Trends in securities lending – Northern Trust’s perspective on 2020
18 June 2020
With pandemics, Brexit and trade wars, the macroeconomic landscape is fast changing beyond all recognition. But, despite this, the case for engaging in securities lending remains the same
Image: Peshkova/Shutterstock.com
For securities lending, 2019 was a mixed year with a feeling of continued buoyancy despite the headwinds that slowed growth in comparison to 2018. Political and economic uncertainty, driven by Brexit and international trade tensions, contributed to a general lack of conviction globally, resulting in reduced demand particularly in the equities space. This was evidenced by 14 percent drop in year-on-year revenues for Asia Pacific equities, according to DataLend.
Throughout this period, securities lending remained a low-risk way to generate additional returns on the investments of asset owners and asset managers alike, through a well-managed, risk-mitigated and transparent program.
Cost pressures and low yield – is securities lending the solution?
In an environment where cost pressures on asset owners and investment managers are growing and returns are more difficult to achieve, securities lending can make a difference by enhancing portfolio performance and offsetting costs.
As investors expand their securities lending programmes in a strategic response to the persistent low yield environment, the securities lending industry is channelling time and resources into developing new markets and revenue streams for asset owners and investment managers. In addition to bringing return benefits to investors, securities lending plays an important role in the smooth functioning of developed financial markets by supporting market liquidity and efficiency.
Case study – Australian superannuation funds
Evidence of the above trend can be seen in Australia. Superannuation funds in Australia currently manage AU$2.9 trillion (US$1.75 trillion) of assets and this is set to continue to grow, with a mandated employer contribution level of 9.5 percent per annum. As their assets grow, we have witnessed a trend of super funds re-visiting securities lending as an integrated investment solution. Amidst increased regulation, rising cost pressures and low returns, lending is viewed as a way to achieve increased returns with low and managed risk.
Optimising returns through a lending programme is often in the best interests of super fund members. We see increasing examples of clients entering lending for the first time, as well as long standing lenders who are already in a lending programme, seek opportunities to further optimise their asset returns through an expanded and increasingly sophisticated lending programme. As funds consolidate and increasingly internalise their investment decision-making, many are incorporating securities lending into their strategies.
Marrying securities lending and ESG
Alongside growing cost pressures and lower yields, another trend is the continued rise of responsible investing. Responsible investing is generally understood as the integration of environmental, social and governance (ESG) factors into investment processes and decisions. ESG as a concept had its first growth wave in the early 2000s, and is now a mainstream approach with many institutions now operating an active ESG agenda, although there are material differences in the specific execution strategies of different investors.
Sustainability is a core element of ESG investing. It is also a benefit that securities lending brings to capital markets generally, and to investors’ returns specifically. Marrying their securities lending programmes with their ESG principles is important to investors as they increasingly look to express their values through voting. On the surface, securities lending can appear to run counter to ESG principles, as when a security is on loan the investor loses the right to vote. However, securities lenders have been successfully balancing the returns from securities lending with the requirement to exercise good governance.
In partnership with a supportive, client-focused securities lending agent, the right balance is achievable, and will come from an agreed approach between the agent and the asset owner or manager. This agreement will cover points such as:
• Which securities need to be voted on
• Which type of votes are important – all or contentious-only
• Whether voting on a percentage of shares is acceptable, or do all shares need to be voted on
• Are all markets of equal importance when it comes to voting
• What revenue might investors be prepared to forego by recalling loans to ensure voting?
A securities lending agent such as Northern Trust will structure a bespoke solution to take these requirements into account, including the automated recall of securities that an investor wants to vote on, thereby combining lending returns with adherence to the ESG principles. Of course, voting is less of a concern for a fixed income lending programme, and some investors may choose to restrict their lending to non-equities only.
The securities lending industry is committed to helping investors align their lending programmes with their ESG philosophies. The International Securities Lending Association recently formed a Council for Sustainable Finance in a bid to introduce and promote ESG and Sustainable Development Goals principles for sustainable securities lending.
