What goes up must come down—how will a reduction in monetary stimulus change the securities lending market?
There is no doubt that the past few years have been challenging from a securities lending perspective, as broader economic factors just did not cooperate. But looking ahead, short and long term, we are confident things are changing—as central banks begin to reduce their stimulus measures, equity markets should begin to normalise and create a better platform for stronger returns.
To elaborate a bit more, we expect that normalised market conditions should lead to decreased correlations between stocks, and increased volatility. This would create more opportunities for the long/short strategies that generate borrowing activity. As individual stocks begin to move more in line with their underlying fundamentals, it should trigger greater conviction from investors, with a long and short bias.
We also feel that the different rates at which central banks taper their stimulus measures could result in a period of divergence among global economies, potentially skewering asset valuations. This could lead to increased mispricing and importantly, volatility.
Which region will rebound first?
In our view, the US equity markets will offer the most short-term opportunity for our clients. Strong corporate activity, including IPOs and M&A, along with increased volatility, present great opportunities for growth. US corporations are arguably holding record amounts of cash and shareholders want to see firms take action and focus on making strategic decisions, not just those about balance sheet operations such as buybacks and dividend distribution. Separately, conditions that generally support M&A activity are improving as concerns around near-term fiscal and monetary policy start to subside in the market.
In Europe, our outlook is much longer term and although sentiment is improving on a fundamental level in terms of the stability and integrity of the eurozone, there is still a great deal of uncertainty around the impact of ongoing regulatory reform.
That said, Europe has had its fair share of M&A activity, though ultimately it has not been the kind that creates securities lending demand. On a brighter note, Q2 2014 did provide some interesting opportunities for our clients around rights issuances, where we were able to optimise returns for our clients.
In Asia, the highly anticipated mutual recognition scheme between Hong Kong and mainland China could present the potential for significant growth in the region in the medium to long-term. Shorter term, we expect Hong Kong and South Korea to continue driving demand and overall, Asia will continue to represent the largest opportunity in terms of revenue growth.
Although we are encouraged by new markets such as China and Indonesia developing their infrastructure, we remain cautious in terms of material opportunities in the near future.
On regulation, what’s the latest and how is it affecting borrowing demand?
It’s been a long time coming, but regulatory reforms are moving into an implementation stage. Pretty much all of the major financial markets regulation will affect the profitability of securities lending for both agent lenders and borrowers, meaning industry participants will need to focus on prioritising resources towards higher-margin activity. This means the shift to intrinsic value lending is likely here to stay as the profitability of general collateral lending stands to be most negatively affected by the cumulative impact of tax and regulatory change. Now more than ever, this is causing beneficial owners to evaluate their lending parameters in line with their risk appetite and focus on higher margin activity.
Collateral flexibility is also an area that remains high on the agenda for borrowers, although less of a concern for intrinsic-value lending programmes. Concerns over a collateral shortfall following the introduction of OTC derivatives regulations appear to have faded somewhat as the consensus indicates that collateral requirements will be met in the short-to-medium term. Central counterparties and the potential capital efficiencies they may provide is an area of interest for the industry at the moment.
Separately, we have seen the borrower environment become increasingly competitive as we continue to see new entrants to the market, further driving the need for borrowers to differentiate their offerings and demonstrate value, whether it is by the markets they operate in, trading strategies, or access to demand. From an agent lender perspective, it is more important than ever to maintain strong relationships with counterparties to ensure that strategies are well aligned.
So, will 2014 mark the turning point for securities lending?
As we approach the mid-year point, we are encouraged by the improvement in the conditions required to generate securities lending demand. The quieter markets of the past few years are, in our opinion, cyclical and 2014 should be a year where we can look back and note real momentum and strong progress toward a full-scale rebound.
We expect deal activity to remain elevated as animal spirits in the corporate world continue to build. The normalisation of equity markets following the ultra-loose monetary policy employed by central banks will lead to a decreased correlation in stock prices and create opportunities for hedging strategies.
Finally, regulation, while still challenging, is beginning to crystallise, and will provide a level of certainty investors require in order to feel confident in putting assets to work and increasing their risk appetite.
Do you have any advice to beneficial owners looking to take advantage of an upswing?
Despite the cyclical lows we have seen in recent years, securities lending is still strategically important to a broad set of asset managers because it still generates significant returns and can really improve fund performance. Those that have kept lending over the past few years will already be well positioned if they are working with the right provider, but that right provider is key.
And it’s different for everyone—it’s really all about finding the provider who is aligned with your investment and lending philosophy—that is what matters most in the long run. Innovation and engagement will become key battlegrounds where providers seek to remain relevant. Devoting the necessary resources and discipline to these areas will become critical in order to continue driving the evolution of the industry.
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