Securities financing markets in the Americas will face similar challenges throughout 2019 as we experienced in 2018. We anticipate markets will continue to be impacted by volatility created through monetary policy and continued geopolitical tensions.
The primary driver of volatility in the US market will likely be the well-telegraphed changes in monetary policy. As the Federal Reserve (Fed) continues their tightening policy, 2019 will present opportunities to monetise market inefficiencies. The steepening interest rate curve offers clients engaged in a cash collateral programme an opportunity to implement a variety of strategies to benefit from the carry between the cost of funds and yield received from the cash collateral investment. Clients may consider adopting a cash collateral programme to take advantage of this interest rate mismatch opportunity.
The steepening LIBOR curve also provides an opportunity for beneficial owners to capture higher yields on their reinvestment portfolios. The ability to lend general collateral and reinvest the cash collateral into a pool of diversified money market instruments enables clients to derive additional return.
This strategy is highlighted by the continued inflows of securities lending cash collateral into prime money market funds. Since the implementation of the Securities and Exchange Commission’s (SEC) 2a-7 money market reform, beneficial owners continue to allocate a portion of their cash collateral to higher yielding investments to capture this market inefficiency.
While cash collateral represents a significant portion of our client strategies, non-cash collateral lending continues to dominate the collateral universe. The industry for several years has been lobbying the US regulatory authorities to expand the permissible collateral a counterparty can pledge in a non-cash collateral transaction to include equities. Market participants will greatly benefit from such changes to SEC Rule 15c3-3, resulting in higher volumes prompted by the efficient usage of counterparty balance sheets and capital.
Regulation has prompted financial institutions (FI) to more closely monitor their balance sheets and liquidity. The ability to pledge securities as collateral helps an FI preserve its liquidity position and put more assets to use, enhancing its liquidity profile and financial flexibility. The focus on balance sheet allocation shifts the demand to borrowing non-cash assets, which offers broker dealers an opportunity to net and move transactions off balance sheet. Non-cash collateral-based transactions are less balance sheet-intensive than cash collateral-based transactions, hence the growth in non-cash collateral. We anticipate these changes to come to fruition in 2019.
Throughout 2018, lending markets in the US have experienced considerable growth in the percentage of transactions which are done on a non cash collateral basis. Approximately 50% of all transactions in the US market are comprised of non-cash collateral which compares to less than 20% nearly 3 years ago. This growth will continue in 2019 and BNP Paribas is well positioned to monetise this shift in collateral preference of borrowers.
We remain convinced that lending general collateral securities and high quality liquid assets (HQLA) will remain popular. The market continues to have an insatiable appetite to borrow HQLA and clients willing to examine the tenor and permitted collateral received in these collateral transformation transactions will be compensated appropriately.
Despite the lack of ‘specials’ in the US Treasury market, lending opportunities still exist. Throughout 2018 several benchmark issues were highly sought after, often receiving hefty premiums to lend. We anticipate these will increase in 2019 as the Fed’s Federal Open Market Committee (FOMC) continues its tighter monetary policy.
The 2019 securities lending equity markets will be much of the same as in 2018. The impact of Amazon on the retail space along with borrowing securities linked to the biotechnology sector will remain factors in demand. Further, the demand for exchange-traded funds (ETF) will likely continue. ETFs linked to politically sensitive regions or sectors are showing signs of continued demand as the geopolitical impacts across the globe unfold. Finally, the healthy status of corporate balance sheets will most likely continue to drive significant merger and acquisition activity, resulting in corporate action revenue opportunities.
Implementing a combination of the above strategies, along with opening new markets and examining new trade structures, will assist clients in generating enhanced programme revenues.
The level of beneficial owner engagement in 2018 has been positive and we anticipate this will continue throughout 2019. Current lenders have been more willing to analyse proposals that lead to higher revenues, increased utilisation rates and greater risk protection. Non-cash collateral lending, a broader collateral policy and non-traditional counterparties and trade structures are examples of changes in their approach to lending.
