In 2024, there have been several challenges in the US equity securities lending market. One of the most anticipated changes, that took place in May, was the transition from a T+2 to T+1 trade settlement cycle. The T+1 shift presented a multitude of operational hurdles for securities lending, such as shortened processing time frames, real-time sell notifications, the need for more timely ingestion and automation of receipt and delivery of data, as well as the related recall cycle amendments associated with it.
Fidelity Agency Lending, and all other impacted businesses across Fidelity, began preparation well before the transition date. Because our securities lending programme was built with flexible, advanced technology, we were able to perform the changeover in a seamless fashion for clients and business partners. The first real test of operational readiness occurred one month later.
The Russell rebalance, an annual event in June, creates waves of settlement volatility. Fidelity Agency Lending was able to navigate the settlement storm in an untested T+1 environment with no negative impacts to clients or the borrower community. In addition to our technological connectivity with interested parties, our efforts also included attention to detail, extensive conversations, and leveraging enduring partnerships. There was no disruption to daily business-related flow or client returns.
Post T+1, Fidelity Agency Lending’s outperformance versus our peers in the T+1 markets increased by almost 10 per cent to 28.65 per cent (average for 1 June - 31 July 2024). The performance data is based on our competitive analysis that uses industry data provided by third parties. We believe this is attributable to our steadiness in the T+1 environment, and the fact that other firms’ technology may have required more restrictive measures post T+1.
An interesting carry-over topic from the US T+1 experience is the ongoing debate as to whether the APAC and EMEA regions could or should follow suit. In the wake of the Securities Financing Transactions Regulation (SFTR) implementation — which we believe had a less-than-optimal impact on settlement effectiveness — the consensus opinion from market participants is that a move to T+1, even in the more mature non-US markets, is still a much bigger leap than we saw in the US earlier this year.
The efficiency and rigour of the US market is not replicated in settlement regimes around the world, so many believe there are intermediate steps to be taken before a T+1 plunge across the globe. If, and when, the change occurs, Fidelity Agency Lending is focused on further strengthening the communication and structural operational efficiencies needed to service clients in an environment with stricter settlement guidelines.
Maintaining performance levels
Aside from the operational challenges that T+1 presented, the market climate itself offered its own obstacles. The first six months of 2024 proved to be relatively infertile when considering the primary drivers of securities financing revenue — hard-to-borrow or specialty securities and special situation related deal issues.
A myriad of drivers such as inflation, interest rates, market performance, regulatory and legislative changes, as well as geopolitical uncertainty, led the list of contributors to a marketplace devoid of real revenue opportunities. With that in mind, Fidelity Agency Lending was well positioned to take advantage of opportunities that did present themselves through leveraging proprietary automation, trading expertise, and extensive market penetration.
In fact, when compared to other third-party and custodial lenders, we are currently one of the top US equity warm and specials agent lenders. By incorporating technology and structural superiority, we were able to react to the ebbs and flows in the marketplace, and swiftly capitalised on trade opportunities as they revealed themselves.
In global trading going forward, client-driven connectivity will be a key factor with a recent inflow of election driven corporate events across EMEA and APAC. In addition, Fidelity Agency Lending will maintain levels of performance in areas requiring higher levels of systematic sophistication, such as qualified dividend income (QDI) and proxy management. To help manage these aspects of securities lending, our clients have access to PB Optimize, a fintech solution that helps with proxy screening, corporate governance, and global securities lending.
Clients can perform a what-if-analysis that allows for the modification of programme parameters and then calculates the impact to the funds, loan balances and revenue. As beneficial owners continue to focus their lending programmes to more granular criteria, we are committed to maintaining a service level our clients have come to depend on.
International headwinds for individual client performance include global tax complexities and suppressed directional demands, alongside a growing global base of supply. Performance is no longer about simply identifying areas of demand. Going forward, technological advances including real-time pricing and automated trading capabilities will ensure matching available supply with up-to-the minute demand side needs. Fidelity Agency Lending is well placed given our resource dedication to auto-trading tools and pricing algorithms supporting our street-facing applications.
