Here to stay
06 October 2015
Is South Africa an emerging securities lending market, or is it more established? Experts discuss the issues
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South Africa has been described as an emerging securities lending market. Is this accurate, and why?
Jonathan Lacey: South Africa is classified by the leading index providers (for example, MSCI and FTSE) as an emerging market, so it’s logical that it retains the same classification from a securities lending perspective. This said, it has had an established securities borrowing and lending model in place for a number of years, and Northern Trust has been actively lending since 1998, so securities lending is not new to this market.
Securities lending liquidity continues to increase and, generally speaking, lendable supply in South Africa is plentiful. However, despite its well-established securities lending model, its burdensome settlement regime is categorist of traditionally less mature markets, and therefore it’s a big differentiator versus more developed markets in Europe and other parts of the world.
Farzana Khan: The South African securities lending market is a well-established market with strong regulatory oversight. Coupled with a reasonably liquid cash and currency market, it allows global investors to consider South Africa as a ‘proxy’ for emerging market strategies. However, it is unfortunately perhaps not as sophisticated as our foreign counterparts and is often described as being ‘vanilla’.
Michael Wright: Securities lending is now an established element of South Africa’s capital markets, which is one of few active markets on the African continent. There has been an active securities lending market since the early 1990s and it is officially recognised by the National Treasury, and is supported by our other regulatory bodies, namely the South African Reserve Bank and Financial Services Board.
The South African securities lending market encompasses more than 20 institutions comprising banks, insurance companies, pension funds, asset managers and service providers. A recent survey of South African lenders estimated that between ZAR 120 billion ($8.6 billion) and ZAR 140 billion ($10 billion) worth of South African securities are on loan at any given time.
The South African securities lending market is mature and well entrenched, and therefore shouldn’t be considered an emerging securities lending market.
Is there much general collateral business in South Africa? What about specials?
Khan: Lending specials can form a sizable portion of business for lending desks, however, the local liquidity on such stock diminishes fairly quickly, thereby leaving lending desks with the option of borrowing stock from offshore sources.
Wright: There is an active general collateral business in the South African market, with the top 40 securities being the bulk of the trading activity. Fees for general collateral securities out on loan typically average 35 to 45 basis points (annualised), but can be as high as 900 basis points in times of extreme demand and, conversely, as low as 20 to 30 basis points for general collateral stock.
Lacey: Trading activity in South Africa is a mix of both general collateral business and specials activity, with the balance between the two fluctuating depending on trading conditions and market sentiment. As a more established emerging market with relatively good levels of trading both on the equity cash market and securities lending liquidity, South African lending and borrowing of equities have often been used by hedge funds for directional trading of the ‘emerging markets’ sector rather than being stock-specific. As such, it has been the source of both robust general collateral and specials activity.
What about the structure of the market? Are agent lenders and prime brokers the main facilitators of business?
Wright: The majority of lenders of securities in South Africa are comprised of the large pension funds. It is estimated that 70 percent of all funds (with net assets above ZAR 10 billion ($716.5 million)) are participating in some form of securities lending programme.
Historically, custodians have been the primary facilitator of securities lending, acting as an agent on behalf of their underlying custody clients. However, we are seeing more third-party agents entering the market, offering alternative securities lending options to beneficial owners. There are also two intuitional investors that have chosen a direct lending model and lend directly to the borrowing community.
It is estimated that non-South African participants comprise approximately 40 percent of market activity.
Lacey: The structure of the South African market offshore lending market is fundamentally no different to other markets. The catalyst for demand is largely being driven by the prime-broker client base, with both onshore and offshore lenders providing the source of supply.
Khan: Since the global financial crisis in 2008 and the subsequent sanction on many firms’ proprietary trading activities, the greatest portion of borrowing is facilitated by prime brokers. Agent lending is not the norm in South Africa, with most participants assuming a principal position from both a legal and credit risk perspective.
How active is the association in working with other associations or liaising with regulators, and what is it currently working on?
Wright: The South African Securities Lending Association (SASLA) is an industry forum established in 1989 to represent the common interests of the participants in the South African securities lending industry. SASLA works closely with regulators and is represented on several industry committees.
