What distinctive activity has 2018 seen in the Nordic equity securities lending markets?
Firstly, we have observed a distinctive shift in activity around equity ‘specials’. The oil sector and related supply chain companies have seen a reduction in short demand as global oil prices recovered and hedge funds, therefore, looked to other opportunities to deploy capital. Directional demand has moved to the retail sector, particularly for those companies burdened by large rental costs and less established online capabilities.
There continues to be a noticeable shift to move investment away from the high street and into e-commerce, to meet consumer demand for more convenient internet-based retailing. In the financial sector, increased short interest has developed across debt collecting companies, given concerns regarding overly complex balance sheets and cash flow accounting, coupled with a very crowded marketplace.
In terms of Nordic lending volumes, an increase in equity market volatility in this year has made it more challenging for traditional equity long/short hedge funds to find the investment conviction to deploy more capital to the short side. In contrast, an increase in trading activity from quantitative strategy funds, which thrive in more volatile conditions, has helped support a growth in lending volumes across the region relative to last year.
The focus on corporate governance is a well-known characteristic of the Nordic markets, and our clients often choose to structure their programmes in ways that ensure they retain the exercise of voting rights in their domestic market to some extent.
What trends are you seeing in terms of fixed income demand?
Financing trades remain a dominant global theme as borrower demand for high-quality liquid assets (HQLA) remains strong. Borrowers continue to request greater collateral flexibility and term trade structures given the focus on operational efficiencies and satisfying regulatory requirements, so those clients who are comfortable with these parameters will enjoy stronger utilisation and returns.
Going forward, the recently announced tapering and eventual termination of the European Central Bank’s asset purchase programme is expected to have little impact on Nordic fixed income lending markets. Any subsequent rise in interest rates across the broader region may fuel some interest, though at this stage it is hard to determine if the motives of demand for Nordic assets will alter.
The regulatory environment continues to evolve. What are the key impacts for securities lending and the Nordics?
The Securities Finance Transaction Regulation (SFTR) is a key focus for the securities lending industry, given the extent and complexity of the data obligations and tight reporting deadlines, with reporting now expected to be live in 2020, staggered by different entity types.
Beneficial owners should be aware of the requirements of the regulation as the reporting obligation rests with them, although Northern Trust will be providing reporting services on behalf of our clients as we recognise we are best placed to perform the SFTR reporting for our clients. We are working closely with the International Securities Lending Association and International Capital Market Association to define new industry best practice.
Regulatory capital continues to be a primary concern for borrowers. Access to assets held by capital efficient beneficial owners or those with less challenging netting opinions, so-called ‘smart bucketing’ or segregated lending, continues to gain momentum with our borrowing counterparts. Nordic clients typically enjoy a more efficient structure in terms of capital usage and so may benefit from this emerging trade type.
The Agency Lending Disclosure process, an industry standard which enables agent lenders to provide banks and broker-dealers with underlying principle level detail for each loan executed, can be operationally challenging for some banks within the Nordic region. The exclusive arrangement route can, therefore, be particularly suited to facilitating trades with the Nordic borrower community.
EU Money Market Reform, which comes fully into force in January 2019, will impact those beneficial owners who reinvest cash collateral in money market funds. For many money market funds, this will result in conversion to low volatility net asset value from constant net asset value and lenders captured by this regulatory change should be aware of its possible effects.
Finally, can you outline an overarching Nordic trend you’re seeing?
Increased interest and engagement in securities lending from portfolio management teams is to the fore. There is now an even greater focus on special term and bespoke trades, as clients look to generate low-risk alpha given ‘every basis point counts’ in the prevailing investment environment.
Our experience is that this is resulting in institutions now considering the benefits of securities lending, and collaborating with clients who have long-standing experience in lending. Risk management remains a key consideration, particularly in relation to counterparty exposure and acceptable collateral.
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