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Catching the next wave of OTC derivative margining

Catching the next wave of OTC derivative margining

Asia’s securities lending markets might be buffeted by the same global headwinds that are making waves in Europe and the US, but the region nevertheless offers much stronger opportunities for growth.

This was the collective conclusion of agent lenders participating in a panel discussion at Euroclear’s Asia Collateral Conference 2016, held in Hong Kong in late November, titled ‘Securities Lending in Asia : how we got here and the path forward - trends and direction for lending markets and assets’.

Potential for growth

Roy Zimmerhansl, Global Head of Securities Lending at HSBC Securities, said he moved to Asia two years ago because he felt it had more potential for growth than other regions. His fellow speakers backed his view, with only a few caveats.

Almost by definition, Asia’s under-developed securities lending markets are ripe for further expansion in the coming years, in comparison with the US and Europe.

In parallel, the shortage of revenue opportunity in those more mature markets – a factor of both regulatory and macro-economic shifts – is acting as a stimulus to explore and encourage Asia’s development, among borrowers, lenders and service providers alike.

Although speakers wished to accentuate the positive, all acknowledged that the financial crisis and its aftermath had reshaped the securities lending market globally.

But obstacles exist

Driven in part by borrowing demand from long-short hedge funds, securities lending volume growth was curtailed sharply in 2008 by a series of short-selling bans that, combined with cash re-investment losses related to asset-backed securities, prompted many beneficial owners to exit their lending programmes.

Short-selling bans are still wielded by regulators in Asia and elsewhere to calm volatile markets, but lenders have now largely returned, albeit to face a very different operating environment.

Directly or indirectly, a number of global reforms have dampened lending activity in all regions over the past decade, notably Basel III’s capital requirements framework, which negatively impacted the capabilities of agent lenders, typically owned by global institutions.

“We’re now having to look much more closely at the economics of doing particular trades, and the return on capital we are generating,” said Martin Corrall, Agency Securities Lending Product Specialist, Asia-Pacific, Citi, and board member of the Pan Asia Securities Lending Association.

In addition, new reporting requirements are being imposed as a result of the Financial Stability Board, while initiatives to open up new markets, including some in Asia, have progressed more slowly than anticipated.

A key shift in the post-crisis global securities lending environment that has impacted Asia is the rise in use non-cash collateral. This has stemmed partly from the desire of borrowers to use internal inventory for collateral purposes (i.e. stocks and bonds) rather than cash, due to balance sheets constraints imposed by Basel III.

Demand for securities collateral

At the same time, the post-crisis rise in demand for collateral has led to a reassessment of eligible assets with high-grade equities and a wider range of government and corporate bonds coming into play.

In Asia, this development has offered opportunities to agents that have persuaded beneficial owners to widen their collateral sets accordingly.

Panellists suggested that the shift from cash collateral was now sufficiently well-entrenched to withstand a marked turn in the interest rate cycle.

“In markets like Korea and Taiwan, the development of solutions by triparty collateral agents to use equities in markets such as Korea and Taiwan are in their early stages, but there are certainly opportunities in Asia from a collateral perspective,” said Corrall.

Despite the fall-out from the financial crisis, securities lending is now in better place than a decade ago, with Asia in particular poised to shine.

According to Dane Fannin, Head of Capital Markets for Asia-Pacific at Northern Trust, supply has been bolstered by product improvements that manage borrower risks more effectively than pre-crisis, further fuelled by the increased attractiveness of lending returns at a time of low yields from other more traditional sources and an ever-tightening squeeze on costs.

While these factors had positively “changed the perception of securities lending” for beneficial owners, Fannin admitted the picture is more nuanced on the demand side. Slim pickings in the US and Europe have led to an increased focus by hedge funds on Asian investment opportunities, but even here strategies have been difficult to deploy against a backdrop of market uncertainty and volatility.

And like agent lenders, borrowers are having to be more circumspect from a balance sheet perspective, using internal inventory wherever possible.

Revenue vs growth

Nevertheless, appetite for Chinese exposure, heightened demand for high-quality liquid assets (a rare positive effect of Basel III on securities lending) and the gradual opening up of emerging markets makes Asia the best prospect for the industry.

“In other jurisdictions, it’s all about revenue protection; in Asia it’s all about growth,” observed Fannin, noting also the increasing lending opportunities for holders of small and mid-cap stock due to the growing popularity of short-term, quant-based and stat-arb strategies in Asia and beyond.

Zubair Nizami, Head of Securities Lending Trading, Asia-Pacific, Brown Brothers Harriman, pointed to recent volume surges in South Korea as an example of the growth potential offered by Asian jurisdictions, given the balanced regulatory framework.

Nizami acknowledged that regulatory requirements and market structure issues continue to hamper participation of beneficial owners in certain markets, notably Taiwan and Malaysia, but pointed to a host of opportunities for growth in the short and medium term.

Alongside those markets that had already taken their first steps to facilitating securities lending, he suggested China, Indonesia and India could bring significant new capacity on-stream in the next five years.

“Shanghai-Hong Kong Stock Connect theoretically permits stock lending, but effectively bars agent lenders, custodian banks and prime brokers from participating in the market. Amending these rules is not at the top of the regulatory reform agenda at present, but could increase in priority,” said Nizami.

Obstacles remain

The panel’s observations on the pace of market development in certain Asian markets was reflected in the results of an audience poll question which cited local rules as by far the biggest limiting factor on securities lending in the region.

While Fannin noted the embedded premium available to beneficial owners willing to work within “more challenging” jurisdictions, Nizami said there was strong latent demand from hedge funds for borrowing in markets such as Malaysia, rewarding the efforts of agent lenders and their beneficial owner clients to offer liquidity, despite regulatory restrictions.

As regulators, market infrastructure providers and market participants work to develop frameworks that balance systemic stability with stimulation of lending activity, how else might further Asian growth be cultivated?

New avenues for lending, notably via central clearing, topped an audience poll, but Zimmerhansl and his panellists voiced a number of reservations, suggesting efforts to develop new markets and/or new product types might generate greater volumes in Asia, at least in the near term.

Corrall said central clearing might be a more suitable solution for more mature, cohesive markets such as US and Europe than the still evolving and diverse Asian landscape, while Nizami argued that supporters of central clearing would need to demonstrate advantages to beneficial owners, such as customised lending programmes, as well as the capital efficiency benefits that appeal to agent lenders and borrowers.

“My personal view has always been that central clearing will come in when there is an economic driver. Right now, there isn’t the pressure; even interest from borrowers is limited,” said Zimmerhansl. “In addition, the idea of having multiple clearing houses operating across the region is a challenge for Asia.”


“We’re now having to look much more closely at the economics of doing particular trades, and the return on capital we are generating,”   Martin Corrall, Citi and PASLA.

“In other jurisdictions, it’s all about revenue protection; in Asia it’s all about growth,”  Dane Fannin, Northern Trust

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