Securities lending siesta
06 March 2012
Spain’s securities lending market has dropped off the radar in the wake of short selling bans
Image: Shutterstock
Spain’s securities lending markets have been forgotten as the country’s sovereign debt and banks’ LTRO participation take centre stage. Meanwhile, low trading volumes after a six-month short selling ban are only just starting to become known.
In its financial results for 2011, Bolsas y Mercados Espanoles (BME), the stock operator of all markets and financial systems in Spain, writes that the ban on short selling in place since August and throughout the year “undermined cash equity market turnover and led to a liquidity squeeze in the order book, resulting in bid-offer spreads widening and an increase in implicit transaction costs for investors”.
Revenue in the equity business unit during the year dropped 3.4 per cent versus 2010 to €133.3 million. The number of equity trades totalled 46.1 million with a turnover of €927.3 billion. These figures imply a 13.0 per cent increase in the number of trades and a 10.7 per cent reduction in turnover, year-on-year, reports BME.
The high levels of volatility and uncertainty seen in the third quarter which spurred regulators to impose the ban persisted in the final quarter of 2011. As a result, in the fourth quarter, trading value in equities was €206.6 billion, a year-on-year decline of 29.8 per cent, with trades down 9.5 per cent. The impact on derivative market volume was even bigger, with a 44.1 per cent slump in the notional value of index derivatives and a 30.1 per cent drop in equity derivatives compared with the same quarter the previous year.
Yet, equity investment flows channelled through the exchange in 2011, including shares already admitted to trading and new shares admitted, amounted to €37.7 billion. This reflects growth in investment flows in both newly-listed companies and companies already admitted to trading. The total implies a 35.1 per cent increase compared to investment flows channelled through the exchange in 2010, the fourth-highest figure in the history of the Spanish securities market.
In the context of investment flows in equities, €4.0 billion were instrumented via scrip dividends in 2011, a 91.9 percent increase versus 2010. Meanwhile, fixed income trading volume soared by 41.4 per cent to €5.6 trillion in 2011.
Size and structure
Though the ban was lifted in February, the market continues to become increasingly long. According to Data Explorers, the LongShort ratio for Spanish equities stands at 7.1, the highest it has been since mid-April of 2011. The value of stock on loan is $7.4 billion against a lendable supply of $53.2 billion.
Securities lending is common practice in Spain. Every loan executed on securities listed on the Spanish market must be communicated to Iberclear, the Spanish CSD, which keeps control of security loans outstanding in separate client accounts.
According to the Spanish markets regulator, Comision Nacional del Mercado de Valores (CNMV), legislation allows margin trading and provides two different systems for securities lending. The credito system is commonly used by retail investors dealing in Ibex35 stocks. The prestamo system is more commonly used by institutional investors and covers a broader range of securities, including ETFs and shares listed on Latibex, the only international market for Latin American securities. Margin trading using the prestamo system is the most important method for short selling on the spot market, notes CNMV.
But lately, interest has been diverted to the repo markets and the participation of Spain’s financial industry in the LTRO. Money and risk managers in European banks will not be very much enthused with securities lending, said Jorge Vrljicak, analyst at Westside Consultants, instead, they will be watching FX markets closely amid criticisms that the ECB’s intervention is causing currency debasement.
“The interest rate parity between the euro and the dollar has embedded an average spread of 50 basis points since before 2008. That spread is waning,w having reached 80 basis points during the worst days of the crisis and is now at 40 basis points. This is because banks are perceived less risky and all these contracts go through banks,” Vrljicak explains, adding that he sees securities as taking a second or third row position in the eyes of investors.
He also sees a potential shift in the high quality government debt markets in an environment flush with the ECB’s money, limited leverage and low interest rates.
“The LTRO displaces certain liabilities on a bank’s balance sheet. Banks don’t have unlimited leverage, so selling low yielding bonds and taking on second or third grade could become attractive. For example, it is not that you have a bund base and on top of it you pile Spanish bonds, because you don’t have leverage wiggle room, it is that you sell bunds and buy Spanish or Italian bonds. So there may be a shift in the market that will impact collateral” Vrljicak says.
