Emerging markets: unlocking dead capital and new liquidity
21 June 2022
The industry maps out routes of opportunity in emerging markets while discussing the pain points of establishing lending and financing activities in the Middle East and Africa regions. Carmella Haswell reports
Image: stock.adobe.com/tostphoto
An increasing support for new markets across the Middle East, Africa and China is rising in the securities finance sector, along with an ambition to unlock new liquidity. Accessing additional potential and connecting domestic markets to international players has become key after the sector continues to operate in a challenging environment.
FrontClear, an organisation focused on maturing money market funds (MMF) and capital markets in developing markets, seeks to unlock access to the global and interbank markets by providing guidance and improving regulatory structure to allow those markets to open.
Consolo director Sarah Nicholson spoke at the International Securities Lending Association’s (ISLA) 29th Annual Securities Finance and Collateral Management Conference as a representative of FrontClear.
Working in the Uganda market, Nicholson says the focus on these markets is on providing liquidity and stability by opening up MMFs. If MMFs are not working properly, the industry could experience additional risk in the market and an inability for markets to function properly.
Nicholson adds: “Focusing on capital markets, the project that FrontClear has been managing is enabling securities lending and repo to get capital moving around. Unlocking that otherwise dead capital, and allowing it back into the market through the repo transactions and the money markets more broadly, will help the local firms manage macro-shocks, provide the mid- and long-term funding that there is a real need for and help that market resilience.”
In the Uganda market, a significant proportion of government bonds are held by pension funds and institutions on a hold-to-maturity strategy. That is locking out liquidity in the market, discouraging people from investing in the market, and impairing capital from moving around the market.
Expanding on the importance of new markets, eSecLending’s managing director of product development Ed Oliver says if a participant becomes one of the first movers when engaging with new markets, that participant is likely to make the lion share of the revenue. Overtime, as liquidity increases in the market, the typical supply and demand dynamics apply and the revenue “drops off a little bit”.
“We have clients who are invested in emerging markets and are keenly aware of that opportunity and push us as a lending agent to ensure that we are doing what we can to operate in those markets as safely as possible,” Oliver interjects. “To do so you need the right infrastructure, the right rules and regulations, but once that is in place, it is very much about trying to get that supply to the market first.”
Finding a route into the market
There are four components which are important to any market, according to Patrick Archenhold, head of securities lending trading at Morgan Stanley. These are ease of access, the stability of the inventory and funding, the liquidity of the inventory, and the cost of running the market.
He continues: “When we look across the globe, generally the first route into markets for firms is a synthetic model — primarily due to ease of entry. When you look to grow a market, having a limited universe of counterparts with which to transact starts to prohibit growth. If you look at what securities lending brings to the market, going back to the other three points, it can bring stability of inventory and funding from real money long-term investors.
“It can also bring the liquidity and breadth of inventory we need from people to really look at short ideas. On an ongoing basis, the cost does end up being materially lower because in a synthetic-only market, dealers are carrying inventory on their books, whether they are using it or not. On demand securities lending market gives you more flexibility.”
Despite the synthetic model becoming a “first route” option into the market, it brings some complexity that not all beneficial owners would be able to address, or are in favour of addressing. eSecLending’s Oliver agreed that the traditional route brings beneficial owners increased options.
This complexity represents a constraint on participating in synthetic transactions. Oliver advises participants that if they want to “throw liquidity at a market”, the securities lending route is the favoured option. He explains: “We do not support the synthetic route, but we have clients who will be using the synthetic route and transacting with people such as Patrick. But for us it is waiting for the securities lending market to be in place.”
Challenges posing markets
As the chair of the ISLA Developing Markets Working Group, Oliver says that Turkey is a market which ISLA members have been lending in for several years. One of the issues highlighted by Oliver was the concern from beneficial owners regarding the ‘two hits and out’ rule. Article 35 explains that if a participant were to fail twice in a three month period, they may have to prefund their purchases and sales. This can be managed by a lending agent through various routes.
“We are all familiar with the concept of buffers and in some cases taking presale notification. As soon as you get into those sorts of measures, it restricts the amount of supply you can bring into the market, some people will not come to the market at all, others will but because you are putting some mitigation around it, it limits the amount you can actually push forward as supply,” comments Oliver.
