…and now for the good news
08 July 2014
Karl Loomes, market analyst for Astec Analytics, SunGard’s capital markets business explains the potential benefits of regulatory and market changes in securities lending
Image: Shutterstock
Much of the macro analysis and commentary surrounding securities lending in recent years has tended to focus on the myriad headwinds facing this industry. It is easy to overlook the other, more positive developments and market changes that might actually benefit the industry. Indeed some of the legislation that has caused so much concern may also offer benefits, whether that is overall growth, improved efficiency or better revenues.
Fundamental market activity, growth and recovering confidence
The first point worth highlighting is that securities lending is vital for many functions within a modern market, whether this is through trade settlement or financing requirements, or facilitating market making and short selling.
Following the global credit crunch and subsequent recessions, many of the world’s economies suffered years of stagnation. Although most indicators are still somewhat mixed, there is a general trend towards recovery starting to show. Stock markets particularly have almost recovered their losses, with benchmarks such as the S&P 500 and FTSE 100 already at higher levels than pre-crisis, with even some of the worst performing indices such as Hang Seng still within a 25 percent range of its 2007 peak.
In addition to this stock market growth, confidence has also seemingly been on the rise. The VIX index, which measures volatility on the S&P 500 and thus a proxy for uncertainty, has, give or take periodic fluctuations, declined in the years following the crisis. Its most notable and consistent decrease has been since the European debt problems in 2011. As it currently stands, the VIX is 70 percent lower than the peak in 2011 and more than 80 percent lower than its 2007 height, implying less volatility and greater confidence in the markets growing stability.
Implications for securities lending
Both this returning confidence and the general growth in the markets could have several positive consequences for securities lending. The most simple of these, and yet potentially one of the strongest, is that market growth is likely to bring about increased activity in ‘secondary’ or ’supportive’ activities, such as those that utilise securities lending. The removal of short selling limitations would perhaps be one of the more obvious, with increased short selling activity increasing the demand, and eventually supply, of equity borrowing. In addition, more mundane functions, such as facilitating trade settlement and market making, will all increase as market activity increases.
New opportunities in emerging markets
Increased growth in emerging markets, at least those with securities lending systems in place, will naturally lead to increased securities lending activity, as those functions that require the borrowing of securities see increased demand. The additional room for growth from emerging economies, or more specifically from frontier economies moving into emerging, is the creation of previously non-existent securities lending programmes. Many of the Middle Eastern countries for example, including the United Arab Emirates, are currently in midst of this process—a move that should see them qualify for the MSCI emerging market index in the next few months (one criteria of which is that an economy must have the facilities to support securities lending and short selling).
Our data shows growth of borrowing activity in those emerging markets that already have securities lending markets in place has been rapid, with the average number of loans taking place now 65 percent higher than they were 12 months ago. In addition, many of these emerging markets are not likely to be subject to much of the regulatory framework and legislation that is causing such concern in securities lending elsewhere, which may leave them somewhat immune from many of the negative consequences, at least while in their fledgling state.
Regulatory changes and increased costs
Perhaps the most fundamental and, potentially, most significant set of changes set to impact securities lending are the ongoing and upcoming regulatory changes and legislative moves in the US and Europe. Most notable of these is Basel III, with its capital and liquidity requirements, but no less significant (and in fact potentially very dramatic) is the Financial Transaction Tax (FTT) in Europe.
Almost all the regulations coming into place are likely to directly increase the costs of securities lending to one extent or another. In addition, and in many ways an even greater concern, are the indirect costs they may have. For example, the potential problems with indemnification, if unresolved, could have a dire impact on the industry.
Collectively these problems are likely to result in some currently operating lenders and beneficial owners, particularly the smaller ones, being forced out while, at the same time, potential new entrants will face higher barriers to entry. The reduced competition will likely result, eventually, in greater revenues for beneficial owners, perhaps even offsetting some of the overall losses in ‘supply’ and reaching a new equilibrium. In addition, those lenders that are left are likely to be the ones that are able to better able to absorb the costs and are therefore presumably those that operate the most efficient and profitable programmes. It could be the case that this, in turn, makes the lending market more efficient as a whole.