New markets for securities lending in 2020
With the addition of China A-shares into MSCI benchmark indexes in 2018 and the subsequent increase in weights in 2019, China continues to be one of the key opportunities for the securities lending industry globally, as borrowers and lenders progressively look for the ability to finance these securities.
Positive steps have been taken towards market liberalisation, there has been an increased offshore participation through the increased MSCI inclusion and links have been developed between onshore and offshore exchanges via Stock Connect; Chinese authorities are continuing to develop securities lending.
However, there is minimal usage of securities lending under the Stock Connect model as it restricts participation to only exchange members, thereby excluding asset managers and custodians who are some of the largest asset holders. The Pan-Asian Securities Lending Association continues to work closely with regulators and authorities to explore the development of a working offshore model and the expansion of the currently-functioning, yet lightly-used, onshore model.
Productive Pan Asia Securities Lending Association (PASLA) industry meetings took place about Indonesia, indicating a smoother road ahead by addressing the topic of improving the lending and borrowing model for that market. The future state will be a simplified bilateral model that is more transparent and inclusive from a participation perspective, with first phase progress expected in 2020.
The road ahead
Despite the backdrop of slower demand and diminished fees in 2019, the lending industry in Asia Pacific remains upbeat and growth-focused. With new markets, new approaches, and positive growth trends, the road ahead looks positive.
COVID-19
In the opening months of 2020, global markets experienced unprecedented volatility. For securities lending on the fixed income front, demand for high-quality liquid assets (HQLA) such as sovereign bonds increased in a flight to quality. Conversely there was also increased demand for emerging and frontier market sovereign debt that has been blighted by rating agency downgrades. For equities, discretionary spend-linked sectors which have been most exposed to the effects of the pandemic, have seen heightened demand from borrowers. Securities such as exchange traded funds are also well sought after as they are an efficient way for hedge funds to gain short exposure or as a hedging tool for their long exposures.
Securities lending activities have also been impacted by several developments in the market. For example, short selling bans introduced by a number of countries as a temporary measure intended to stabilise stock markets, have impacted hedge fund demand, although on a limited basis. The rising number of dividend cancellations by corporates, as encouraged by governing bodies and regulators around the globe, is also likely to have a slightly negative impact on securities lending demand over coming months, especially where the borrowing demand may have been tied to a company’s dividend distribution.
As we brace ourselves to deal with the reverberations of the COVID-19 pandemic, markets continue to be cautiously optimistic that the securities lending business will remain relevant in the “new normal” environment.
Throughout this period, securities lending remained a low-risk way to generate additional returns on the investments of asset owners and asset managers alike, through a well-managed, risk-mitigated and transparent program.
Cost pressures and low yield – is securities lending the solution?
In an environment where cost pressures on asset owners and investment managers are growing and returns are more difficult to achieve, securities lending can make a difference by enhancing portfolio performance and offsetting costs.
As investors expand their securities lending programmes in a strategic response to the persistent low yield environment, the securities lending industry is channelling time and resources into developing new markets and revenue streams for asset owners and investment managers. In addition to bringing return benefits to investors, securities lending plays an important role in the smooth functioning of developed financial markets by supporting market liquidity and efficiency.
Case study – Australian superannuation funds
Evidence of the above trend can be seen in Australia. Superannuation funds in Australia currently manage AU$2.9 trillion (US$1.75 trillion) of assets and this is set to continue to grow, with a mandated employer contribution level of 9.5 percent per annum. As their assets grow, we have witnessed a trend of super funds re-visiting securities lending as an integrated investment solution. Amidst increased regulation, rising cost pressures and low returns, lending is viewed as a way to achieve increased returns with low and managed risk.
Optimising returns through a lending programme is often in the best interests of super fund members. We see increasing examples of clients entering lending for the first time, as well as long standing lenders who are already in a lending programme, seek opportunities to further optimise their asset returns through an expanded and increasingly sophisticated lending programme. As funds consolidate and increasingly internalise their investment decision-making, many are incorporating securities lending into their strategies.
Marrying securities lending and ESG
Alongside growing cost pressures and lower yields, another trend is the continued rise of responsible investing. Responsible investing is generally understood as the integration of environmental, social and governance (ESG) factors into investment processes and decisions. ESG as a concept had its first growth wave in the early 2000s, and is now a mainstream approach with many institutions now operating an active ESG agenda, although there are material differences in the specific execution strategies of different investors.