Troubled economy?
Though unemployment in the country remains persistently high, hovering at around 20 per cent, commentators are noting that there have been positive signs that the government is getting control of public finances.
Vrljicak notes that the consolidation of “caxias”, or domestic banks, is moving forward in a positive direction. Meanwhile, Mariano Rajoy, Spain’s prime minister, is reigning in public finances. One of the more recent moves by the government has been to get municipalities’ public debt out in the open. Still, a larger than expected deficit from the previous government, which was 8.5 per cent of GDP in 2011 compared to a target of six per cent, will make it hard to meet the EU-agreed deficit target of 4.4 per cent this year.
The Financial Times reports that Rajoy said Spain would do “everything we can” to cut the budget deficit because the public sector could not carry on spending €90 billion more than it earned each year, but that this statement was wrapped in a request for other eurozone leaders to soften deficit targets in the face of an imminent recession.
This may cause controversy within the EU, but for Spanish companies, it may have few implications. “Spain’s economy is still not doing well and mortgages will continue to be a problem for a while, but Spanish companies diversify their investments globally. Telefonica, for example, has more investment in Latin America than in Spain and it is the same for renewables company Iberdrola in the US. Union Fenosa and Repsol also have large investments outside Spain” Vrljicak says.
Opening markets
Of all the criticisms levelled at Spain, perhaps the most heated discussions, with both trade and post-trade infrastructure market participants, are in response to the country’s protectionist leanings.
BATS Chi-X Europe (BATS) recently bumped their market share to 3.4 per cent in January 2012 compared to 1.9 per cent in the same month the previous year. But BME still controls 95 per cent of trading. And in terms of post-trading, when BATS announced four-way CCP interoperability for the markets it trades within Europe, only Spain was excluded.
However there have been some signs that the country will move forward on opening up the market to competition.
When the crisis came to a head in the summer of 2011, Spain’s reliance on domestic structures had caused risk to accumulate. Spanish banks were holding Spanish government bonds with all transactions going through the domestic clearing system.
As this risk reached thresholds of tolerance, some banks went to outside CCPs – Eurex Clearing in Germany and LCH.Clearnet in France and the UK. By September 2011, the Spanish bond government clearing services at LCH Clearnet cleared trades with a total notional value of more than €1.5 trillion. Nine Spanish banks were active as direct clearing members and a further two operated as repo dealers under a third-party clearing arrangement.
Since then, MEFF, the domestic CCP, has changed its model to be compatible with other CCPs in Europe.
Meanwhile, Spanish banks have been the biggest receivers of the ECB’s three-year LTRO. The first round of the ECB’s liquidity programme saw Spanish banks increase holdings of sovereign bonds by 29 per cent to €230 billion over the two-month period between December and January. The second liquidity injection shows that a further €530 billion has been tapped by some 800 banks, compared to €489 billion by 523 banks in December 2011, of which almost 50 per cent of the latter is attributed to Spanish and Italian banks.
“Aside from accessing this funding from central banks, the crisis has pushed domestic banks to avail of international liquidity funding through repo by using non-domestic CCPs, which has helped Spanish banks weather the storms,” says Godfried De Vidts, chair of the European Repo Council of the International Capital Market Association (ICMA).
“I think this opening up is irreversible and particularly new regulations, such as EMIR and MiFID II, are going to further underpin this. ESMA has the powers to name and shame if national authorities don’t apply new regulations within three months. In a way, domestic limitation of markets is over. In the last two years, Spain has realised that domestic barriers do not help the market, instead of resisting change, endorsing change is the strategy now and I think it will continue to be going forward,” he adds.
CSD regulations from the European Commission, anticipated for publication in March, are expected to target cross-border charges in Europe and national favouritism. One of the goals of the single market is that the place of issue for securities will no longer be the determining factor for where investors hold them.
But De Vidts believes that there will be more opening up beforehand. Iberclear is part of the Link Up Markets initiative with Clearstream in Luxembourg, which will allow investors to keep securities with the ICSD instead of Spain for non-domestic banks.