Dealing with constraints
While overall US Treasury trading volumes are at extremely healthy levels, the number and depth of issues trading with any specialty has been muted year-to-date. We expect that any upcoming interest rate volatility could bring more spread opportunity to a broader number of issues in Q4 2024. With current US treasury on-loan figures topping US$1 trillion, financing liquidity is robust. The timing and depth of upcoming interest rate cuts will impact the scope of the short basis, as well as longer-term financing adjustments for the remainder of 2024 and beyond.
Also on the forefront for most firms is the required clearing of certain cash US Treasury security transactions by the end of 2025. The preparation for this regulation is well underway given that multi-trillions of dollars of Treasury activity occurs daily worldwide.
Around the world, regulations designed to update global capital standards have increased capital and operational requirements for some participants. Some regulations continue to negatively impact certain agents and borrowers and can potentially have a knock-on negative effect on lending clients.
Some agents are capital constrained and do not want to indemnify general collateral (GC) lending activity to the extent they once did because of additional capital required, and/or they are at capacity limits with borrowers. Some borrowers are also looking to optimise their capital and are seeking to borrow from clients who have a lower risk weighting to improve their returns.
Clients, who fall into one or both categories, can potentially see a negative impact to their revenue from securities lending. There are signs that may alert a beneficial owner to evaluate a new agent, such as if the current agent suggests parameters that could reduce revenue, lowering the fee split, or altering the indemnification guidelines.
Other signs to watch out for include a drop in revenue, or the current agent suggests models or counterparties that your firm may not be comfortable with from a risk perspective. Not all agents are the same, and with nominal effort, a beneficial owner may find a better solution for their stakeholders.
Future forecast
Looking ahead to the remainder of 2024, there are some significant upcoming events that should prove to be exciting and exert influence on the markets.
The upcoming US Presidential election scheduled for 5 November 2024, could provide some clarity to a marketplace in need of feedback and direction. With a potential shift due to regulatory and legislative changes, taxation, and social policy, we could see varying degrees of influence across multiple market sectors. Energy, technology, AI, banking and real estate are just a few potential sectors in a sway that will unfold on 5 November.
Also, interest rate guidance will undoubtedly play a role in the markets as we enter the later stages of 2024. With the Federal Reserve poised to potentially make several cuts, all eyes will remain focused on the upcoming meetings scheduled in 2024 (18 September, 7 November, and 18 December).
As such, it may be a good time for institutions to discuss cash reinvestment strategy with their agent lending provider. With Fed funds futures pointing to at least a 25 basis point cut in September, this will be the earliest indicator we will see as to what the Federal Open Market Committee (FOMC) has in mind.
Lastly, we will be keeping our eye on the IPO market and how it unfolds. The autumn IPO window is set to open after Labor Day in the US, 2 September 2024. It will be interesting to see what, if any, appetite companies exploring going public have in the face of the election and interest rate uncertainty. IPOs can be a strong contributor to the securities finance revenue equation and a stronger fall market would boost year-end results.
On the international front, the ripple effect of a potential real estate debt crisis in China, Australia’s recession risk, Europe’s ever-changing political landscape, and the cross-regional tensions from the Russia/Ukraine and Middle East conflicts, all have the potential to be a driver of supply and demand shocks. Institutional investor flows out of China and into several emerging economies has created new opportunities and a re-emergence of activity in Japanese equities — a space which had seen diminished activity for a significant time period.
With a continually expanding distribution structure, more advanced analytical applications and an experienced team, Fidelity Agency Lending is prepared to capitalise on opportunities to enhance revenue through the end of 2024 and beyond.
Securities lending market dynamics and regulatory events are ever-changing and complex. Advanced technology and a team with deep capital markets and trading expertise are important considerations when working with an agent lending provider.
Fidelity Agency Lending has a highly automated trading platform, real-time connectivity, and reconciliations with borrowers and six major global custodians, strategic relationships with borrowers who seek out Fidelity’s lendable assets, and we are focused on a narrow subset of the lender community to ensure no programme dilution. Our goal is to outperform the markets and optimise performance and revenue for clients and their stakeholders.
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