While the Asian market is still seen as an emerging marketplace, industry participants suggest technology and innovation remain a key component for growth in the securities lending industry
Asian equity owners have enjoyed revenue growth over the past few years. What has contributed to this growth and do you see this trend continuing?
Paul Solway: Asian markets are still seen as emerging marketplaces that continue to bring new stories both in terms of corporate and economic activity. This helps to provide traders with a plethora of long-short opportunities.
Japan and Hong Kong are still at the core of volumes and activity, given the former’s size and breadth domestically and the latter’s liquidity and access to corporate activity related to China.
Five out of the top 10 earning stocks in Asia last year were from Japan. The country is also the number one revenue earner with huge volumes. South Korea is third and, despite lower on-loan volumes, spreads of more than 300 basis points make up for that.
Going forward, the market in Asia will continue to grow. There are now nine securities lending markets with a further two markets potentially opening up as well, with the Philippines recently adding new short-sell rules and Indonesia looking at potential models.
However, there are risks, while Asian markets are often seen as engines of global demand, impacts can be felt if even one company’s performance is down. For example, Taiwan felt Apple’s lower Q4 results last year which no doubt impacted supply chains.
Zubair Nizami: An increase in specials activity across the Asia Pacific in the past few years has contributed to strong lending returns for asset owners in the region, specifically high asset values, healthy borrower demand, increased beneficial owner participation, and strong corporate deal activity. And while Asian markets overall have generated strong lending returns, we continue to see Hong Kong, Korea and Japan leading the way.
In Hong Kong, we saw renewed confidence in the local and mainland Chinese economies early last year, which led to an increase in the initial public offering (IPO) and secondary capital activity. In the second half of the year, US/China trade tensions and rising US interest rates resulted in increased market volatility and consequently increased directional trading opportunities for hedge funds.
In Japan, lending activity was boosted by robust corporate deal flows, as Japanese corporates, flush with cash in a continued low-interest environment, look to consolidate or seek opportunities abroad to diversify their revenue streams.
In addition, we saw demand driven by familiar themes in the past such as corporate governance concerns and accounting scandals, as well as directional demand in the consumer electronics sector as increased manufacturing competition from China continues to place further pressure on leading firms in this industry.
South Korean lending demand was once again strong due to renewed interest in the heavy industry and shipbuilding sectors. Biotech and pharmaceuticals also generated demand on speculation of industry consolidation, concerns over accounting irregularities in specific firms and the overvaluation of the sector.
David Lai: At its simplest, the continued upward trend in index levels and equity prices have accounted for some of this increased revenue. We have also seen global funds allocate more to Asia, which has not only increased the amount of inflows into the region but also led to the need to hedge some of this inflow. Finally, the continued development of the regions’ markets and securities lending frameworks has been critical.
We see the potential for this growth to continue; as a whole, the percentage of total Asian assets available for lending is still relatively low compared to a European or US perspective. Further, there are still some Asia Pacific markets that have yet to launch their own securities lending frameworks.
From our perspective, our agency securities lending clients have been actively seeking more of the potential alpha, which our 24-hour/’follow the sun’ trading approach can support. Clients located in Asia have also benefited from local support in the region from a dedicated team, who combine their deep understanding of the Asian markets with global expertise.
Simone Broadfield: There is a higher prevalence of assets trading on a specials basis within the region with market volatility providing frequent event driven and directional short opportunities. A smaller supply of lendable assets in the emerging markets is also a contributing factor with markets such as South Korea and Taiwan consistently returning high average lendable fees. Trading automation and greater transparency across the region in recent years has also allowed traders to better optimise performance.
Mark Snowdon: Our experience is that securities lending is increasingly viewed by clients as an integrated investment vehicle to complement the suite of front office activities in pursuit of meeting performance objectives. In this regard, beneficial owners are looking for ways to ensure their securities lending programmes are being optimised within prescribed levels of risk tolerance—allowing agent-lenders to work closely with beneficial owners on initiatives such as expanding collateral profiles or reviewing alternate trading structures such as pledge in order to drive increased returns. This is markedly different from previous days of securities lending being deployed almost to solely offset costs. It is also a trend that we see continuing.
