May you live in interesting times
16 March 2021
A pandemic upended the world. Industry experts predict what the New Normal will mean for securities finance revenues
Image: Nuthawut/adobe.stock.com
In the Before Time, volatility created opportunity. The markets rewarded enterprising individuals and institutions who spotted its inefficiencies and resolved them. But last year was the exception that proved the rule. Equities went off a cliff, and, while the writing was on the wall, many did not anticipate just how far they would fall.
But because the events of last year were of the organic, rather than financial, variety — this was no subprime implosion like ‘08, but a plague visited on us from above — market fundamentals have remained largely intact. And so, after the highs of 2018, a middling 2019 and the annus horribilis of last year, will 2021 witness a significant rebound in lending revenue?
The beginning of the end
There’s plenty coming down the chute in 2021 that warrants cautious optimism. A highly anticipated consumer spending boom — the Bank of England’s chief economist said last month £180 billion is burning a hole in Joe Public’s pocket — will fuel the unfolding retail investor revolution. The short selling bans across Asia Pacific (APAC) are set to be belatedly lifted. Countless initial public offerings (IPOs) and the new kid on the block, SPACs — which raise money from investors, list on a stock market and then look for an acquisition target to take public — are lining up. Combined with some early contenders for hottest stock of the year and historically low interest rates, the tea leaves portend a vintage year.
The year has got off to a great start. Global securities finance revenues totalled $812 million in February, a 10 per cent year-over-year (YoY) increase, according to IHS Markit.
Surging specials balances thanks in no small part to the January short squeeze, fixed income exchange-traded funds (ETF) shorts, APAC American depository receipts (ADRs) and the corporate action-related demand for DuPont de Nemours shares all helped boost global revenues these past two months.
In the US, the high-profile “short-squeeze fireworks” of the GameStop saga made January the most-revenue-generating month for equity finance in the nation’s history, at $453 million, a 75 per cent year-on-year (YoY) increase. This record-breaking start to the year outdid previous highs of $407 million in December and $416 in June last year, and $410 million in September 2008.
Looking at the year ahead, Dane Fannin, global head of securities lending at Northern Trust, while optimistic, is mindful that revenue generation will be heavily influenced by the broader picture. “As vaccine programmes gain good momentum and the global economy continues to open up, we expect to see further market normalisation,” Fannin says.
These positive developments should provide a more conducive environment for traditional long and short fundamental-based strategies, Fannin says, which should bode well for securities lending demand.
“Notwithstanding this optimism, there are also tail risks associated with a resurgence or emergence of new COVID-19 variants,” Fannin adds.
Lending, spending, mending
Sam Pierson, director of securities finance at IHS Markit, says that although interest rate cuts were one of the “big themes” of last year — “when interest rates are cut, that’s a good thing for the reinvestment of cash collateral, even when using reinvestment products with fairly short duration”, he does not expect a repeat rate cut boost this year.
“You’ll get some reinvestment return but not like last year, when that was a really big deal for lenders who accept cash collateral, who got an uplift after the Fed cut rates”, Pierson says.
If central banks hike rates, “reinvestment returns may suffer in the short run, but that may be partially offset over time if reinvestment product spreads widen with rates,” Pierson explains.
Elsewhere, Fannin further notes that the low interest rate environment will continue to assist the ongoing need for companies to raise capital to repair or strengthen balance sheets post-COVID. These material adjusted company valuations, Fannin says, may be the catalyst for increased corporate restructuring. “This activity typically translates into increased securities lending demand due to subsequent price arbitrage opportunities.”
IPO FTW
So far, this year has been good for specials, Pierson says, between the short squeeze in January and a lot of IPOs — particularly ones people want to short.
The bevy of specials looks set to continue. “When the IPO lockup expires, there will be an increase in borrower demand,” Pierson says, adding that a fair amount of IPOs have already taken place in the second half of last year and the opening months of 2021. Nonetheless, there’s “still a lot in the pipeline” and a lot of these are SPACs, Pierson adds.
Elevated global equity market valuations should be supportive of IPO issuance, especially in the technology sector, Fannin says, bolstered by the popularity of SPACs which continue to thrive in the current environment.