SASLA has contributed to a number of major industry initiatives, including the development of the South African Stock Borrowing and Lending Code of Guidance, and has published standard securities lending documentation to be used in conjunction with the Global Master Securities Lending Agreement. The association—with the backing of the Banking Association of South Africa and supported by Strate, the Association for Savings and Investment South Africa, and the Johannesburg Stock Exchange (JSE)—was successful in lobbying the National Treasury for an exemption of collateral arrangements from Securities Transfer Tax (and other tax impacts).
The first Securities financing master class in South Africa was also arranged in early 2015, which proved a huge success. The association is currently actively involved with the JSE in the move to a T+3 settlement cycle in the South African equities market.
Khan: SASLA is very active in liaising with regulators and other organisations such as the JSE, Strate, the Financial Services Board and National Treasury. SASLA has represented the industry before the National Treasury on the tax exemptions required for outright transfers of non-cash collateral. Similarly, SASLA worked quite closely with the Financial Services Board on the draft securities lending note as it pertains to Regulation 28 of the Pension Funds Act.
How well developed is South Africa in terms of cross-border collateral transfer? Is it a useful source of liquidity and/or HQLA?
Khan: South African exchange control regulation controls the ‘flow’ of money in and out of South Africa and securities lending transactions with offshore counterparties are limited to authorised dealers (generally banks) only. Owing to these regulations, as well as the uncertainty around the ‘pledge’ mechanism in respect of non-cash collateral, cross-border collateral transfers are typically settled in cash only, and most specifically, South African rand as opposed to foreign currency.
Anthony van Eden: The South African market lags behind its European counterparts when it comes to cross-border collateral transfer. This is mainly due to the local exchange control restrictions, taxation implications on equities collateral under cession, regulatory equivalence, and the use of triparty collateral management services offered by Strate (which have been available to the South African market since August 2014).
The ability to access foreign-held assets to collateralise local financial obligations, and local assets to collateralise foreign financial obligations (whereby the assets remain and settle in the local jurisdiction under local regulations and legislation), would greatly improve liquidity and the efficient use of high-quality liquid assets (HQLA).
What developments are you looking forward to in the next 12 months?
Lacey: The JSE is looking to reform its settlement regime, with the aim of reducing the current protracted T+5 settlement cycle to bring it in line with other more developed markets. Northern Trust is excited about the prospect that the JSE is migrating to T+3 with a target date of between May and July 2016. It is hoped that this change will also be the catalyst for South Africa to adopt a more streamlined trade matching system, with notably removing the current pre-matching requirement.
If this is the case, we should expect liquidity to increase. However, should the pre-matching requirement remain post-migration to T+3 then it may create challenges within the securities lending market and could have an overall negative impact on lendable supply. We await further details from the JSE to clarify the scope of the settlement regime reforms.
Brett Kotze: The JSE is currently spearheading a project that will see the South African equities market moving from a T+5 to a T+3 settlement cycle. This is a highly complex undertaking that will bring about many changes, one of them being increased demand for securities lending and borrowing to bring down the potential fails rates from a settlement perspective.
Wright: The proposed tax dispensations for equities transferred under cession of transfer (under a financial collateral arrangement) will significantly improve market liquidity and relieve the pressure on available HQLA. The collateralisation of financial obligations has traditionally been in the form of cash or by the pledging of securities in order to avoid attracting tax charges.
The finalisation of the triparty collateral management model will assist with seamless cross-border collateralisation for foreign exposures covered by domestic collateral and domestic exposures covered by foreign collateral. Local providers of securities lending and borrowing platforms will be offering enhanced straight-through processing for this service, to assist the market in its daily activities and with the move to T+3.
Van Eden: There will also be mandatory clearing of standard over-the-counter derivatives through a central counterparty (CCP).
This could see greater use of CCPs, perhaps for securities lending and repo transactions.