How are technological advancements driving the securities lending industry in Asia?
Nizami: Speaking for BBH, the increased drive towards digitisation and automation continues to be a key trend not just within trading but also throughout our broader lending programme. We are investing significantly into both our e-trading platforms and enhancing our digital client experience for beneficial owners.
These enhancements have already had a positive impact across our entire business, with the trading execution discipline seeing some of the greatest benefits. Using modern data science tools, we are able to draw upon our historic execution data to optimise future performance, optimised pricing algorithms support and assist traders in their decision making and ensure e-trading and manual execution strategies are closely aligned.
A key benefit of technology deployment is increased efficiencies between counterparties, especially in executing volume activity, which enables our trading team to maintain a strong focus on higher revenue generating opportunities. As an intrinsic lender, with a strong focus on book optimisation, e-trading allows our trading team to increasingly focus their attention on oversight and extracting additional value for our clients.
Solway: Unlike other geographies, Asia still remains behind the curve in terms of technological advancement. Despite that, it is only logical that this gap will narrow in time as more institutions connect to new systems and improvements that have been made in other markets, like the US.
The make-up of the market also makes it harder for technology to develop in Asia given its disconnectedness, with traders in different markets having a diverse set of customs. This takes additional time and money for standardised systems to develop.
However, I expect there to be huge technological gains in Asia in 2019 given that investment is now starting to flow into the market in this region.
Technological improvements won’t just help traders focus on higher value items like specials or more complex trades, but they also enable back and middle office advancements that are critical in order for the rest of the trade lifecycle to function efficiently. Without this, post-trade issues become inevitable.
Snowdon: Advances in technological capabilities continue to transform not only the securities lending industry in Asia but the broader financial markets globally.
At Northern Trust, we view advancements in technology as an opportunity to enhance everything from trading strategies through to operational efficiencies and are focused on investing in those areas we believe will unlock value for our clients.
We’ve already seen significant investment across the industry into trading technology, which at Northern Trust, has allowed for greater automation of the trading function, allowing trading teams to focus on those opportunities that derive the most value for clients.
We are also working with a number of new technologies such as machine learning and robotics as well as developing our data analysis capabilities. Our expectation is that the practical application of these technologies will help drive competitive advantage in delivering greater efficiencies, optimising performance and enhancing the client experience.
Lai: The increasing ability to access accurate and timely industry data is leading to more transparency and the need to refresh transactions on a regular basis. At J.P. Morgan, we believe this is a positive trend that will help beneficial owners continue to utilise securities lending in the future.
We are focused on ensuring that more loans are handled automatically (both pre and post trade)—critical since info from Markit Group Limited shows that over 75 percent of all outstanding loans are at or below 50 basis points across the industry. By providing greater automation or straight-through processing (STP) for those transactions, our trading team can dedicate more time to value-added transactions, working closely with counterparties to identify and agree on trades with the potential to deliver higher value.
As markets in the region evolve, various corporate events affected demand in the Hong Kong market. To what extent has this impacted the Asian market as a whole?
Solway: Hong Kong will always be hugely relevant to Asia given that it is viewed as the easiest route to China, with topical sectors including property, heavy industry, transport and financials.
Last year was also a banner year for Hong Kong in IPOs. Companies such as Xiaomi, Meituan Dianping and China Tower listed and were responsible for 20 percent of the top 10 earners in Hong Kong.
Do you think harmonisation across the Asia Pacific can be achieved? What benefits would this bring?
Snowdon: Despite the Asia Pacific’s regulatory fragmentation, it is not unreasonable to expect the gradual convergence of securities lending rules across jurisdictions over time. Asian economies are all developing at a different pace, and hence regulators will have differing priorities, abilities and willingness to make changes to securities lending rules that align with a standardised model.