“SPACs typically fuel strong directional securities lending demand given price volatility as well as investor appetite to pursue price arbitrage strategies related to the associated warrants,” Fannin adds.
Northern Trust’s Mark Coker also thinks the raft of IPOs caused by pent-up demand thanks to the pandemic could mean a stellar year for securities lending revenue.
In a webinar hosted by the bank in January, Coker, who serves as head of North American equity securities lending trading, argued that “a lot of the headwinds [of 2020] are behind us” and 2021 will constitute a post-COVID-19 recovery phase in the markets.
Coker reinforced Pierson’s observation that although there were very few IPOs in the first half of 2020, as equity markets improved in the second half of the year some IPOs of firms in sectors that thrive in the remote working environment flourished, a trend he expects to continue in 2021.
Ghost town
While the US looks set to benefit from IPOs, SPACs, increased demand for ETFs, depository receipts — an ADR of a Chinese or Hong Kong company listed on the NYSE could be significant — and high borrower demand for US treasuries and US equities, “Europe is different,” Pierson notes.
While there were some specials last year, mostly in Germany, numbers have thinned out, Pierson says. “Things are quiet right now.”
However, dividends are a good source of demand, Pierson adds, so it’s likely with reinstated dividends in Europe, that is going to help provide a boost with regards to specials.
“Last year, there was a lot of capital raising, all the IPOs, and a lot of volatility meant convertible issuance or other issuance, so that will continue to be a factor, firms being restructured,” but, significantly, not like a post-financial crisis, Pierson says.
In the same vein, Fannin says that further market normalisation should be supportive of greater corporate activity in 2021, which in-turn should create a more “robust” specials environment.
Fannin also echoes Pierson’s rosy predictions for ETFs, as they continue to prompt strong borrower interest. “This asset class acts as an efficient way for investors to gain broad-based sector or market exposure in a single instrument, especially in less developed markets or countries absent of a securities lending model,” Fannin says.
And he sounded a note of caution on specials post-GameStop. The recent short squeeze created by the group of retail investors, Fannin says, has caused borrowers to re-evaluate their short exposure and take caution on some of the markets’ most highly shorted names, “softening the specials environment”.
“The expectation is that as the dust settles, global equity specials volumes will improve with company fundamentals again at the forefront of investor decisions,” Fannin predicts.
The sun rises in the East
Although APAC has been relatively quiet, Pierson says, revenues from lending ADRs increased 549 per cent YoY, part of a broader narrative taking shape, according to IHS Markit.
The short selling ban in South Korea is also set to end. The ban continues to limit lending revenue, with $6.4 million in February revenue reflecting an 83 per cent YoY decline.
South Korea’s Financial Services Commission (FSC) extended its short selling ban again until 2 May, amid pressure from politicians and retail market participants to curb bearish trading. The lack of lending revenue from this market will continue to leave a big hole in the region’s performance.
The ban was imposed on KOPSI, KOSDAQ and KONEX indexes in March 2020 as equities prices tumbled in reaction to the first spread of COVID-19 infections across the country, and, after two extensions, was due to sunset in March this year.
Similarly, the Securities Commission Malaysia and Bursa Malaysia Berhad extended its suspension — which took effect on 24 March 2020 — on intraday short selling, due to expire on 28 February, until 29 August.
After a high in 2018, Asia is slowly improving, Pierson says — specials balancing are increasing and there was also a significant dividend effect in the region.
Sunlit uplands
Everywhere looks to be in a “pretty good place”, in terms of revenue drivers, Pierson concludes.
What’s going to be different to last year, Pierson says, will be the lack of an interest rate change-led cash uplift, “and therefore less convertibles — when there is a lot of convertible issuance, there’s likely to be a lot of demand.”
Ending on an optimistic note, Fannin highlights the role of emerging markets, which have the potential to deliver a strong performance for beneficial owners in 2021 and beyond.
Fannin says that demand for untapped jurisdictions, such as the Middle East, remains “robust” although further regulatory developments are needed. “In the short to medium term, Saudi Arabia potentially represents a significant opportunity for the industry.”