The full consequences of all these changes still remain to be seen, though at least there is a potential upside for our industry in the coming months and years. It may not all be doom and gloom.
For more on securities lending, read SunGard’s white paper, “The Potential Benefits of Regulatory and Market Changes for Securities Lending.”
Fundamental market activity, growth and recovering confidence
The first point worth highlighting is that securities lending is vital for many functions within a modern market, whether this is through trade settlement or financing requirements, or facilitating market making and short selling.
Following the global credit crunch and subsequent recessions, many of the world’s economies suffered years of stagnation. Although most indicators are still somewhat mixed, there is a general trend towards recovery starting to show. Stock markets particularly have almost recovered their losses, with benchmarks such as the S&P 500 and FTSE 100 already at higher levels than pre-crisis, with even some of the worst performing indices such as Hang Seng still within a 25 percent range of its 2007 peak.
In addition to this stock market growth, confidence has also seemingly been on the rise. The VIX index, which measures volatility on the S&P 500 and thus a proxy for uncertainty, has, give or take periodic fluctuations, declined in the years following the crisis. Its most notable and consistent decrease has been since the European debt problems in 2011. As it currently stands, the VIX is 70 percent lower than the peak in 2011 and more than 80 percent lower than its 2007 height, implying less volatility and greater confidence in the markets growing stability.
Implications for securities lending
Both this returning confidence and the general growth in the markets could have several positive consequences for securities lending. The most simple of these, and yet potentially one of the strongest, is that market growth is likely to bring about increased activity in ‘secondary’ or ’supportive’ activities, such as those that utilise securities lending. The removal of short selling limitations would perhaps be one of the more obvious, with increased short selling activity increasing the demand, and eventually supply, of equity borrowing. In addition, more mundane functions, such as facilitating trade settlement and market making, will all increase as market activity increases.
New opportunities in emerging markets
Increased growth in emerging markets, at least those with securities lending systems in place, will naturally lead to increased securities lending activity, as those functions that require the borrowing of securities see increased demand. The additional room for growth from emerging economies, or more specifically from frontier economies moving into emerging, is the creation of previously non-existent securities lending programmes. Many of the Middle Eastern countries for example, including the United Arab Emirates, are currently in midst of this process—a move that should see them qualify for the MSCI emerging market index in the next few months (one criteria of which is that an economy must have the facilities to support securities lending and short selling).
Our data shows growth of borrowing activity in those emerging markets that already have securities lending markets in place has been rapid, with the average number of loans taking place now 65 percent higher than they were 12 months ago. In addition, many of these emerging markets are not likely to be subject to much of the regulatory framework and legislation that is causing such concern in securities lending elsewhere, which may leave them somewhat immune from many of the negative consequences, at least while in their fledgling state.
Regulatory changes and increased costs
Perhaps the most fundamental and, potentially, most significant set of changes set to impact securities lending are the ongoing and upcoming regulatory changes and legislative moves in the US and Europe. Most notable of these is Basel III, with its capital and liquidity requirements, but no less significant (and in fact potentially very dramatic) is the Financial Transaction Tax (FTT) in Europe.
Almost all the regulations coming into place are likely to directly increase the costs of securities lending to one extent or another. In addition, and in many ways an even greater concern, are the indirect costs they may have. For example, the potential problems with indemnification, if unresolved, could have a dire impact on the industry.
Collectively these problems are likely to result in some currently operating lenders and beneficial owners, particularly the smaller ones, being forced out while, at the same time, potential new entrants will face higher barriers to entry. The reduced competition will likely result, eventually, in greater revenues for beneficial owners, perhaps even offsetting some of the overall losses in ‘supply’ and reaching a new equilibrium. In addition, those lenders that are left are likely to be the ones that are able to better able to absorb the costs and are therefore presumably those that operate the most efficient and profitable programmes. It could be the case that this, in turn, makes the lending market more efficient as a whole.
The full consequences of all these changes still remain to be seen, though at least there is a potential upside for our industry in the coming months and years. It may not all be doom and gloom.
For more on securities lending, read SunGard’s white paper, “The Potential Benefits of Regulatory and Market Changes for Securities Lending.”
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