Will growth in securities lending in Asia this year come from developed markets or will emerging markets increase their share?
Notwithstanding the untapped potential of the Asian emerging market space, which is unlikely to develop significantly in the short term, securities lending growth is likely to be driven more by demand from developed markets for the rest of the year.
Historically speaking and with the exception of Hong Kong, developed markets have been largely underinvested when you look at on loan volumes, driven by fewer corporate deals and a general lack of conviction for hedge fund funds to deploy risk and invest in size. However, the horizon looks more optimistic for these markets particularly Japan, as participants gear themselves for inflows of investment should the government’s aggressive stimulus measures prove to be effective for the economy. There is also potential for growth in Australia should the resource sector be perceived to be over extended at some point.
Although Hong Kong’s revenue stream has softened relative to last year following perceptions that China evaded a hard landing and is now poised for improved growth, we do expect volumes to remain robust relative to other Asian markets. Given lower levels of correlation, the environment is now more conducive for stock picking and we therefore expect long/short hedge fund demand to sustain volumes, albeit at weaker spreads compared to last year.
Certainly emerging markets such as Taiwan will continue to drive demand given its embedded intrinsic value, however, when we look at where overall growth is likely to emerge from in Asia in the short term, we understand this to be developed markets. In the long term, indeed the focus continues to be frontier markets such as China and India.
Do emerging markets (such as Malaysia, Taiwan, South Korea, Thailand, Vietnam, Indonesia, the Philippines) offer significant untapped potential for securities lending?
Taiwan continues to be the most attractive emerging market as robust demand outstrips supply. Although offshore inventory is growing, the pace of this growth is slow and inconsequential for market dilution. Thus, for any new untapped inventory, the potential revenue streams remain compelling for investors.
South Korea has matured such that supply is now relatively robust, apart from small to mid cap inventory. However, growth potential in Korea is more a function of demand rather than supply, as we continue to see a modest level of appetite outside of a selected few securities. This is partly driven by an existing short sale ban on financials, which continues to constrain demand.
Given the absence of workable models in Vietnam, Indonesia and the Philippines, it is hard to believe that there is a significant amount of untapped potential at this stage. In order for demand to flourish in these markets, there first needs to be growth in liquidity to allow hedge fund strategies to make economic sense. For this reason, agent lenders should be looking at getting into such markets in anticipation of demand, with an incentive that those who launch first will enjoy the benefits. Malaysia is a good example of this in that although various lenders are live, hedge fund demand is modest and concentrated in selected securities. However, in the long term as more agents open Malaysia, we are likely to see more interest from long/short hedge funds as the liquidity profile improves, thus offering higher returns.
Those emerging markets that offer the more obvious potential include China and India given the relative size of their economies. However, we are yet to see material progress for an offshore model in China, and India’s current borrowing and lending framework is not conducive for offshore participants to launch.
Do differences in regulation and tax laws between different Asian countries create opportunities in specific markets?
Certainly from a regulatory perspective, this remains a key factor in contributing to a market’s overall growth profile. Those markets that operate with opaque and punitive settlement regimes constrain the ability of agent lenders to maximise inventory, thus hampering supply and liquidity, which ultimately determines the willingness for hedge funds to trade on occasions. For those markets with more transparent settlement structures, liquidity tends to be deeper and hence, attracts a wider source of demand.
Similarly, short sale bans have a direct consequence on demand and growth. This not only limits the ability of hedge funds to deploy their conviction on the short side, but also on the long, since hedging such long positions is also constrained.
To what extent do these differences force you to change the way you operate in different markets?
From an agent lenders perspective, risk mitigation for the underlying client is of utmost importance. Particularly in markets where punitive regimes exist, it is critical that lenders adopt sound liquidity management policies to ensure a balance between maximising client inventory and protecting against settlement failure.
What benefits do clients derive from custodians establishing securities lending operations into new Asian markets?
Those clients who are able to launch into key emerging markets earlier are those that will realise the greatest return, since spreads are likely to remain higher whilst liquidity remains limited during the infancy of a markets maturity cycle.
Furthermore, given the wave of regulatory measures being considered across Europe, it is important for clients to identify alternative sources of revenue from securities lending, given potential uncertainty surrounding the sustainability of existing revenue streams in other regions.
What can custodians do to boost demand for securities lending in these emerging Asian markets—for example, do custodians have a role in educating beneficial owners on the merits of this type of transaction?
Given entry in most new markets for securities lending tends to require some form of client involvement in the lending process such as pre-notifications generally clients need to understand the additional nuances of these markets and if relevant any risks inherent in additional processes versus the additional revenue that can be generated. The onus of this due diligence and education would lie with the agent lenders to ensure that clients understand clearly the nuances of lending in new markets where the investment process for fund managers or clients may not be seamless when securities lending takes place as the case may be in the traditional developed markets.
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