Before considering a market, Consolo’s Nicholson warns that a “phenomenal” level of due diligence must be completed. One of the complications are the minutiae details, which can catch firms out. For example, Nicholson recalls previous situations where accounting practices in a particular market were different to international standards and this led to complications.
Next steps
With a host of opportunities present in markets across the globe, industry experts are predicting future potential within markets in Asia and the Middle East and North Africa (MENA) region. With so many markets on the radar, it is difficult to pinpoint which region offers the most exciting for opportunities — whether that be those already mentioned, or lending opportunities that are now emerging in Central and Eastern Europe.
“We have been working on some of these markets and engaging with the infrastructure providers onshore for many years. You have to keep all of the balls in the air and keep the engagement going and I think that is the key,” eSecLending’s Oliver interjects. “Being able to have that ability to help present best practice internationally to onshore providers and hopefully, when securities lending filters up to the top of the agenda, change happens. That is what we are waiting for.”
Focusing on China, Morgan Stanley’s Archenhold says there remains no liquid offshore lending mechanism for A shares. Presenting as the second biggest stock market in the world, China is only partially represented in MSCI EM indices at the moment. “If this becomes more prominent and an offshore mechanism is established, there will be a good opportunity for growth in China.”
“Other potential opportunities include the MENA region,”Archenhold explains. “Looking at its presence in the main EM indices, free-flow adjusted, you are looking at half a trillion worth of investable assets. Looking through four or five key markets, as with China, there is not an established securities lending mechanism. There are multi-billion or multi-trillion companies in these markets that are not currently covered by securities financing, and I think that is exciting.”
According to Neil McLeod, head of group treasury markets, Erste Group Bank AG, there is real potential in the Eastern Europe region, especially with the area’s regulatory rules being “relatively friendly” and an absence of major constraints. Furthermore, from the perspective of someone from a retail bank, McLeod indicates a natural shift into the asset management industry. In reality, the industry can view the development of each one of these economies and track the movement in terms of greater investment, which, in turn, needs greater securities financing in reality.
Analysing the region further, McLeod reflects on the benefit of operating securities financing and lending outside of the cash market. With a mounting pressure on all banks in the region and an influx of constraints in terms of balance sheet, the situation in the MENA region is becoming “extreme” for a variety of reasons. He continues: “The more that you can optimise the collateral the better or the stronger the situation will become. I see that coming together at the moment in the sense that we are starting to see increased volumes.”
FrontClear, an organisation focused on maturing money market funds (MMF) and capital markets in developing markets, seeks to unlock access to the global and interbank markets by providing guidance and improving regulatory structure to allow those markets to open.
Consolo director Sarah Nicholson spoke at the International Securities Lending Association’s (ISLA) 29th Annual Securities Finance and Collateral Management Conference as a representative of FrontClear.
Working in the Uganda market, Nicholson says the focus on these markets is on providing liquidity and stability by opening up MMFs. If MMFs are not working properly, the industry could experience additional risk in the market and an inability for markets to function properly.
Nicholson adds: “Focusing on capital markets, the project that FrontClear has been managing is enabling securities lending and repo to get capital moving around. Unlocking that otherwise dead capital, and allowing it back into the market through the repo transactions and the money markets more broadly, will help the local firms manage macro-shocks, provide the mid- and long-term funding that there is a real need for and help that market resilience.”
In the Uganda market, a significant proportion of government bonds are held by pension funds and institutions on a hold-to-maturity strategy. That is locking out liquidity in the market, discouraging people from investing in the market, and impairing capital from moving around the market.
Expanding on the importance of new markets, eSecLending’s managing director of product development Ed Oliver says if a participant becomes one of the first movers when engaging with new markets, that participant is likely to make the lion share of the revenue. Overtime, as liquidity increases in the market, the typical supply and demand dynamics apply and the revenue “drops off a little bit”.
“We have clients who are invested in emerging markets and are keenly aware of that opportunity and push us as a lending agent to ensure that we are doing what we can to operate in those markets as safely as possible,” Oliver interjects. “To do so you need the right infrastructure, the right rules and regulations, but once that is in place, it is very much about trying to get that supply to the market first.”
Finding a route into the market
There are four components which are important to any market, according to Patrick Archenhold, head of securities lending trading at Morgan Stanley. These are ease of access, the stability of the inventory and funding, the liquidity of the inventory, and the cost of running the market.