However, if one observes the overarching regulatory trends across the region, and recognises that ultimately there are clear benefits to participants in pursuing greater standardisation, it is reasonable to expect the Asia Pacific to follow this trajectory—albeit at a pace which complements the ongoing development of capital markets country-by-country.
Nizami: Harmonisation of rules and regulations in securities lending markets would have clear benefits, such as the standardisation of operational processes and a reduction in costs—ultimately making it easier for markets to thrive. This, in turn, would likely spur greater activity across the industry as it would encourage increased participation from asset owners, especially those who are currently reluctant to lend due to operational complexities. We believe that harmonisation is unlikely to occur in the Asia Pacific region in the near term. Each market in this region has its unique characteristics and differences that are driven largely by local laws and regulations, which would make standardisation difficult to achieve.
That being said, there has been a recent push by regional governments to increase cooperation. Particularly in the asset management industry, increased cooperation is visible through the implementation of passporting schemes, as well as broader discussions in regional platforms such as the Asia Pacific Financial Forum (APFF), whose goal is to accelerate development of robust and integrated financial markets in the region. We believe that over time these initiatives and increased cooperation between regional countries will lead to positive outcomes for the industry as a whole.
Broadfield: The potential upside from harmonising governance, market regulations, market trading rules and securities lending frameworks—to name but a few—across the Asia Pacific region would be significant to say the least, however, the likelihood of this being achieved is low in the foreseeable future, given the number of markets, regulators and exchanges who would need to align—it would be a herculean task.
Lai: While harmonisation may bring benefits that are not limited to securities financing, the idiosyncrasies of each regional market is to an extent what creates potential value in lending opportunities for counterparties.
From our perspective as a global securities lending agent, clients are looking for a provider that has the ability to support different transaction parameters to deal with regional market realities.
This could include booking a T+0 trade, booking across multiple currencies, booking an internal loan swap to make a client sufficient within a strict external cut off deadline, or booking holds that feed into Next Generation Trading.
Solway: Harmonisation in the Asia Pacific would definitely make it an easier market to operate in, and to some extent, the market is already seeing some standardisation such as a shift to T+2 settlement.
However, the beauty of Asian markets is there are a number of different factors which create different trading opportunities and volatility for market participants in the region.
What challenges do you see on the horizon for the securities finance industry in Asia?
Lai: There will likely be a continued focus on regulation and further market volatility. Off the back of this, we have an opportunity to provide further education on the features and benefits of securities lending as part of a well-functioning market. As Oscar Wilde once said: “You can never be (overdressed or) overeducated,” so I truly believe that our challenge and opportunity will be to continue to provide education about what our industry does.
In terms of challenges, the various evolving tax regimes in the region may impact the agency lending business. The industry will need to be mindful of these and undertake necessary due diligence to truly understand any potential impacts.
Broadfield: The reluctance of some markets within the Asia Pacific region to open up securities lending to offshore lenders will continue to provide challenges to the securities finance industry, although recent developments within markets such as China bode well for the longer term.
Solway: In Singapore, the Singapore Stock Exchange moved its settlement cycle from T+3 to T+2, which has created some operational difficulties for the local market as a result of early settlement regulations and this makes it hard for institutions to move securities to the right place on time. This has meant some providers of lending liquidity have reduced or stopped their lending activity.
Nizami: The past few years have resulted in robust lending demand in Asia. However, the outlook for the global economy is now looking increasingly uncertain, whether it is because of concerns over the state of China’s economy, the fallout from Brexit, geopolitical risks in Continental Europe, or the outcome of US/China trade talks.
While this could provide some pockets of opportunities for lenders in the region, the growing uncertainty and the effect it could have on the markets in terms of increased volatility could be negative for the industry.