Sustainability is a core element of ESG investing. It is also a benefit that securities lending brings to capital markets generally, and to investors’ returns specifically. Marrying their securities lending programmes with their ESG principles is important to investors as they increasingly look to express their values through voting. On the surface, securities lending can appear to run counter to ESG principles, as when a security is on loan the investor loses the right to vote. However, securities lenders have been successfully balancing the returns from securities lending with the requirement to exercise good governance.
In partnership with a supportive, client-focused securities lending agent, the right balance is achievable, and will come from an agreed approach between the agent and the asset owner or manager. This agreement will cover points such as:
• Which securities need to be voted on
• Which type of votes are important – all or contentious-only
• Whether voting on a percentage of shares is acceptable, or do all shares need to be voted on
• Are all markets of equal importance when it comes to voting
• What revenue might investors be prepared to forego by recalling loans to ensure voting?
A securities lending agent such as Northern Trust will structure a bespoke solution to take these requirements into account, including the automated recall of securities that an investor wants to vote on, thereby combining lending returns with adherence to the ESG principles. Of course, voting is less of a concern for a fixed income lending programme, and some investors may choose to restrict their lending to non-equities only.
The securities lending industry is committed to helping investors align their lending programmes with their ESG philosophies. The International Securities Lending Association recently formed a Council for Sustainable Finance in a bid to introduce and promote ESG and Sustainable Development Goals principles for sustainable securities lending.
New markets for securities lending in 2020
With the addition of China A-shares into MSCI benchmark indexes in 2018 and the subsequent increase in weights in 2019, China continues to be one of the key opportunities for the securities lending industry globally, as borrowers and lenders progressively look for the ability to finance these securities.
Positive steps have been taken towards market liberalisation, there has been an increased offshore participation through the increased MSCI inclusion and links have been developed between onshore and offshore exchanges via Stock Connect; Chinese authorities are continuing to develop securities lending.
However, there is minimal usage of securities lending under the Stock Connect model as it restricts participation to only exchange members, thereby excluding asset managers and custodians who are some of the largest asset holders. The Pan-Asian Securities Lending Association continues to work closely with regulators and authorities to explore the development of a working offshore model and the expansion of the currently-functioning, yet lightly-used, onshore model.
Productive Pan Asia Securities Lending Association (PASLA) industry meetings took place about Indonesia, indicating a smoother road ahead by addressing the topic of improving the lending and borrowing model for that market. The future state will be a simplified bilateral model that is more transparent and inclusive from a participation perspective, with first phase progress expected in 2020.
The road ahead
Despite the backdrop of slower demand and diminished fees in 2019, the lending industry in Asia Pacific remains upbeat and growth-focused. With new markets, new approaches, and positive growth trends, the road ahead looks positive.
COVID-19
In the opening months of 2020, global markets experienced unprecedented volatility. For securities lending on the fixed income front, demand for high-quality liquid assets (HQLA) such as sovereign bonds increased in a flight to quality. Conversely there was also increased demand for emerging and frontier market sovereign debt that has been blighted by rating agency downgrades. For equities, discretionary spend-linked sectors which have been most exposed to the effects of the pandemic, have seen heightened demand from borrowers. Securities such as exchange traded funds are also well sought after as they are an efficient way for hedge funds to gain short exposure or as a hedging tool for their long exposures.
Securities lending activities have also been impacted by several developments in the market. For example, short selling bans introduced by a number of countries as a temporary measure intended to stabilise stock markets, have impacted hedge fund demand, although on a limited basis. The rising number of dividend cancellations by corporates, as encouraged by governing bodies and regulators around the globe, is also likely to have a slightly negative impact on securities lending demand over coming months, especially where the borrowing demand may have been tied to a company’s dividend distribution.
As we brace ourselves to deal with the reverberations of the COVID-19 pandemic, markets continue to be cautiously optimistic that the securities lending business will remain relevant in the “new normal” environment.
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