“For an international client, like an insurance company which has equities across many countries, it makes sense to consolidate their holdings in one place, it is much cheaper administratively. So I see this interconnectivity as a sign that the market will open up before the regulation is final,” he says.
It remains to be seen what that might mean for securities lending markets.
In its financial results for 2011, Bolsas y Mercados Espanoles (BME), the stock operator of all markets and financial systems in Spain, writes that the ban on short selling in place since August and throughout the year “undermined cash equity market turnover and led to a liquidity squeeze in the order book, resulting in bid-offer spreads widening and an increase in implicit transaction costs for investors”.
Revenue in the equity business unit during the year dropped 3.4 per cent versus 2010 to €133.3 million. The number of equity trades totalled 46.1 million with a turnover of €927.3 billion. These figures imply a 13.0 per cent increase in the number of trades and a 10.7 per cent reduction in turnover, year-on-year, reports BME.
The high levels of volatility and uncertainty seen in the third quarter which spurred regulators to impose the ban persisted in the final quarter of 2011. As a result, in the fourth quarter, trading value in equities was €206.6 billion, a year-on-year decline of 29.8 per cent, with trades down 9.5 per cent. The impact on derivative market volume was even bigger, with a 44.1 per cent slump in the notional value of index derivatives and a 30.1 per cent drop in equity derivatives compared with the same quarter the previous year.
Yet, equity investment flows channelled through the exchange in 2011, including shares already admitted to trading and new shares admitted, amounted to €37.7 billion. This reflects growth in investment flows in both newly-listed companies and companies already admitted to trading. The total implies a 35.1 per cent increase compared to investment flows channelled through the exchange in 2010, the fourth-highest figure in the history of the Spanish securities market.
In the context of investment flows in equities, €4.0 billion were instrumented via scrip dividends in 2011, a 91.9 percent increase versus 2010. Meanwhile, fixed income trading volume soared by 41.4 per cent to €5.6 trillion in 2011.
Size and structure
Though the ban was lifted in February, the market continues to become increasingly long. According to Data Explorers, the LongShort ratio for Spanish equities stands at 7.1, the highest it has been since mid-April of 2011. The value of stock on loan is $7.4 billion against a lendable supply of $53.2 billion.
Securities lending is common practice in Spain. Every loan executed on securities listed on the Spanish market must be communicated to Iberclear, the Spanish CSD, which keeps control of security loans outstanding in separate client accounts.
According to the Spanish markets regulator, Comision Nacional del Mercado de Valores (CNMV), legislation allows margin trading and provides two different systems for securities lending. The credito system is commonly used by retail investors dealing in Ibex35 stocks. The prestamo system is more commonly used by institutional investors and covers a broader range of securities, including ETFs and shares listed on Latibex, the only international market for Latin American securities. Margin trading using the prestamo system is the most important method for short selling on the spot market, notes CNMV.
But lately, interest has been diverted to the repo markets and the participation of Spain’s financial industry in the LTRO. Money and risk managers in European banks will not be very much enthused with securities lending, said Jorge Vrljicak, analyst at Westside Consultants, instead, they will be watching FX markets closely amid criticisms that the ECB’s intervention is causing currency debasement.
“The interest rate parity between the euro and the dollar has embedded an average spread of 50 basis points since before 2008. That spread is waning,w having reached 80 basis points during the worst days of the crisis and is now at 40 basis points. This is because banks are perceived less risky and all these contracts go through banks,” Vrljicak explains, adding that he sees securities as taking a second or third row position in the eyes of investors.
He also sees a potential shift in the high quality government debt markets in an environment flush with the ECB’s money, limited leverage and low interest rates.
“The LTRO displaces certain liabilities on a bank’s balance sheet. Banks don’t have unlimited leverage, so selling low yielding bonds and taking on second or third grade could become attractive. For example, it is not that you have a bund base and on top of it you pile Spanish bonds, because you don’t have leverage wiggle room, it is that you sell bunds and buy Spanish or Italian bonds. So there may be a shift in the market that will impact collateral” Vrljicak says.
Troubled economy?
Though unemployment in the country remains persistently high, hovering at around 20 per cent, commentators are noting that there have been positive signs that the government is getting control of public finances.