We remain optimistic that this year will be another strong year for lending returns in Asia, however, these potential headwinds could result in increased cautiousness for investors, which may impact lending demand throughout the year.
Snowdon: The global challenges we see emerging across the broader beneficial owner community are very much applicable to those participants in the Asia Pacific.
Among these, the drive to enhance performance amidst rising cost pressures, while a challenge, is also helping to grow momentum in the securities lending industry both for asset owners and asset managers.
Can you name a market driver in Asia that industry players must be aware of for this year?
Broadfield: We have seen increased efficiencies and transparency through the use of automation and analytics across the Asia Pacific region.
As per the global execution space, the use of automated trading technology to handle increased volumes of quant driven flow is increasing, as is a more recent trend towards using analytics and algorithms to automate allocation methodologies in order to significantly reduce manual touch points from the very beginning, through to the end of the lifecycle of a trade.
Therefore, it stands to reason, that the continued developments around these topics seen in other trading spaces will also cross-over into the securities lending industry.
Solway: Like other markets, technology is going to be a big driver for Asia given its lack of standardisation—this will be relevant for both the trading floor and the operational side of the business, which both need to develop symbiotically in order to get the most out of those developments.
Additionally, traders have a plethora of short-selling rules to consider across each market, so using technology as an enabler to navigate quotas and other exchange limiters will certainly be of benefit to the high-frequency or quant traders.
Lai: Regulatory change continues to be an area of focus in Asia and globally. Commentary in the last year or so has been on the pending Securities Financing Technology Regulation in Europe and the likely extraterritorial impacts; however, it should be noted that the Asia region is also seeing developments in the transparency and reporting space.
One example is the expected launch of Australia’s disclosure of interest requirements for the lending industry. Another is the recent introduction of the broker to client identification number model by Chinese authorities for NorthBound China Connect flows, which has the aim of enabling the more efficient monitoring of cross border market surveillance. J.P. Morgan has worked closely with local regulators, such as ASIC, to understand and prepare to meet future transparency and reporting requirements.
Overall, the need to provide timely transparent information will mean further investment from the industry as we believe Asia will continue to look to align with the objectives of the International Organization of Securities Commissions.
What will be the top securities lending trend in Asia this year?
Lai: Innovation will remain a key component of the securities lending industry in Asia this year as beneficial owners seek solutions to help generate additional alpha for their portfolio. The ability to use collateral pledge, for example, provides a scalable indemnification solution for beneficial owners and their counterparties.
The focus on China continues, as market participants look forward to more open securities and lending frameworks and, in many cases, are liaising with the relevant authorities to foster that environment.
Nizami: This is not necessarily a trend specific to Asia, but rather a focus for the entire industry, we expect the drive towards increasing efficiency and reducing operational costs to continue.
The way this will most likely be achieved is through the usage of more efficient trade structures such as pledge, rather than title transfer, and a continued focus on flexible collateral financing.
In addition, we expect a ramp up in the implementation of technology by industry participants at a much broader level, which will further automate low touch activities.
Solway: This year, from a market perspective, Japan will continue to be the main focus of participants as it pulls out of low growth rates. We have already seen a good uptick in activity this year in corporate activity—such as Takeda Pharm/Shire deal and the SoftBank IPO at the end of last year.
Technology will, of course, continue to be a key trend as it drives further efficiency in securities lending. It will help solve the issue of how to run this business better, faster, cheaper and safer.
Broadfield: Markets across the Asia-Pacific region are continuously developing, providing a plethora of growth and revenue optimisation opportunities.
At BNP Paribas, we anticipate a continuation of borrower demand for high quality liquid assets in particular for those assets held by lenders who are able to offer flexible collateral schedules and commit to longer term trade structures.
2019 will be a pivotal year as we capitalise on the enhancements and changes made across the global BNP Paribas’ agency platform throughout 2018 and expand our trading capabilities later this year with the addition of a trading desk in Hong Kong.
