Normalization of Monetary Policy in Europe and Securities Lending

currency market

After a decade of historically low global interest rates, we are seeing the economic environment in Europe begin to shift as the BOE and ECB signal a change in the winds.

The BOE has recently indicated that interest rate rises are on the horizon to curb inflation, and the ECB will stop quantitative easing in 2018. Convertible bond activity is one area that we have seen a significant increase in demand for, from a securities lending perspective, as a result of these developments. Digging into the data, we have seen a steady expansion of convertible bond issuances since 2012. In 2015 there were $25.6 billion, compared to new issues of $29.1 billion in 2016, according to Union Bancaire Privee (UBP) data. In the last two weeks we have seen a total issuance of $2.3bn.

The majority of companies will tend to opt to issue convertible bonds rather than other forms of capital raising, owing to the lower rate of debt and to delay the dilution effect. Convertible bonds are generally accepted with a lower coupon rate due to the conversion feature (call option). As we are in a raising rates environment, we are seeing more issuers getting ahead of potential raises. This enables the issuer to save on interest rates, and therefore is a cheaper way to secure finance, whilst minimizing the downside risk on the stock price due to the delayed dilution effect.

The securities lending demand we have witnessed is a result of hedge funds entering into arbitrage strategies. This typically involves buying the convertible bond and shorting the underlying stock, which enables them to make the difference in yields between the bond and the stock, while remaining relatively risk free. Recent convertible bonds which have given rise for demand on the desk are Capital Stage ($115 million), Qiagen ($350 million) AMS ($350 million), Nyrstar ($118 million), Deutsche Wohen ($941 million) Ca Immobilien ($235 million), and Vallourec ($235 million) according to Bloomberg.