What are you seeing in the Canadian securities lending market as a result of the financial downturn?
Canada’s securities lending market continues to maintain its strong position as a global safe-haven market in turbulent times, particularly now amid the global pandemic. Buoyed by the strength, stability, maturity and transparency of Canada’s financial and regulatory environment, and its continued AAA debt rating, Canada’s securities lending market is still among the world’s largest and most active.
Canada saw increased demand in both Canadian fixed income and equities. On the fixed income side, borrowers sourced high-quality liquid assets (HQLAs) – such as Government of Canada bonds and treasury bills (T-bills) – to shore up their liquidity needs. Demand for term-loans of HQLA jumped as borrowers looked to secure sources of liquidity. Given the situation of tremendous volumes in Q1, most notably in March, and the Bank of Canada (BoC) auctioning record T-bill issuance, while we saw borrowers continuing to move to shorter-dated Canadian HQLA issues. We also saw beneficial owners increase their sales of HQLA to support their own liquidity needs. With the recent introduction of the first-ever quantitative easing programme by the BoC, we have seen the need for borrowing term HQLA start to ease.
Canadian equities also experienced a significant increase in demand. Canada, being a resource-based market, was particularly hit hard with the recent significant decline in oil prices. We saw demand spike in the energy and materials sectors, especially in the small-to-mid-cap space, as questions arose concerning the viability of some firms – if they can continue their operations. The Canadian equity market experienced its quickest turnaround from a bull to a bear and back to bull market in history, and we have since seen some stability and normalcy return to demand and volumes within Canadian equity. We also saw our balances jump in the Canadian equity space, while overall this area was flat. We continue to see the majority of participants remaining in their securities lending programs.
How is the BoC maintaining market liquidity during this period of economic stress?
It has been an extraordinary time globally, which has resulted in unprecedented market events and measures in Canada. The BoC acted decisively and quickly, using the lessons learned from the 2008 financial downturn.
In early March, as global markets were quickly adjusting to a correction, the BoC reduced its benchmark lending rate at a record-setting pace. In response to the COVID-19 pandemic and dropping oil prices, the BoC, in a series of emergency 50bps movements, reduced its benchmark lending rate by 150bps to 0.25 percent. Prior to those emergency measures, the BoC kept its interest rate unchanged at 1.75 percent since late 2018.
In addition to its rate cuts, the BoC launched its first-ever quantitative easing programme in which it buys Government of Canada securities, provincial and commercial debt in the secondary market to help address strains in the Government of Canada bond market, thereby supporting Canada’s economy and financial system amid the major disruptions being experienced by COVID-19.
The programme expands the BoC’s balance sheet by a minimum of CAD 5 billion a week through purchases in the secondary market and this is expected to total CAD 200 billion by the end of 2020.
The BoC’s Commercial Paper Purchase Programme, which began on 2 April, supports the flow of credit to the economy by easing strains in Canada’s commercial paper markets over a 12-month period. CIBC Mellon is proud to be the selected custodian supporting this BoC programme. In addition, there are several other stabilising measures in place that were launched in response to the pandemic and designed to support and uphold the stability of Canada’s financial system. On top of that, the federal government has implemented emergency aid, fiscal stimulus packages and a tax deferral programme. In spite of this, at the time of going to press, Canada still maintains its long-standing AAA credit rating and is one of only 10 countries with this top credit status.
What do you see as some key themes facing the industry now and further into 2020?
The sectors most impacted by this economic slowdown – mainly the energy sector, materials, travel, airlines, and retail sector – are expected to continue to struggle and we plan to see continued securities lending demand in those sectors until we see an economic recovery on the horizon. Until we have that ‘light at the end of the tunnel’ clarity, we expect to continue to see those sectors pressured.
As a result of the increased market volatility recently experienced, we have seen some asset allocation shifts, due to market valuations and potential opportunities. For example, we saw some pension plan clients moving out of fixed income into equities. Furthermore, we expect the market correction will have many clients reviewing their portfolio composition and asset mix, as they reassess and rebalance their investments.
We continue to focus on collateral expansion as borrowers’ collateral needs change and evolve more quickly than ever. We are also continuing to provide client education on the trade-off between collateral flexibility, revenue generation and risk, and maximising their risk-adjusted returns.
All in all, Canada’s securities lending market can be expected to continue as a stable bright spot for lenders and borrowers, offering new opportunities along with the strength, stability and resiliency of the Canadian financial market.
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