Beneficial owners currently not involved in lending are also beginning to recognise opportunity cost. Assisted by broader education, we are now seeing new participants coming into the market and look forward to providing them with industry-leading solutions.
Securities lending revenue from European markets in 2018 saw a healthy increase in both fixed income and equity markets. While we anticipate challenges in 2019, we remain optimistic that we will continue to bring incremental value to clients who participate in our agency lending programme.
Within European fixed income, lending HQLA will remain a strong driver as borrowers impacted by regulation continue to create demand. The regulation driving change in borrower behaviour and collateral includes the Supplemental Leverage Ratio (SLR), the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). These requirements are natural drivers for HQLA demand, so the ability to lend these assets on a term structure instead of overnight will be highly sought.
We anticipate a trend for borrowers to look to place more varied types of non-cash collateral. Therefore, agents will need to assist lenders to understand the inherent risks, as well as equipping them with the tools to manage them.
The political landscape in Europe and the end of the European Central Bank’s Quantitative Easing programme, are areas that will be closely watched. We will be monitoring any lending opportunities brought about by changes in market spreads with a view to maximising revenue.
Political uncertainty, including Brexit, is a potential driver of underlying demand because we expect this to lead to increased volatility. We also remain hopeful that gradually improving Eurozone economics will lead to an increase in merger activity, creating opportunities for securities lending.
During 2018, a common theme expressed at securities finance market industry events was that more regulation was now part of business as usual and companies have adapted to this. That said, the adoption in 2019 of the Securities Financing Transactions Regulation (SFTR) is demanding considerable planning and investment across the market as a whole.
Consistent with other regions, due to the regulatory capital requirements we have seen increased demand for global fixed income assets traded within the Asia-Pacific time-zone. This demand is likely to continue in 2019, with a need for longer-term structures and flexible collateral schedules. Key revenue opportunities lie in the acceptance of Korean, Taiwanese and China A-shares and continued appetite to borrow HQLA such as Australian Government bonds (ACGB’s).
General collateral (GC) trades in equities are a core driver of revenue across liquid markets such as Hong Kong, Japan and Australia. Industry returns in Hong Kong and Japan were positive throughout 2018, however proxy voting has had a negative impact on the Australian domestic securities financing market. There are no signs of this abating in 2019, due to the corporate governance requirements of beneficial owners.
We see significant opportunities for agency-lending in South Korea and Taiwan. GC levels have normalised in recent years for South Korea, as the onshore lending market has grown and liquidity of supply has increased. However, it is still a ‘specials’ driven market, generating high returns on lendable assets.
In summary, the outlook for agency-lending in Asia-Pacific for the year ahead is one of growth and opportunity.
BNP Paribas Securities Services Agency Lending Global Programme
2018 was a transformational year for our agency-lending programme. A combination of organisational changes and enhancements to our platform’s operating model, has enabled us to better service our existing clients while preparing the business to grow substantially.
Our global lending platform now enables assets in any market across the globe to be placed on loan 24 hours a day, five days a week. This model results in better execution for client assets due to the local expertise of lending desks around the world to distribute assets in their local markets. A single lending platform also permits a full suite of lending transactions, including cash and non-cash collateral. These provide clients with a range of options when lending across the globe in accordance with their risk profiles.
The adoption of this proprietary platform technology will make our business more efficient while strengthening counterparty relationships. We expect to expand our trading counterparties to approximately 90 different borrowers in early 2019. This will benefit clients directly as the distribution network of programme participants expands.
We have implemented changes in our management structure to realise the major developments we’ve made in our Agency Lending Global Programme.
BNP Paribas Securities Services often provides multiple services to our clients and our management changes are also designed to holistically meet the overall needs of our clients.
In summary, we are committed to providing clients with an industry leading securities lending platform and optimistic for securities finance for the year ahead.
Securities Lending Update
The merits of securities lending
SFTR regulatory memo
Agency Lending Factsheet
Securities lending: unlocking the hidden value of my portfolio