He continues: “When we look across the globe, generally the first route into markets for firms is a synthetic model — primarily due to ease of entry. When you look to grow a market, having a limited universe of counterparts with which to transact starts to prohibit growth. If you look at what securities lending brings to the market, going back to the other three points, it can bring stability of inventory and funding from real money long-term investors.
“It can also bring the liquidity and breadth of inventory we need from people to really look at short ideas. On an ongoing basis, the cost does end up being materially lower because in a synthetic-only market, dealers are carrying inventory on their books, whether they are using it or not. On demand securities lending market gives you more flexibility.”
Despite the synthetic model becoming a “first route” option into the market, it brings some complexity that not all beneficial owners would be able to address, or are in favour of addressing. eSecLending’s Oliver agreed that the traditional route brings beneficial owners increased options.
This complexity represents a constraint on participating in synthetic transactions. Oliver advises participants that if they want to “throw liquidity at a market”, the securities lending route is the favoured option. He explains: “We do not support the synthetic route, but we have clients who will be using the synthetic route and transacting with people such as Patrick. But for us it is waiting for the securities lending market to be in place.”
Challenges posing markets
As the chair of the ISLA Developing Markets Working Group, Oliver says that Turkey is a market which ISLA members have been lending in for several years. One of the issues highlighted by Oliver was the concern from beneficial owners regarding the ‘two hits and out’ rule. Article 35 explains that if a participant were to fail twice in a three month period, they may have to prefund their purchases and sales. This can be managed by a lending agent through various routes.
“We are all familiar with the concept of buffers and in some cases taking presale notification. As soon as you get into those sorts of measures, it restricts the amount of supply you can bring into the market, some people will not come to the market at all, others will but because you are putting some mitigation around it, it limits the amount you can actually push forward as supply,” comments Oliver.
Before considering a market, Consolo’s Nicholson warns that a “phenomenal” level of due diligence must be completed. One of the complications are the minutiae details, which can catch firms out. For example, Nicholson recalls previous situations where accounting practices in a particular market were different to international standards and this led to complications.
Next steps
With a host of opportunities present in markets across the globe, industry experts are predicting future potential within markets in Asia and the Middle East and North Africa (MENA) region. With so many markets on the radar, it is difficult to pinpoint which region offers the most exciting for opportunities — whether that be those already mentioned, or lending opportunities that are now emerging in Central and Eastern Europe.
“We have been working on some of these markets and engaging with the infrastructure providers onshore for many years. You have to keep all of the balls in the air and keep the engagement going and I think that is the key,” eSecLending’s Oliver interjects. “Being able to have that ability to help present best practice internationally to onshore providers and hopefully, when securities lending filters up to the top of the agenda, change happens. That is what we are waiting for.”
Focusing on China, Morgan Stanley’s Archenhold says there remains no liquid offshore lending mechanism for A shares. Presenting as the second biggest stock market in the world, China is only partially represented in MSCI EM indices at the moment. “If this becomes more prominent and an offshore mechanism is established, there will be a good opportunity for growth in China.”
“Other potential opportunities include the MENA region,”Archenhold explains. “Looking at its presence in the main EM indices, free-flow adjusted, you are looking at half a trillion worth of investable assets. Looking through four or five key markets, as with China, there is not an established securities lending mechanism. There are multi-billion or multi-trillion companies in these markets that are not currently covered by securities financing, and I think that is exciting.”
According to Neil McLeod, head of group treasury markets, Erste Group Bank AG, there is real potential in the Eastern Europe region, especially with the area’s regulatory rules being “relatively friendly” and an absence of major constraints. Furthermore, from the perspective of someone from a retail bank, McLeod indicates a natural shift into the asset management industry. In reality, the industry can view the development of each one of these economies and track the movement in terms of greater investment, which, in turn, needs greater securities financing in reality.
Analysing the region further, McLeod reflects on the benefit of operating securities financing and lending outside of the cash market. With a mounting pressure on all banks in the region and an influx of constraints in terms of balance sheet, the situation in the MENA region is becoming “extreme” for a variety of reasons. He continues: “The more that you can optimise the collateral the better or the stronger the situation will become. I see that coming together at the moment in the sense that we are starting to see increased volumes.”
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