How are the securities lending and repo markets looking in the different regions?
In Europe, the potential threat of tax harmonisation is becoming more tangible due to changes in withholding tax. This is shifting the focus from the more traditional countries to Eastern European, Latin American and Asian markets. Access to these markets often requires the use of alternative products.
Changes to collateral acceptability policies for various funds have also had an impact on revenue-generating efficiency, which has led to a squeeze in supply.
A wider pool of supply is of paramount importance, as is the need to be able to generate revenue via various product types, such as stock loan, repo or equity swaps.
On the repo side, regulations in general (but especially Basel III), plus high usage of collateralised derivative products, have fuelled activity in the European repo markets. The core countries, such as France, Germany and the Netherlands, are experiencing substantially higher returns, while generally speaking, the peripheral countries are seeing special interest on specific issues only.
Currently, there are many contradictions in the cash market. As the European Central Bank reduced its deposit facility to zero, there has been a significant reduction in bank borrowing of short-term cash from money market funds due to the zero or even negative yields. As a direct result, we see that on the stock lending market many borrowers are very willing to optimise their cash by using it as collateral.
The Asian fixed income market looks to be gaining ground in terms of interest and volume, but the story there is not regulatory driven, so interest is general collateral-based, but volumes are increasing locally.
While both markets (equity and fixed income) have been affected by reduced demand on the borrow side, lenders with strong balance sheets and ratings are the players capturing the majority of the activity taking place.
How are client demands changing the solutions that you offer?
From the borrowers perspective, we see increased interest in financing term trades via central counterparties in order to free up the balance sheet for other business.
Term trades are generating lucrative returns, but there are many beneficial owners who do not want to be directly exposed to the collateral downgrade risk from their perspective, so they want to lend via a principal programme that absorbs the risk on their behalf.
Again on the client side, we are seeing a symbiotic relationship emerging where we can both finance otherwise idle assets and generate alpha on the high quality liquid assets of their portfolios via our various programmes. Clients are certainly more proactive in coming forward or being open to alternative trading ideas to meet their internal requirements.
Across the board, we are also experiencing an increased adherence to and focus on corporate governance. Risk and operational processes and procedures are being reviewed in detail and tightened where possible. This is having a direct impact on the way in which relationship management now interacts with clients on a regular basis—operational and trading performance is of equal importance. Increased regulatory requirements on reporting are putting pressure on providers to make specific IT enhancements to ensure adherence.
We are seeing a lot of interest from all market participants in alternative routes to market from a product and programme perspective. In the interest of generating quality returns, clients need to partner with institutions that can offer a wide variety of products including stock loan—term/open, repo and equity swaps.
We have been trading evergreen, bullet and extendable trades for a number of years, but they are becoming more and more popular as regulatory changes come into force.
How popular are equity swaps proving with your clients?
Our clients are opening up to generating additional returns through new structures and markets such as Latin America, Eastern Europe and Asia.
Having the ability to meet this request in the form of the various products and routes to market that we offer is proving beneficial. Clients want to partner with a provider that can generate additional return via these solutions, but not necessarily be exposed to them directly.
Equity swaps are one of the tools that can be used to facilitate this need. The evolving complexity of our markets in general has meant that we have had to expand our product range within those programmes over the past three to four years. As far as we can see, this is set to continue.
As solutions and products change, how are you working to keep returns at attractive levels for clients?
We have increased and reinforced the communication that we have with clients about new regulation and the effects that it is having on the market in terms of revenue-generating capability. In our experience, clients respond well to increased transparency about various types of trades, which can be utilised to ensure that returns remain attractive to them. As long as clients are aware of the risk return profile of a trade, the more inclined they are to participate.
Principal and agency routes to market allow clients to diversify portfolio, counterparty and trade-type risk by utilising all programme and product options that are available to them.
By maintaining a flexible and varied product offering, we can offer attractive and sustainable returns.
How are regulatory reforms affecting your clients and the demands that they place on you?
Regulatory reforms are extensive and fast moving. To this end, it is important that we stay ahead of the game on behalf of our clients as well as ourselves. Interpreting the constant flow of papers is an important role that we play for our clients and they certainly expect us to provide guidance in this arena.
Restrictions with regards to what is lent, how it is lent, and what is accepted as collateral, plus additional reporting requirements, are only some of the elements that need to be reviewed and understood correctly by all market participants.
Having a broad range of institutional types that form part of our programmes means there are numerous clients that are exposed, or will be exposed, to many changes over the coming months.
It is in our interest, and that of our clients, to ensure that we remain focused and ahead of the game in terms of interpreting and preparing for any of these changes. Our clients need to know that the environment in which they lend is fully understood by the agent lending on their behalf or the direct borrower of their assets.
What is proving more important at the moment—returns or risk—or is it possible to have both?
It is clear clients want to be assured that their assets are being traded in a low risk environment and that their parameters with regards to collateral and counterparty exposure are being respected.
Nevertheless, in a difficult environment, generation of returns remains at the top of the agenda globally, so in effect, both are as important as ever.
The safety and protection of client assets is at the heart of our lending programmes, but we also realise that they expect quality revenue generation and innovation in terms of how this can be done. This is something we can ensure, as we structure trades around a number of variables at our disposal, so it is possible to have both, but not in the traditional ways in which businesses were run in the past.
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