The Saudi Arabian Capital Markets Authority is expected to release revisions to its securities lending and covered short selling regulations over the coming months, which will “hopefully help open this market up, representing an exciting development in a region that potentially offers significant long term promise,” Fannin concludes.
But because the events of last year were of the organic, rather than financial, variety — this was no subprime implosion like ‘08, but a plague visited on us from above — market fundamentals have remained largely intact. And so, after the highs of 2018, a middling 2019 and the annus horribilis of last year, will 2021 witness a significant rebound in lending revenue?
The beginning of the end
There’s plenty coming down the chute in 2021 that warrants cautious optimism. A highly anticipated consumer spending boom — the Bank of England’s chief economist said last month £180 billion is burning a hole in Joe Public’s pocket — will fuel the unfolding retail investor revolution. The short selling bans across Asia Pacific (APAC) are set to be belatedly lifted. Countless initial public offerings (IPOs) and the new kid on the block, SPACs — which raise money from investors, list on a stock market and then look for an acquisition target to take public — are lining up. Combined with some early contenders for hottest stock of the year and historically low interest rates, the tea leaves portend a vintage year.
The year has got off to a great start. Global securities finance revenues totalled $812 million in February, a 10 per cent year-over-year (YoY) increase, according to IHS Markit.
Surging specials balances thanks in no small part to the January short squeeze, fixed income exchange-traded funds (ETF) shorts, APAC American depository receipts (ADRs) and the corporate action-related demand for DuPont de Nemours shares all helped boost global revenues these past two months.
In the US, the high-profile “short-squeeze fireworks” of the GameStop saga made January the most-revenue-generating month for equity finance in the nation’s history, at $453 million, a 75 per cent year-on-year (YoY) increase. This record-breaking start to the year outdid previous highs of $407 million in December and $416 in June last year, and $410 million in September 2008.
Looking at the year ahead, Dane Fannin, global head of securities lending at Northern Trust, while optimistic, is mindful that revenue generation will be heavily influenced by the broader picture. “As vaccine programmes gain good momentum and the global economy continues to open up, we expect to see further market normalisation,” Fannin says.
These positive developments should provide a more conducive environment for traditional long and short fundamental-based strategies, Fannin says, which should bode well for securities lending demand.
“Notwithstanding this optimism, there are also tail risks associated with a resurgence or emergence of new COVID-19 variants,” Fannin adds.
Lending, spending, mending
Sam Pierson, director of securities finance at IHS Markit, says that although interest rate cuts were one of the “big themes” of last year — “when interest rates are cut, that’s a good thing for the reinvestment of cash collateral, even when using reinvestment products with fairly short duration”, he does not expect a repeat rate cut boost this year.
“You’ll get some reinvestment return but not like last year, when that was a really big deal for lenders who accept cash collateral, who got an uplift after the Fed cut rates”, Pierson says.
If central banks hike rates, “reinvestment returns may suffer in the short run, but that may be partially offset over time if reinvestment product spreads widen with rates,” Pierson explains.
Elsewhere, Fannin further notes that the low interest rate environment will continue to assist the ongoing need for companies to raise capital to repair or strengthen balance sheets post-COVID. These material adjusted company valuations, Fannin says, may be the catalyst for increased corporate restructuring. “This activity typically translates into increased securities lending demand due to subsequent price arbitrage opportunities.”
IPO FTW
So far, this year has been good for specials, Pierson says, between the short squeeze in January and a lot of IPOs — particularly ones people want to short.
The bevy of specials looks set to continue. “When the IPO lockup expires, there will be an increase in borrower demand,” Pierson says, adding that a fair amount of IPOs have already taken place in the second half of last year and the opening months of 2021. Nonetheless, there’s “still a lot in the pipeline” and a lot of these are SPACs, Pierson adds.
Elevated global equity market valuations should be supportive of IPO issuance, especially in the technology sector, Fannin says, bolstered by the popularity of SPACs which continue to thrive in the current environment.
“SPACs typically fuel strong directional securities lending demand given price volatility as well as investor appetite to pursue price arbitrage strategies related to the associated warrants,” Fannin adds.
