One of the big stories to come out of Asia in 2019 was GPIF’s decision to partially pull out of lending. How big a shock was this and what is the impact on the market in Asia and further afield?
The decision of Japan’s Government Pension Investment Fund (GPIF) to suspend equities lending was based on its belief that the transfer of stock ownership rights during the course of a securities loan is “inconsistent with the fulfillment of the stewardship responsibilities of a long-term investor”.
Studies undertaken by regulators have reached a different conclusion. Most recently, the European Securities and Markets Authority (ESMA) published a detailed report on securities finance in December 2019 which found that “securities lending, if done in a controlled way, is an opportunity to add value for fund investors and [is] compatible with long-term investment strategies”.
We’ve not seen any measurable wider market impact from the GPIF suspension so far, which may suggest that beneficial owners agree with ESMA’s conclusions that lending and long-term investment are entirely compatible.
That said, it is more important than ever to have a strong corporate governance policy underpinning lending activities. This has been a major area of focus for regulatory bodies in recent years, including ESMA and the United Nations, both of which have written at length about what a strong corporate governance framework should entail.
Just this past December, the International Securities Lending Association announced the formation of a new Council on Sustainable Finance which will also introduce a new series of Principles for Sustainable Securities Lending, so there are resources for beneficial owners to turn to when looking for guidance around developing robust lending policies.
Every year the developing markets of Asia are catching up with the more established markets. Which Asian markets do you expect to shine in 2020?
I would expect that South Korea will emerge as the Asia Pacific (APAC) market to watch in 2020. It’s only been 15 years since South Korea established offshore securities lending but the growth we’ve seen has been absolutely tremendous. In that time we’ve seen insurance companies, sovereign wealth funds and others begin lending and participation has increased year on year. Today, South Korea is the fourth largest lending market in APAC with $120 billion in Korean equities available to lend at the end of Q3 2019, and with around $13.2 billion of that out on loan. We expect that number to grow as more institutions recognise the potential for yield enhancement through securities finance.
Lending in local fixed income has also been growing rapidly as demand for Korean treasury bonds (KTBs) has swelled. Roughly 10 percent of the overall financing flows in KTBs are for securities lending purposes, with the remainder of the demand stemming from onshore banks and alternatives raising short-term cash by pledging KTBs as collateral. IHS Markit found that just 3.3 percent of available Korean government bonds were being loaned out as of Q3 2019, so there is a huge amount of runway to grow lending activity in KTBs. Given all that, South Korea is definitely a market to watch.
Asia’s securities lending revenue outperformed on the global stage in 2019. What drove this trend and can we expect it to continue this year?
Certainly, the first part of 2020 is going to be dominated by the ongoing COVID-19 situation, which we must anticipate will continue for at least a while longer. Consequently, we can expect APAC lending activity to focus on tourism and retail securities, and particularly in any names linked to China.
Once that situation is resolved – or at least stabilised – we could see a jump in lending activity as investors try to make up for lost time. We suspect that stocks in technology, biotech and biochemical industries could be popular in 2020 in addition to names in the healthcare space.
Looking at individual APAC nations, in Australia we can’t see any specials on the horizon, so we expect 2020 lending to centre around the banking and retail sectors. Retail is also where we are looking for activity in Hong Kong, along with property, tourism and any names linked to the Chinese tech sector.
In Japan we’re looking at export firms and the technology sector, with tech also being the centre of lending activity in Taiwan, as it almost always is. Finally, returning to Korea, we are watching out for borrower interest in bio names, export and the tourism sector.
2020 will see big moves in Europe to harmonise markets and improve data quality and transparency under SFTR, could a similar framework exist in Asia? Would you want it to?
With so much focus on the Securities Financing Transactions Regulation (SFTR) in Europe, many participants forget that there are many markets in APAC that already offer full transparency around securities finance trades to both investors and regulators.
In countries such as South Korea, Taiwan and Malaysia, lending trades are facilitated by domestic intermediaries that include brokers, custodians and depositories. Those intermediaries track and record in some detail the movement of all domestically listed securities. Admittedly, those records don’t encompass the more than 150 fields required to be reported under STFR, but they certainly provide enough information to ascertain volumes and fees by security and tenure.
What other challenges do you see on the horizon for the securities finance industry in Asia 2020?
There are a number of issues across the region with different challenges in different regions. The perennial challenge in domestic-only lending markets such as India and China is the question about when will they open up. There’s little clarity on that issue on the horizon, beyond the much anticipated results of China’s QFII/RQFII consultation that could see more market friendly developments potentially being rolled out.
Then there are issues around the differing routes to market we’ve seen emerging globally in recent years and the ongoing questions about when we are going to see them being embraced in APAC. Just to mention a few, we’ve seen the rise of central counterparties (CCPs) really accelerating in the past year or two, with repo clearing at the Fixed Income Clearing Corporation in the US and the first cleared securities lending trades in Europe taking place in 2019. We’re yet to see comparable developments in APAC, although we are seeing clearing in Japan through the Japan Securities Clearing Corporation, but at this stage it’s only used onshore by domestic counterparts.
Then there is the development of pledge structures being deployed in other parts of the world, which has delivered some meaningful operational efficiencies over the title transfer model. There has certainly been an uptake of pledge models in APAC, but there is definitely room to do more in this space and to expand the utilisation of these types of structures.
One of the challenges here is that these changes require a substantial investment in time, documentation, manpower, financial resource and operational support, so we made need to provide a bit more of a helping hand to see more clients in APAC through those issues.
Additionally, from a technology standpoint, the industry continues to automate right across the spectrum of active regional markets, vertically through the asset classes as well as the varying degrees of specialness (general collateral, warm and specials). Clearly the quant/algo space requires as much straight-through processing (STP) as possible in order to reduce latency and increase volumes but it’s fair to say that the classic trader role even in securities lending is changing. Answering the question ‘why’ is becoming a differentiator across the street, as the buy-side continues to seek greater transparency over the qualitative and quantitative aspects of this business. This ‘datatech’ arms-race is set to continue whether it be lenders facing beneficial owners or primes feeding their hedge funds – all the while the cost-benefit conundrum keeps banging on in the background.
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