therefore not surprising to see it undergo a correction. However, given the steep losses so far, it will take some time to recover, so I expect some volatility in the first half of 2016 and improvements later in the year.
We need further transparency before the uncertainty will subside, including on US Federal Reserve interest rate decisions, the Bank of Japan’s path to reach its inflation target, and Chinese growth. As decisions unfold and clarity sets in, a relief rally in the second part of the year is a plausible scenario.
Madalin Prout: Based on data from FIS’s Astec Analytics, 2015 was a particularly flat year for securities lending in the majority of the Asian markets, despite the market volatility. The majority of developed markets finished the year with volumes on loan either flat or slightly down on where they started, with Japan and Singapore being the exceptions. Three names stand out as notable trades in 2015—Hanergy Thin Film Power Group, Samsung C&T and Celltrion Inc—together accounting for nearly 20 percent of the 2015 securities lending revenues generated from Asian securities.
Andrew McCardle: The first half of the year was a good year for Asia with there being a lot of profit to be made in a few securities in particular. The year started with the outlook for China being very positive, and the PASLA conference in Shanghai was very informative. Then, in the middle of the year with markets moving as they did, China was no longer as far forward as it had looked. One particular revenue-driving security, 566 HK, also hit a difficult patch as the stock was suspended by the Hong Kong exchange.
David Raccat: The securities lending industry did well, and better than other regions in terms of growth. According to Markit data, revenues from securities lending activity in Asia were up 21 percent year on year to a record $672 million in fees. That number is small when compared to other markets such as the US ($4.2 billion), but when you look at growth and then further potential, the Asian region is key. Hong Kong continues to be a strong performer with continued corporate activity, but South Korea has again returned to the top of the table and we have noticed a strong increase in this market.
Dane Fannin: The Asian securities lending market still appears to dominate others in the region. In particular, the Hong Kong equity lending market continued to be an important revenue stream for clients, given exposure to China via the dual listed H-shares listed on the Hang Seng index, which created arbitrage opportunities.
Over time, there has been a shift in risk appetite with the market volatility caused by uncertainty over the Chinese economy, lowering demand for these securities. However, these Hong Kong equity lending market impacts were offset by increased demand in other jurisdictions, notably South Korea. The South Korean securities lending market has seen an increase in directional strategies and increases in revenue to clients that hold such securities.
The Asian hedge fund industry continues to thrive, and this has also helped increase volumes across the board.
Ariel Winiger: 2015 was generally a good year for the securities lending industry. According to Markit, outstanding securities lending balances on Asian equities have increased by about 30 percent year on year while the average securities lending fees across Asia Pacific are above 1 percent.
The average fee level has been volatile throughout the year and reached 1.5 percent in March and April, mainly driven by China related demand in the Hong Kong market where average fees peaked at 3 percent.
Paul Solway: Asia has nine active markets open to securities lending—ranging from Japan to New Zealand—with no two markets being the same in terms of liquidity, structure, flows or industry dependence. Whether consumer or producer, the primary or downstream drivers of investment activities across each of the markets always makes lending in Asia fairly dynamic.
During the first half of 2015, securities lending fared well across the region, and indeed most of the year’s revenue was generated during the first six months of 2015. Hong Kong and Japan somewhat dominated in Asia with Hong Kong being the primary driver of 2015 lending revenue as it continued to be the main link into corporate issues coming out of China, which currently does not allow foreign investors to engage in securities lending. Japan was not as volatile as Hong Kong, but its size in terms of loan balances drove significant revenue.
Volatility also helped boost securities lending activity in a number of the smaller Asian markets. As money flowed out of the emerging markets and into the US during the summer months, there was a significant uptick of borrowing in South Korea, Malaysia, Singapore and Thailand.
Paul York: The volatility we witnessed throughout Asia in 2015 certainly proved beneficial in terms of promoting strong returns within our securities lending programme. From a purely State Street Asian perspective, there were positive like-for-like annual returns in every single country that we operate in, bar one, which was extremely pleasing. From a macro client perspective, we continue to see new entrants into Asian markets, which are both highly encouraging and beneficial in terms of adding new liquidity to core and emerging market supply. It’s these markets in particular where we can generate strong income streams on behalf of our customers.
