As the second largest securities lending market in APAC, Hong Kong has been the success story in recent times and industry experts are seeing continued growth for clients there. Zubair Nizami, Head of Asian Securities Lending Trading at BBH recently discussed his market observations with Securities Lending Times.
What is the current state of the securities lending industry in Hong Kong?
An increase in specials activity across Asia-Pacific has contributed to strong lending returns for asset owners in the region over the past few years. This growth can be attributed to several factors, such as high asset values, robust borrower demand, increased beneficial owner participation in lending programs and strong corporate deal flows.
While Asian markets overall generated strong lending returns, we have certainly seen Hong Kong as one of the stand-out markets in recent times. However, we have witnessed a softening in securities lending demand across the region since the beginning of the second quarter of 2019, with Hong Kong particularly impacted. A slowdown in corporate deal activity, coupled with an uncertain macro environment, largely due to the escalation in the China/US trade war, has resulted in reduced hedge fund activity and consequently subdued borrowing demand. Given an uncertain external environment, we expect lending returns in the region to reflect this trend in the second half of 2019.
What has contributed to the success of Japan’s securities finance market?
The Japanese securities finance market has continued to thrive for a variety of reasons. Firstly, Abenomics and more specifically the loose monetary policy set by the Bank of Japan (BOJ), has driven key Japanese interest rates into negative territory for a prolonged period. As a result, Japanese banks looking for foreign currency funding have been actively engaging in financing transactions and thereby boosting overall volumes. In addition, this has enabled foreign banks and brokers to be active in placing their surplus Japanese yen or assets to Japanese counterparts that accept this form of collateral.
Secondly, there has been healthy demand for specials in the past few years spurred on by strong corporate deal activity and an increased focus on corporate governance for Japanese-listed companies by activist investors.
Finally, Japan has an established securities finance framework which has less rigid rules and regulations compared to other markets in the Asia-Pacific region, and a deep pool of liquidity in both equities and fixed income. This provides investors with the confidence to actively participate in the market. The lower barriers to entry for new entrants is also a major factor in encouraging both foreign and domestic participation, thereby boosting overall market liquidity and returns for investors.
What trends are you seeing from clients?
We are seeing several trends from our global clients with an overarching theme focused on generating additional revenue from securities lending to augment their investment activity. In Japan, institutional clients remain focused on meaningful returns, as securities lending returns are an important revenue generator in the current environment. Additionally, a relatively new development in Japan is the rise of actively managed equity mandates in lending programs. In the past there has been a misconception in the market that only passively managed global index mandates would be suitable for lending. However, because of increased engagement with active managers about the benefits of lending we have been able to advance this discussion, which is an overall positive for boosting liquidity and generating returns for investors.
In the US and Europe, securities lending continues to remain at the forefront of many discussions with asset owners, particularly passive funds. Given the continued low yield environment, the additional basis points generated by lending for a low-cost fund can be invaluable to offset management fees. For active managers the ability to not only enhance alpha but, in some cases, completely offset management fees. Given the rise of passive investing and increased focus on performance and cost mitigation for asset owners, we are continuing to see more engagement from both clients and prospects in relation to either commencing or expanding their securities lending programs. Indeed, some asset managers are looking into starting their own in-house securities lending operations to capture revenue for their investors as well as themselves.
Looking to the next five years, what changes do you anticipate for Hong Kong’s securities?
In the long-term we would expect to see the Hong Kong securities market become more integrated with mainland China. However, the big question on the minds of many market participants is – “when will China open its securities lending market for foreign investors?” In our view, whilst the potential will be a game changer, we believe that we are quite some time away from an established and robust securities lending framework, that can compete with the likes of Hong Kong, Japan or South Korea. However, the desire to do so is certainly there and the recent engagement between the relevant exchanges, regulators and industry associations has been positive.
Are there any challenges that you anticipate over the next 12 months?
From a demand perspective, we believe a further escalation in the China/US trade war, continued uncertainty in the Eurozone economy and geopolitical risk factors such as Brexit and escalating tensions in the Middle East may lead to significant challenges for the capital markets. As we have seen in the second quarter of 2019, this market uncertainty has started to reflect on reduced returns for the securities finance industry.
Aside from the macro environment, the implementation of SFTR in 2020 will continue to remain a major focus for the industry. Ensuring a successful roll-out to ensure securities finance data can reported to trade repositories by the stated deadline will be of paramount importance for market participants.
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