Khan: The JSE is moving to a T+3 settlement cycle in the equity market, which will have a significant impact on securities lending and borrowing activity. We also anticipate that the changes in outright transfer of equity collateral will bring about a definite change in the way that non-cash collateral is managed
Jonathan Lacey: South Africa is classified by the leading index providers (for example, MSCI and FTSE) as an emerging market, so it’s logical that it retains the same classification from a securities lending perspective. This said, it has had an established securities borrowing and lending model in place for a number of years, and Northern Trust has been actively lending since 1998, so securities lending is not new to this market.
Securities lending liquidity continues to increase and, generally speaking, lendable supply in South Africa is plentiful. However, despite its well-established securities lending model, its burdensome settlement regime is categorist of traditionally less mature markets, and therefore it’s a big differentiator versus more developed markets in Europe and other parts of the world.
Farzana Khan: The South African securities lending market is a well-established market with strong regulatory oversight. Coupled with a reasonably liquid cash and currency market, it allows global investors to consider South Africa as a ‘proxy’ for emerging market strategies. However, it is unfortunately perhaps not as sophisticated as our foreign counterparts and is often described as being ‘vanilla’.
Michael Wright: Securities lending is now an established element of South Africa’s capital markets, which is one of few active markets on the African continent. There has been an active securities lending market since the early 1990s and it is officially recognised by the National Treasury, and is supported by our other regulatory bodies, namely the South African Reserve Bank and Financial Services Board.
The South African securities lending market encompasses more than 20 institutions comprising banks, insurance companies, pension funds, asset managers and service providers. A recent survey of South African lenders estimated that between ZAR 120 billion ($8.6 billion) and ZAR 140 billion ($10 billion) worth of South African securities are on loan at any given time.
The South African securities lending market is mature and well entrenched, and therefore shouldn’t be considered an emerging securities lending market.
Is there much general collateral business in South Africa? What about specials?
Khan: Lending specials can form a sizable portion of business for lending desks, however, the local liquidity on such stock diminishes fairly quickly, thereby leaving lending desks with the option of borrowing stock from offshore sources.
Wright: There is an active general collateral business in the South African market, with the top 40 securities being the bulk of the trading activity. Fees for general collateral securities out on loan typically average 35 to 45 basis points (annualised), but can be as high as 900 basis points in times of extreme demand and, conversely, as low as 20 to 30 basis points for general collateral stock.
Lacey: Trading activity in South Africa is a mix of both general collateral business and specials activity, with the balance between the two fluctuating depending on trading conditions and market sentiment. As a more established emerging market with relatively good levels of trading both on the equity cash market and securities lending liquidity, South African lending and borrowing of equities have often been used by hedge funds for directional trading of the ‘emerging markets’ sector rather than being stock-specific. As such, it has been the source of both robust general collateral and specials activity.
What about the structure of the market? Are agent lenders and prime brokers the main facilitators of business?
Wright: The majority of lenders of securities in South Africa are comprised of the large pension funds. It is estimated that 70 percent of all funds (with net assets above ZAR 10 billion ($716.5 million)) are participating in some form of securities lending programme.
Historically, custodians have been the primary facilitator of securities lending, acting as an agent on behalf of their underlying custody clients. However, we are seeing more third-party agents entering the market, offering alternative securities lending options to beneficial owners. There are also two intuitional investors that have chosen a direct lending model and lend directly to the borrowing community.
It is estimated that non-South African participants comprise approximately 40 percent of market activity.
Lacey: The structure of the South African market offshore lending market is fundamentally no different to other markets. The catalyst for demand is largely being driven by the prime-broker client base, with both onshore and offshore lenders providing the source of supply.
Khan: Since the global financial crisis in 2008 and the subsequent sanction on many firms’ proprietary trading activities, the greatest portion of borrowing is facilitated by prime brokers. Agent lending is not the norm in South Africa, with most participants assuming a principal position from both a legal and credit risk perspective.
How active is the association in working with other associations or liaising with regulators, and what is it currently working on?
Wright: The South African Securities Lending Association (SASLA) is an industry forum established in 1989 to represent the common interests of the participants in the South African securities lending industry. SASLA works closely with regulators and is represented on several industry committees.