Order flow last year was extremely buoyant in high revenue generative markets such as Hong Kong and Japan. Here we witnessed a good eclectic mix of demand side strategies, particularly in the quantitative, long/short and event-driven space. It was also encouraging to see resurgence in markets that had arguably been underperforming in 2014, namely Australia, South Korea, Singapore and Thailand.
Darren Measures: There was volatility in the Asian markets in 2015—as much, if not more than, the rest of the globe. However, the demand and interest in securities lending has held up well across both developed and emerging markets across the region. On the demand side, Hong Kong has had a very positive year and South Korea and Taiwan were also very strong. In Japan, demand for dividend names was positive as always and we saw directional interest from the technology sector in particular.
On the supply side, international lender sentiment towards Asian markets represents one of the strongest areas of revenue generation with many lenders seeking ways to capture additional earnings even in the more hands-on markets of Taiwan and Malaysia. For Asia-based lenders, our emphasis on education and building long term relationships has been very positive. We saw new lenders bringing assets to market, existing lenders modifying their parameters, and strong desire for third party (non-custody) programmes.
Asian-based lenders have been quite adept at looking at opportunities arising from the new environment and have used this to capture additional returns from structured and term trades.
Francois Maury: The securities lending business has been relatively lacklustre during the past year. We see a few main trends having a material impact. The overall compression of margins in a world of high liquidity is not favourable, while the hedge fund world appears to have struggled in the second half of 2015, particularly smaller funds that strive to differentiate themselves to keep the interests of investors.
The second part of the year, however, provided opportunities on very select names and exchange-traded funds (ETFs), especially on those tracking China. However, most clients remained on one side only and unwinding/de-risking was the mood.
Has there been any notable difference in the development of the securities lending industry in each of the Asian countries? Were you surprised by which countries did best or struggled?
McCardle: I think everyone was a little taken aback about how China suddenly became much less important in the securities finance industry in the second half of 2016. Obviously, everyone is still very keen to see China truly emerge. In the first few months of 2015, it seemed that this might be the year for China, but now it is less certain as to when it will become a market for securities borrowing and lending.
Another noteworthy issue in the region in 2015 was when the Indonesian market announced that it would be instituting a requirement for securities borrowing and lending to be collateralised in the Indonesian rupiah, which meant that there may be less interest in this market from securities finance participants than was hoped for. It was a good year in Japan, Hong Kong and South Korea, with these making up the lion’s share of revenue.
Solway: In 2015, Hong Kong and Japan dominated the securities lending market in Asia, which was consistent with 2014 trends. One notable and pleasant surprise was South Korea returning to its number three spot in the Asian securities lending marketplace, according to our data. South Korean regulators eased the daily bandwidth in which stocks could move intra-day while refraining from any other restrictive measures. As a result, investor confidence returned, demonstrated by decent South Korean quant flow throughout the year, combined with some deep special plays in sectors such as pharmaceuticals, shipping and chemicals, and South Korea produced balances and returns that were stronger in 2015 than they were in the previous year.
The nascent but usually subdued Malaysian securities lending market also did very well in 2015 compared to 2014. We began to see activity and significant returns from the middle of the year, and this was driven by emerging market macro demand, for example, US dollar strength, emerging market exit, falling oil prices and political uncertainty. Between the beginning of 2015 and year-end, Malaysian loan volumes grew by a factor of five and returns grew by a factor of 3.5, according to Markit.
Measures: Generally across the emerging market countries, the supply of securities has increased, leading to greater liquidity in the market while spreads have held up. In the developed market countries, the spreads have come under pressure as supply has increased. The countries that have historically been strong performers in the last few years—Hong Kong, Taiwan and South Korea—continued to generate excellent returns in 2015. As we look at the outbound flow of investments from the emerging market countries, we see a greater accumulation of international equities coupled with a desire to capture additional returns from lending.
Raccat: The Hong Kong market is very much linked to what has happened in China and has become the third biggest market worldwide. Directional demand (all sectors affected) keeps increasing significantly whereas liquidity can vanish very quickly. Hong Kong ETFs are extremely popular and have generated impressive revenues for some of them. Scrip arbitrage has also been very active in 2015 with more and more companies offering this optional dividend programme. South Korea’s shipping industry has suffered quite a lot. Some names (like in Hong Kong) have been trading specials for years. All industries linked to oil are massively targeted by short sellers.