Northern Trust’s Mark Coker also thinks the raft of IPOs caused by pent-up demand thanks to the pandemic could mean a stellar year for securities lending revenue.
In a webinar hosted by the bank in January, Coker, who serves as head of North American equity securities lending trading, argued that “a lot of the headwinds [of 2020] are behind us” and 2021 will constitute a post-COVID-19 recovery phase in the markets.
Coker reinforced Pierson’s observation that although there were very few IPOs in the first half of 2020, as equity markets improved in the second half of the year some IPOs of firms in sectors that thrive in the remote working environment flourished, a trend he expects to continue in 2021.
Ghost town
While the US looks set to benefit from IPOs, SPACs, increased demand for ETFs, depository receipts — an ADR of a Chinese or Hong Kong company listed on the NYSE could be significant — and high borrower demand for US treasuries and US equities, “Europe is different,” Pierson notes.
While there were some specials last year, mostly in Germany, numbers have thinned out, Pierson says. “Things are quiet right now.”
However, dividends are a good source of demand, Pierson adds, so it’s likely with reinstated dividends in Europe, that is going to help provide a boost with regards to specials.
“Last year, there was a lot of capital raising, all the IPOs, and a lot of volatility meant convertible issuance or other issuance, so that will continue to be a factor, firms being restructured,” but, significantly, not like a post-financial crisis, Pierson says.
In the same vein, Fannin says that further market normalisation should be supportive of greater corporate activity in 2021, which in-turn should create a more “robust” specials environment.
Fannin also echoes Pierson’s rosy predictions for ETFs, as they continue to prompt strong borrower interest. “This asset class acts as an efficient way for investors to gain broad-based sector or market exposure in a single instrument, especially in less developed markets or countries absent of a securities lending model,” Fannin says.
And he sounded a note of caution on specials post-GameStop. The recent short squeeze created by the group of retail investors, Fannin says, has caused borrowers to re-evaluate their short exposure and take caution on some of the markets’ most highly shorted names, “softening the specials environment”.
“The expectation is that as the dust settles, global equity specials volumes will improve with company fundamentals again at the forefront of investor decisions,” Fannin predicts.
The sun rises in the East
Although APAC has been relatively quiet, Pierson says, revenues from lending ADRs increased 549 per cent YoY, part of a broader narrative taking shape, according to IHS Markit.
The short selling ban in South Korea is also set to end. The ban continues to limit lending revenue, with $6.4 million in February revenue reflecting an 83 per cent YoY decline.
South Korea’s Financial Services Commission (FSC) extended its short selling ban again until 2 May, amid pressure from politicians and retail market participants to curb bearish trading. The lack of lending revenue from this market will continue to leave a big hole in the region’s performance.
The ban was imposed on KOPSI, KOSDAQ and KONEX indexes in March 2020 as equities prices tumbled in reaction to the first spread of COVID-19 infections across the country, and, after two extensions, was due to sunset in March this year.
Similarly, the Securities Commission Malaysia and Bursa Malaysia Berhad extended its suspension — which took effect on 24 March 2020 — on intraday short selling, due to expire on 28 February, until 29 August.
After a high in 2018, Asia is slowly improving, Pierson says — specials balancing are increasing and there was also a significant dividend effect in the region.
Sunlit uplands
Everywhere looks to be in a “pretty good place”, in terms of revenue drivers, Pierson concludes.
What’s going to be different to last year, Pierson says, will be the lack of an interest rate change-led cash uplift, “and therefore less convertibles — when there is a lot of convertible issuance, there’s likely to be a lot of demand.”
Ending on an optimistic note, Fannin highlights the role of emerging markets, which have the potential to deliver a strong performance for beneficial owners in 2021 and beyond.
Fannin says that demand for untapped jurisdictions, such as the Middle East, remains “robust” although further regulatory developments are needed. “In the short to medium term, Saudi Arabia potentially represents a significant opportunity for the industry.”
The Saudi Arabian Capital Markets Authority is expected to release revisions to its securities lending and covered short selling regulations over the coming months, which will “hopefully help open this market up, representing an exciting development in a region that potentially offers significant long term promise,” Fannin concludes.
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