ETF Securities lending: creating a path to greater market liquidity
The US ETF securities lending market is worth about USD$100bn, with 30% of that total on loan at any one time. Europe by comparison is just one quarter of that size – USD$25bn – with a significantly smaller average percentage of securities in use, at 5% (2015 Markit / SLT survey - ETFs as Collateral).
These contrasting figures led Olivier Grimonpont, Global Head of Collateral Management and Securities Lending at Euroclear, to ask panellists at the recent Euroclear/Citi iETF conference in London a simple question: “Is ETF securities lending on your New Year’s list of things to do?”
For not only is the European market smaller and typically more expensive than the US, volumes of ETF securities lending in Europe have stagnated over the last five years.
Gareth Mitchell, Global Head of Agency Lending Trading at Citi, started the responses with an acknowledgement that investment funds in Europe do not seem to hold ETFs as their American peers do. “Some of our clients struggle with the question of where ETFs fit into their European lending programme,” he said.
There is also the problem of gathering availability of an ETF issued on numerous exchanges across Europe. Mitchell stated that ETFs with multiple security codes caused problems with locating supply. (To overcome this problem, Euroclear has created the structure for an internationally settled ETF).
Matthew Fowles, BlackRock, agreed with Mitchell. One of the most common questions from clients is around how much revenue they are likely to make – however with few data points in Europe, it is difficult to estimate this with any level of confidence. He added the numerous number of codes for the same fund, combined with agency lenders typically holding inventory under a SEDOL identifier, was another major challenge for market participants.
Grimonpont said all market participants could benefit from greater access to data. He believed ETF securities lending was a chicken-and-egg situation where increased demand would foster greater supply and vice versa.
Citi’s trading desk – independent from the securities finance division represented by Mitchell – is one party leading by example when it comes to increasing demand. James Burchell, responsible for ETFs on the Citi trading desk, said that his team had worked extensively to increase the supply of the major ETFs and reduce rates to a level that would allow for a growth in activity. Increasing the size of trades is crucial to ensuring that all parties get some value from the deal, according to Burchell.
BlackRock, the world’s biggest asset manager, has been one of the other parties keen to make lending ETFs more attractive and see availability and loan balances increase. Fowles said that he believed there was now increasingly competitive pricing, more in line with underlying securities and gradually improving supply, particularly on flagship equity and fixed income funds. An efficient lending market was seen as a critical building block for ETFs to be considered true financial instruments. Critically lowering trading costs, increasing liquidity and supporting the establishment of an options market.
Hitherto it has been this gap, often of several hundred basis points, that has dissuaded brokers and marketmakers from borrowing European ETFs.
A leading market maker on the panel, which quotes more than 2,000 ETFs globally in real time, said his firm had just started digging into lending pools. He said it was still tough to find a quick borrow but for a marketmaker, this side of the market could make a major improvement to their books.
Here Grimonpont turned the discussion towards ETFs themselves as collateral, which is another function where Europe lags behind the US. Markit has recently introduced lists of fixed income and equity ETFs to offer some general, open criteria for acceptable collateral. “Are the Markit lists enough to grow this market?” asked Grimonpont.
Fowles described the Markit lists as landmark development, stimulating some institutions to look at ETFs as collateral for the first time. He said that collateral efficiency in Europe for ETS was challenging, and that the greatly improved transparency provided by the lists would help make ETFs truly `fundable’.
All the panellists agreed that it is essential to get more hedge funds as would-be borrowers – and to have them consider ETFs as essential tools. Fowles added that the collateral and lending market would need to develop in tandem.
Mitchell summed up by saying that as agency lender, Citi was pushing as hard as it could to increase ETFs’ role in the lending business. It is clear the use of ETFs in the lending business has become a feature of many conversations, and even estimates, taking place in the industry today.