There is still an impressive list of Japanese companies raising cash. It’s probably the most active market in terms of flow.
Fannin: The most notable advancement in development was the Shanghai-Hong Kong Stock Connect scheme, offering offshore investors a means to invest directly in designated Chinese shares. However, the securities lending rules within the framework create some challenges for offshore participants, but they are nonetheless an important milestone in the development of the Chinese securities lending market. We believe market participants remain optimistic that progressive development of the Shanghai-Hong Kong Stock Connect scheme could open up a significant opportunity for securities lending, and result in incremental revenue streams for clients.
In other Asian jurisdictions, development of securities lending markets has been relatively muted. In Taiwan for example, a number of punitive rules pertaining to settlement and execution of trades that continue to constrain some securities lending activity, not the least of which is the daily quota applied to short selling volume. However, overall market development in Taiwan and other jurisdictions nonetheless remains encouraging.
Maury: The widely anticipated opening of China’s stock lending market didn’t materialise in 2015. To a lesser extent, we could say the same about Taiwan’s efforts. We believe, however, that the positive direction towards a more open environment is making significant inroads and hope to see further progress in 2016. Japan is resisting to a certain extent in this volatile environment and, indeed, we find that clients occasionally forget that it is still a tremendously big, albeit not ‘exciting’ market.
Prout: Despite starting from a low base in terms of volumes on loan, the Malaysian securities lending market looks to be firmly on a growth trajectory with volumes more than doubling from the start of the year. This growth is being noticed by local firms, many of whom are looking to enter the market or expand their securities lending activity.
In Hong Kong, there is a clear trend of the local entities of Chinese securities houses entering the securities lending space. They bring new sources of inventory to this established market, often holding securities that are hard to find elsewhere.
Winiger: The most noticeable change we observed was in the demand for South Korean equities where the overall securities lending market balances reaching $10 billion for the first time in July 2015, with a high average fee level of 3.25 percent, according to Markit.
Nevertheless, Taiwanese equity lending balances are also doing well with more international supply coming to market. Balances stood below $7 billion at the start of 2015, reaching almost $10 billion in the summer before ending the year at about $8 billion. Fees have reduced though because of the increased supply over the last few years. They are still at an attractive 1.8 percent, but down from the 3.9 percent of three years ago.
The main country to mention is Hong Kong. With fee levels going up in the first half of the year, comparable with the high demand seen in 2012, lenders were pleased to see their revenues soaring compared to 2014. Some of the Hong Kong-listed ETFs also traded at very high levels. CSOP’s FTSE China A50 ETF, 2822 HK, traded at an average of 13 percent in 2015 and was, together with China AMC’s CSI300 ETF, 3188 HK, and BlackRock’s iShare FTSE China A50 ETF, 2823 HK, among the most actively sought after ETFs in Hong Kong.
Which of these would you still consider to be ‘emerging’ and which are now developed? Are there any new Asian countries likely to develop a securities lending industry?
Measures: There are obviously many ways to categorise the divisions between emerging and developed market, but one safe proxy is the MSCI index definitions. These would put Japan, Australia, New Zealand, Hong Kong and Singapore in the developed bucket, and Taiwan, South Korea and Malaysia in the emerging bucket. Indonesia, Philippines and Vietnam are markets on our watch list for the creation of a non-domestic stock borrow loan model, with perhaps Indonesia the one closest. China and India have securities borrowing and lending activities but these are either limited to domestic entities and/or have challenges that are inhibitive for non-domestic lenders.
Maury: As does the overall economy of Asia, the future of securities borrowing and lending in the region relies heavily on China. Indeed, the pressing question is whether we are going to see the emergence of a securities borrowing and lending market on the mainland.
Furthermore, clients are looking at Thailand, Indonesia and Malaysia. We believe interest for those Southeast Asian economies will progressively deepen as the various foreign exchange regulations loosen. However, we anticipate this to be a slow evolution.
Meanwhile, enthusiasm for Taiwan seems to be wavering as the securities borrowing and lending market failed to materialise in 2015, as many clients expected.