SASLA has contributed to a number of major industry initiatives, including the development of the South African Stock Borrowing and Lending Code of Guidance, and has published standard securities lending documentation to be used in conjunction with the Global Master Securities Lending Agreement. The association—with the backing of the Banking Association of South Africa and supported by Strate, the Association for Savings and Investment South Africa, and the Johannesburg Stock Exchange (JSE)—was successful in lobbying the National Treasury for an exemption of collateral arrangements from Securities Transfer Tax (and other tax impacts).
The first Securities financing master class in South Africa was also arranged in early 2015, which proved a huge success. The association is currently actively involved with the JSE in the move to a T+3 settlement cycle in the South African equities market.
Khan: SASLA is very active in liaising with regulators and other organisations such as the JSE, Strate, the Financial Services Board and National Treasury. SASLA has represented the industry before the National Treasury on the tax exemptions required for outright transfers of non-cash collateral. Similarly, SASLA worked quite closely with the Financial Services Board on the draft securities lending note as it pertains to Regulation 28 of the Pension Funds Act.
How well developed is South Africa in terms of cross-border collateral transfer? Is it a useful source of liquidity and/or HQLA?
Khan: South African exchange control regulation controls the ‘flow’ of money in and out of South Africa and securities lending transactions with offshore counterparties are limited to authorised dealers (generally banks) only. Owing to these regulations, as well as the uncertainty around the ‘pledge’ mechanism in respect of non-cash collateral, cross-border collateral transfers are typically settled in cash only, and most specifically, South African rand as opposed to foreign currency.
Anthony van Eden: The South African market lags behind its European counterparts when it comes to cross-border collateral transfer. This is mainly due to the local exchange control restrictions, taxation implications on equities collateral under cession, regulatory equivalence, and the use of triparty collateral management services offered by Strate (which have been available to the South African market since August 2014).
The ability to access foreign-held assets to collateralise local financial obligations, and local assets to collateralise foreign financial obligations (whereby the assets remain and settle in the local jurisdiction under local regulations and legislation), would greatly improve liquidity and the efficient use of high-quality liquid assets (HQLA).
What developments are you looking forward to in the next 12 months?
Lacey: The JSE is looking to reform its settlement regime, with the aim of reducing the current protracted T+5 settlement cycle to bring it in line with other more developed markets. Northern Trust is excited about the prospect that the JSE is migrating to T+3 with a target date of between May and July 2016. It is hoped that this change will also be the catalyst for South Africa to adopt a more streamlined trade matching system, with notably removing the current pre-matching requirement.
If this is the case, we should expect liquidity to increase. However, should the pre-matching requirement remain post-migration to T+3 then it may create challenges within the securities lending market and could have an overall negative impact on lendable supply. We await further details from the JSE to clarify the scope of the settlement regime reforms.
Brett Kotze: The JSE is currently spearheading a project that will see the South African equities market moving from a T+5 to a T+3 settlement cycle. This is a highly complex undertaking that will bring about many changes, one of them being increased demand for securities lending and borrowing to bring down the potential fails rates from a settlement perspective.
Wright: The proposed tax dispensations for equities transferred under cession of transfer (under a financial collateral arrangement) will significantly improve market liquidity and relieve the pressure on available HQLA. The collateralisation of financial obligations has traditionally been in the form of cash or by the pledging of securities in order to avoid attracting tax charges.
The finalisation of the triparty collateral management model will assist with seamless cross-border collateralisation for foreign exposures covered by domestic collateral and domestic exposures covered by foreign collateral. Local providers of securities lending and borrowing platforms will be offering enhanced straight-through processing for this service, to assist the market in its daily activities and with the move to T+3.
Van Eden: There will also be mandatory clearing of standard over-the-counter derivatives through a central counterparty (CCP).
This could see greater use of CCPs, perhaps for securities lending and repo transactions.
Khan: The JSE is moving to a T+3 settlement cycle in the equity market, which will have a significant impact on securities lending and borrowing activity. We also anticipate that the changes in outright transfer of equity collateral will bring about a definite change in the way that non-cash collateral is managed
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