Overall the market has had a good year with equity lending revenues returning a healthy 17% YoY increase and fixed income 7%. Asia is the hot spot with revenues increasing by 40%, and the US and EMEA 2% and 23% respectively1.
Revenues are concentrated, with a few key specials generating a high proportion of revenue in each market. Familiar names like Tesla, Celltrion and Sharp have featured again.
Although asset managers account for 47% of assets available to lend, making them the largest lender group by lendable assets, they account for just 18% on loan, ranking third amongst lender types2.
We have highlighted three topics that came up at last week’s conference that should be of particular interest to asset manager lenders.
The first was a question, raised by a closed door beneficial owners group, that was posed to a panel of agent lenders. “Do agent lenders have any pricing power in the GC3 space?” Given that this part of the market is oversupplied by about eight times, it was a question that really answered itself.
When any asset is eight times oversupplied the seller will be a price taker. Lending of GC securities is no different, and the larger the size of a GC book the more it can work against you. This in part explains why the agendas of securities lending conferences are dominated by borrowers and agents pushing ideas like collateral flexibility, pledge, term structures and other GC enhancing strategies. They need their clients to adopt these strategies to make their GC assets more attractive in a heavily oversupplied market. Obviously, it is a lender’s prerogative to take more credit risk to increase GC revenues but that doesn’t make you a price maker.
The ‘specials’ market is a different place altogether (Agents also use the phrase “Intrinsic Value” to describe this part of the market). Here a stock is ‘special’ precisely because demand outstrips supply. Unlike the GC market, this is where Agents have genuine pricing power, provided two conditions are satisfied:
Size of ‘Specials’ book. If an agent is one of the largest holders of a Special name (top 5, ideally top 3) this will give them pricing power.
Size of GC book. If an agent has a large GC book to manage for other clients, this can blunt their pricing power for their Specials. Agents will sometimes have to allocate Specials to borrowers to encourage the borrower to maintain their GC balances and the prospect of a borrower returning billions of GC will be in the agent’s mind when determining how to price or re-price a special. This has always been a feature of what remains a relationship driven market and it’s unlikely to change soon given the growth in GC supply coming to the market, which is adding to further competition for GC allocations from borrowers.
Using an agent with low GC balances relative to their Specials balance is a good step in reducing the potential drag of performance. However, beware. The market is dominated by GC (around 90% of loans are GC loans), and so by extension are most lending programs.
Most agents will lend Specials as well as GC, so working out the relative size of each part of their book can be tricky. You will need to get precise and consistent data to get a true picture of each agent’s profile in order to address this conflict effectively.
Few asset managers do not have some form of ESG methodology today, so it is natural that the compatibility of lending and ESG principles was a hot topic at the conference. Two key questions emerged, firstly “is it ethical to lend (and facilitate shorting)” and secondly “will lending interfere with voting?”
A panel of two asset managers, a pension fund and a leading pension consultant agreed that lending is not only ethical (because it supports market liquidity and proper market functioning) but also forms part of their fiduciary duty to generate returns for their investors. Though all did concede that they have to invest time educating fund boards, PMs and trustees on its merits.
All three investment firms have active stewardship programs that require them to vote. As a result, all three firms have policies in place that help guide their decision on when to recall a stock on loan so that they can vote and when to maintain the loan and forgo the vote. Investor interest is at the centre of these policies and all are used regularly.
One panellist from an asset manager was kind enough to summarise the options available to his peer group to enhance revenue.
Buffers; Review buffers regularly, particularly in high earning funds.
Exclusive arrangements for certain funds or markets can yield higher returns in some cases.
Corporate Actions; work with your investment teams to capture the value of these events.
Collateral flexibility. “Collateral will come into play but don’t be fooled by agent lender’s promises, stick to your guns and do what you think is best”.
To this wise advice we would only add that managers should look closely at all their idle assets, particularly non-lending funds. There are better tools, data and technology than ever before to help address the concerns PMs and fund boards may have around lending, and these days every basis point counts.
1Datalend, 2018 2ISLA, 2018 3General Collateral (GC)