Winiger: I would categorise the region as follows. First, you have the established countries of Japan, Hong Kong, Australia, Singapore and New Zealand. The second category contains the two big emerging markets that have been operating for many years now and are becoming more mainstream, South Korea and Taiwan. Then you have two smaller emerging markets in Thailand and Malaysia. The latter revised its rules only a few years ago to accommodate securities lending flows better and has shown good balance growth over the past year.
Then you have two markets that officially offer a securities lending market, the Stock Connect and India, but in reality the rules are not practical and there has been little to no volumes. The next Asian securities lending market to open up is supposed to be Indonesia, which is expected to go live as early as this year.
Raccat: Thailand, Malaysia and Indonesia are still emerging. We all hope to see a proper mechanism in place on the Chinese onshore market. The current set up via the Shanghai-Hong Kong Stock Connect doesn’t work. But for the moment, Japan, Hong Kong, Australia, Taiwan and South Korea will be the key markets for many more years to come.
York: I suppose it depends on how you define ‘developed’ versus ‘emerging’ but I think with so many idiosyncrasies within multiple jurisdictions throughout Asia, it’s imperative for any country wishing to gain ‘developed’ status to incorporate a fluid working capital markets framework that offers high levels of liquidity and encompasses meaningful regulatory bodies. In Asia, it’s not uncommon to have a ‘workable’ structure for securities lending, but it’s certainly not as liquid or fluid as participants would perhaps like them to be. Taiwan, South Korea and Malaysia, for example, are all viable and working structures, but they are not arguably as fluid as, say, Japan, Hong Kong or Australia.
Obviously, all eyes are on China right now in terms of how looks to develop its securities lending capability. As it currently stands, the model is simply unworkable from an offshore agency perspective and, until that changes, China will remain stifled in terms of both market participation and liquidity.
That said, through organisations such as PASLA, the industry had some excellent dialogue with both the Shanghai Stock Exchange and Hong Kong Stock Exchange last year. Participants remain positive in their commitment to working closely with them in order to help formulate a more workable framework that will better serve Chinese market and foreign institutional investors going forward.
McCardle: The emerging and developed markets have not really changed in 2015. Some people see South Korea becoming more developed, with the focus and level of trading in the market, but I still believe that it is more likely to have three levels of market development in Asia. South Korea and Taiwan can be seen as developing, somewhat ahead of emerging, but not fully developed yet.
Fannin: Asia continues to boast an impressive landscape of untapped emerging markets that offer attractive return profiles for securities lending participants. Most notably, the industry is acutely focused on developments pertaining to the Shanghai-Hong Kong Stock Connect initiative in respect of the ability to lend and borrow Chinese inventory. The launch of a Shenzhen-Hong Kong Stock Connect platform is also widely anticipated and it is thought that this would be an important milestone for index providers to include China in various global indices at some point. This would ultimately serve as a critical source of supply for the purposes of securities borrowing and lending via the Stock Connect schemes.
Other jurisdictions, such as Indonesia, continue to progress developments of their offshore securities lending frameworks. Indonesia, having previously engaged its counterparts in South Korea to facilitate creating a robust securities and lending offshore market, is hopefully anticipating a model that will closely resemble the successful one established in South Korea. From a demand perspective, Indonesia promises an attractive demand profile, given its changing economic backdrop.
Prout: Although still making changes to their operating models to support securities borrowing and lending activity, South Korea and Taiwan can broadly be considered emerged markets in Asia. Malaysia is a key emerging market in the region that appears to be gaining momentum with both local and international players. Other markets that have signalled an intention to develop securities lending activity include Indonesia, the Philippines and Vietnam, but any development in these markets is likely to be cautious and gradual.
Solway: One could consider markets open for 10 or more years to be developed or mature by nature, depending on local regulations that may restrict access and therefore liquidity. In Asia, this would include Hong Kong, Japan, South Korea, Singapore, Australia, New Zealand and Thailand. Taiwan continues to lag a number of markets due to regulations that constrain the freedom of investment that is enjoyed elsewhere. Malaysia, which opened up three years ago, continues to grow both in terms of supply and demand. Both of these markets are still considered by many as still emerging.