Vrljicak notes that the consolidation of “caxias”, or domestic banks, is moving forward in a positive direction. Meanwhile, Mariano Rajoy, Spain’s prime minister, is reigning in public finances. One of the more recent moves by the government has been to get municipalities’ public debt out in the open. Still, a larger than expected deficit from the previous government, which was 8.5 per cent of GDP in 2011 compared to a target of six per cent, will make it hard to meet the EU-agreed deficit target of 4.4 per cent this year.
The Financial Times reports that Rajoy said Spain would do “everything we can” to cut the budget deficit because the public sector could not carry on spending €90 billion more than it earned each year, but that this statement was wrapped in a request for other eurozone leaders to soften deficit targets in the face of an imminent recession.
This may cause controversy within the EU, but for Spanish companies, it may have few implications. “Spain’s economy is still not doing well and mortgages will continue to be a problem for a while, but Spanish companies diversify their investments globally. Telefonica, for example, has more investment in Latin America than in Spain and it is the same for renewables company Iberdrola in the US. Union Fenosa and Repsol also have large investments outside Spain” Vrljicak says.
Opening markets
Of all the criticisms levelled at Spain, perhaps the most heated discussions, with both trade and post-trade infrastructure market participants, are in response to the country’s protectionist leanings.
BATS Chi-X Europe (BATS) recently bumped their market share to 3.4 per cent in January 2012 compared to 1.9 per cent in the same month the previous year. But BME still controls 95 per cent of trading. And in terms of post-trading, when BATS announced four-way CCP interoperability for the markets it trades within Europe, only Spain was excluded.
However there have been some signs that the country will move forward on opening up the market to competition.
When the crisis came to a head in the summer of 2011, Spain’s reliance on domestic structures had caused risk to accumulate. Spanish banks were holding Spanish government bonds with all transactions going through the domestic clearing system.
As this risk reached thresholds of tolerance, some banks went to outside CCPs – Eurex Clearing in Germany and LCH.Clearnet in France and the UK. By September 2011, the Spanish bond government clearing services at LCH Clearnet cleared trades with a total notional value of more than €1.5 trillion. Nine Spanish banks were active as direct clearing members and a further two operated as repo dealers under a third-party clearing arrangement.
Since then, MEFF, the domestic CCP, has changed its model to be compatible with other CCPs in Europe.
Meanwhile, Spanish banks have been the biggest receivers of the ECB’s three-year LTRO. The first round of the ECB’s liquidity programme saw Spanish banks increase holdings of sovereign bonds by 29 per cent to €230 billion over the two-month period between December and January. The second liquidity injection shows that a further €530 billion has been tapped by some 800 banks, compared to €489 billion by 523 banks in December 2011, of which almost 50 per cent of the latter is attributed to Spanish and Italian banks.
“Aside from accessing this funding from central banks, the crisis has pushed domestic banks to avail of international liquidity funding through repo by using non-domestic CCPs, which has helped Spanish banks weather the storms,” says Godfried De Vidts, chair of the European Repo Council of the International Capital Market Association (ICMA).
“I think this opening up is irreversible and particularly new regulations, such as EMIR and MiFID II, are going to further underpin this. ESMA has the powers to name and shame if national authorities don’t apply new regulations within three months. In a way, domestic limitation of markets is over. In the last two years, Spain has realised that domestic barriers do not help the market, instead of resisting change, endorsing change is the strategy now and I think it will continue to be going forward,” he adds.
CSD regulations from the European Commission, anticipated for publication in March, are expected to target cross-border charges in Europe and national favouritism. One of the goals of the single market is that the place of issue for securities will no longer be the determining factor for where investors hold them.
But De Vidts believes that there will be more opening up beforehand. Iberclear is part of the Link Up Markets initiative with Clearstream in Luxembourg, which will allow investors to keep securities with the ICSD instead of Spain for non-domestic banks.
“For an international client, like an insurance company which has equities across many countries, it makes sense to consolidate their holdings in one place, it is much cheaper administratively. So I see this interconnectivity as a sign that the market will open up before the regulation is final,” he says.
It remains to be seen what that might mean for securities lending markets.
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