As to new countries developing a securities lending industry, all eyes are on China. Currently, foreign investors are not allowed to engage in securities lending in China and instead use the Hong Kong securities lending market as a proxy, where able. If China opens up securities lending to foreign investors, this will no doubt have a huge impact on the securities lending market in Asia.
How important is an active equity market to Asia’s securities lending industry?
Fannin: Generally, an active market would imply a strong supply of liquidity and large daily average trading volumes, which all are critical components to the level of securities lending demand. In the absence of sufficient liquidity, investors are unable to benefit from the advantages brought by securities lending through the various trading strategies. This is increasingly important as the various markets continue to grow.
York: Securities lending plays a pivotal role in providing both liquidity and settlement, not just in Asia but on a global basis. Furthermore, it reduces volatility and creates greater price discovery on exchanges and in bilateral markets. An active equity market is clearly a prerequisite to encouraging investment within any particular country, therefore creating a more fluid securities lending product offering. This in turn is likely to promote multiple investor strategies from which all market participants can benefit and engage.
Maury: The equity market’s health is essential to the securities borrowing and lending business. We need end-user clients, such as hedge funds and asset managers, to be active and successful in their trading to be the catalyst for securities lending markets. Furthermore, a lack of liquidity and light volumes do not favour the securities borrowing and lending markets We also believe that unhealthy market valuations are not conductive to the long term development of our businesses. Beyond liquidity, depth and market valuation, the securities borrowing and lending business requires healthy legal, regulatory and fiscal environments. There are complex legal environments in Asia, while stamp duties are another form of unfortunate restrictions to the business.
Measures: The two things go in lockstep: one of the hallmarks of an active market is a vibrant lending (short selling) market. The foundation of any successful securities lending market is the ease of conducting international investments, sufficient liquid stocks to trade in, securities borrowing and lending rules that can are viable for the international borrower community, and limited restrictions on short selling. Importantly, tax legislation needs to keep pace with market evolution so that loan transactions are not treated as sales activity. The more constrained and restricted a market, the less attractive it is for securities lending, which in itself limits liquidity in the equity/bond markets and makes the market more expensive for capital investments.
Winiger: An active equity market is very important. Securities lending is only a secondary market and depends on an equity market flows to generate the demand for short selling and hedging needs.
Solway: An active equity market is extremely important because consistent activity drives securities lending returns. The active and volatile equity market in 2015 demonstrated this relationship, as volatility drove earnings up significantly during the first half of the year.
The equity market’s volume, liquidity and transparency are also key considerations. Japan and Hong Kong are strong markets in terms of volume and liquidity, with the remaining markets perhaps less so.
Before participating in securities lending in Asia, investors need to be aware of the breadth and depth of the Asian equity market and know any nuances or limitations that may prevent them from completing their investment strategies during their desired time-frame.
With specific regard to transparency, Asia does very well. South Korea and Taiwan may not be as liquid as some other markets, but their securities lending platforms are among the most transparent of all markets globally.
Overall, the Asian equity market is very active, volatile and driven by fundamentals—all good characteristics for generating securities lending revenue.
Raccat: The cash equity market is the driving force of our securities lending industry. The ability to short sell a stock has a direct impact on our activity.
In Asia, many stocks in Hong Kong or Taiwan cannot be short sold at all, which can limit the utilisation rate of a long portfolio. Regular bans on short selling occur when stock markets tumble. Securities lending continues to suffer from a bad reputation.
Have the close ties that smaller Asian economies have to China been an advantage or disadvantage for securities lending participants and short sellers? Is this likely to change?
McCardle: In the first half of the year the economies linked heavily with China did see an advantage, but in the second half of the year, as China slowed, those countries also saw the downside to the relationship.
Fannin: Asia’s regional economies are directly or indirectly exposed to the health of the Chinese economy (as are most global economies). This may benefit or equally hinder the securities lending industry. With a slowing growth rate in China, directional demand has manifested in some jurisdictions most exposed to this theme, particularly those who maintain China as a key export trading partner (for example, within Australia, Singapore and South Korea).
The volatility of regional exchange rates and the pursuit for export-led economies to remain competitive in this regard has also presented opportunities for revenue to be generated for clients who participate in securities lending.
Prout: Following the significant market volatility in the Chinese stock markets in the second half of 2015 and the public condemnation of short selling by the Chinese government, many short sellers, especially those in Hong Kong, scaled back their activities in the latter part of the year. This has clearly been a disadvantage for the prime brokers servicing these clients in the region as lower levels of demand from short sellers hit their bottom lines.
On the other hand, the close links with China seem to be working well for the local Chinese-owned brokers in Hong Kong. Their access to wealthy Chinese investors is allowing them to take advantage of the opportunities created by the investors’ demand to short international markets and the access to attractive inventories for their emerging securities lending programmes.
Raccat: One of the key challenge for securities lending participants is to offer stable inventory to the sell side. Demand is there and keeps increasing but thin liquidity available for short selling can refrain from entering into a deal. This is unlikely to change anytime soon. For example, many stocks in Hong Kong are held by investment vehicles not part of any securities lending programme. On top of that, it is fairly usual to see some funds pulling out temporarily from lending programmes in case of high volatility in the market.
Solway: In 2015, all of Asia’s securities lending markets felt the effects of the market volatility caused by China as it continues to open up its market to the rest of the world. Currently, foreign investors cannot participate in securities lending in China, but instead must use other Asian markets as proxies. Technology focused economies, such as Taiwan, South Korea and Japan, can serve as proxies for China as does Hong Kong, especially with the Shanghai-Hong Kong Stock Connect platform now in place.
China’s slow transformation from a production to a consumption economy, combined with is relative slowdown in GDP, has had impact on a number of sectors with commodities being hardest hit. An obvious market that in turn has been affected is Australia, where many mining companies, both large and small, saw earnings slump in 2015.
There is certainly potential for change. In Taiwan, the pro-Chinese KMT political party was recently replaced by the pro-independence DPP, party which may affect trade relations between China and Taiwan with potential knock-on effects for the rest of Asia. Such change and uncertainty ultimately attracts speculation both at the macro and micro level.
Maury: It is a relative disadvantage as non-Asian investors and clients often lack the breadth to focus on smaller economies, where we believe there could be interesting opportunities for them. Also, the flows are massively macro-driven with monetary policies playing a major role and somehow swamping more local factors.
If we dig further into the question, we can observe a pattern; local investors are focused on their own markets but very few are going into other Asian markets. Asia, in that respect, displays very little unity.
The link to China benefits the small number of sophisticated cross-border sellers in Asia (outside of Japan) because most of the sectors are somehow linked to the Chinese economy. This explains the short selling of sectors across Asia, such as the recent action in the commodities markets. In other words, excluding Japan, many Asia Pacific markets have benefitted from the Chinese market. Australia is a clear example.
The link does not favour autonomous development of smaller Asian markets, and sometimes penalises local long-term investors. From our perspective, this is not a positive environment and it is unlikely to change rapidly. One rebalancing factor for the longer term could be the expansion of India.
York: Naturally, one would expect both countries and companies alike with deeply integrated supply chains with China such as Hong Kong, Japan and South Korea to be more affected in terms of short side demand. In Europe, Germany is arguably most at risk as a producer of capital goods to China and large commodity exporters such as Australia also find themselves in the firing line, especially within the mining sectors and such like.
One way to amplify the trade effects would be through a massive depreciation of the currency in an attempt to revive Chinese export-led growth and that is what we have been witnessing over the last few months. That said policy makers have strengthened the yuan rate since early January. However, in doing so, the central bank has burned through more than $400 billion in foreign reserves to prop up the yuan since the surprise August devaluation, raising concern that the cash stockpile may soon fall below adequate levels.
Measures: The volatility in the local economies in Asia are always, to some extent, going to take their lead from how the dominant economies in the region are faring, especially China and Japan. However, each country has its own dynamic around balance and composition of trade, exposure to foreign exchange and trade reserves. Exposures to global pressures such as commodity prices and internal political pressures will affect how each country deals with the reverberations from changes in those economies. For example, an economy such as Malaysia is more likely to be driven by the price of oil and foreign exchange devaluations than by events in China, whereas Hong Kong will be materially more affected.
China has already experienced its first wobble of 2016, which automatically affects all of the Asia Pacific and even global markets. What are your predictions for the next 12 months?
McCardle: I think that people will continue to concentrate on Japan, Hong Kong and South Korea as the revenue drivers in 2016, but, as always, if there are opportunities in markets such as Malaysia, Taiwan or others, there will be activity there also. Asia is a region that is hard to predict, as we saw in 2015. Last year in particular showed that there are many influences in this region compared to others, as the regulatory environment is less aligned and, as we have seen, things such as elections have large impacts on the markets.
Prout: Since the beginning of 2016, FIS’s Astec Analytics has observed a 10 percent reduction in the available supply of Asian securities for lending. This is particularly notable in the Hong Kong market, which has seen the largest decrease of over 12 percent. The well documented sell off among long investors is likely to account for this, at least in part, and while this does result in supply constraints, the prolonged market volatility does create opportunities for the short side of the market.
Looking more broadly, the much discussed regulatory changes will continue to shape market activities in 2016, with further increases in the use of synthetic financing options likely as prime brokers seek to maximise their balance sheet efficiency. From a technology perspective, at FIS we are already seeing the effects of this as banks seek to optimise their IT infrastructure with multi-asset solutions that can simplify their IT footprint. Coinciding with this is a clear industry move towards hosted and managed services for their platforms, driven by firms seeking to take advantage of the expertise of their technology providers and benefit from operational efficiencies. We see both of these technology trends continuing throughout 2016 and beyond.
Raccat: Volatility will continue, consistent and stable supply will become more critical and in regards to China, we shall see. The regulators have surprised us in the past with their speed and pace of market change, but this may be slowed down in line with the economic environment. But you never know, the regulators may see securities lending for what it is—a market facilitator—and surprise us by reviewing market rules to attract more market participants.
Solway: Over the next 12 months, we believe market volatility will undoubtedly continue, fueling the type of activity that provides opportunities to lend securities. There is still a great deal of uncertainty in the market regarding regulation, currencies, commodities, and monetary and fiscal policy.
Similar to 2015, Hong Kong and Japan will continue to generate good returns, and macro trends (for example, the U.S. political situation) will likely influence the market. Currencies have a huge influence on markets and so drive volatility. It’s also worth remembering that weaker emerging market currencies will suppress securities lending earnings in US dollar terms.
On a country-specific level, I see the following. South Korea returned to the third spot in the Asian securities lending space in 2015, according to our data, and these high levels of activity are set to continue into 2016. In Malaysia, loan volumes grew five-fold above their 2014 levels throughout 2015, according to Markit, so in 2016 spreads may compress as additional new supply is added during the year. In Thailand, given that average borrow rates remain healthy due to limited supply, any new entrants to lending will likely see good returns in 2016.
Japan spreads were compressed due to broader supply being available in 2015, and this trend will likely continue in 2016, albeit on a healthy volume base. Negative interest rates are already a reality—the impacts of which are yet fully to be seen.
York: Being the second largest market in the world, China is always going to be a major cause for concern across all global markets if it continues to go through a period of correction. With ongoing weakening economic data, a devaluation of the yuan, falling commodity prices and growing concerns over aggressive credit expansion and the potential for bad loans—all of these issues weigh heavily on market sentiment.
A plethora of attempts have been made by the central bank to intervene within the capital markets in a bid to buoy mainland indices and artificially introduce restrictive selling practices, particularly on major shareholders. If this trend continues throughout the year, it will only serve as a selling proxy for China in markets such as Hong Kong, where investors look to bypass the ongoing intervention. This in turn is highly likely to induce further securities lending activity.
Hong Kong has long benefited from a unique blend of Chinese growth and a well-established currency peg to the US dollar. If China continues to slow down and the US Federal Reserve stays on the current path of raising rates, Hong Kong may face the possibility of a property and equity market downturn, again which would culminate in specific strong sector shorts for the securities lending market.
Maury: Overall, global equity markets have been expensive. Indeed, equities are very much in a bull market, so it is therefore not surprising to see it undergo a correction. However, given the steep losses so far, it will take some time to recover, so I expect some volatility in the first half of 2016 and improvements later in the year.
We need further transparency before the uncertainty will subside, including on US Federal Reserve interest rate decisions, the Bank of Japan’s path to reach its inflation target, and Chinese growth. As decisions unfold and clarity sets in, a relief rally in the second part of the year is a plausible scenario.
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