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Strong and Resilient

The Canadian securities lending market has always held a strong position but how did it react to the significant volatility triggered by the COVID-19 pandemic and what does the future look like in terms of economic recovery?

As featured in Securities Lending Times, Issue 278

Q: Canadian pension funds closed 2020 in the black, according to Northern Trust, but how did lenders get on in 2020 where are they at now? 

A:  2020 was a year where clients, including Canadian pension funds, saw positive returns from a variety of factors.  The year started out with relatively strong demand for securities lending. However, as the COVID-19 pandemic kicked off market volatility, this led to clients repositioning their portfolios, which triggered an influx of sales and a demand for High Quality Liquid Assets (HQLA) in the form of Canadian Government bonds and US Treasuries. The securities lending business proved its resilience and was able to meet the demand. Governments and Central Banks around the world stepped in to pledge unprecedented levels of economic support.

The primary areas of revenue in 2020 for Northern Trust’s Canadian lending clients were centred around “in demand” single name equities, ETF’s, SPAC’s, and DRIPS. Specials were centred in sectors affected by COVID-19 including airlines, travel & tourism, energy and industrials which continued to experience an increase in demand, and in many cases at increased lending spreads.  In the fixed income space, there was continuous demand around the Canadian Government Bond benchmark issues as well as HQLA collateral upgrade trades for open and term structures.   

We expect that securities lending in 2021 will continue to be a consistent source of alpha for pension funds.  Currently, overall demand remains strong for securities lending in Canada with utilization up slightly with fixed income balances accounting for most of that increase.

Q: The Canadian central bank was among those that opened new liquidity lines last year. How did Canada's strategy to cope with COVID financial strife, compared to the US or Europe? Are any of those liquidity facilities still available?

A:  While many of the Bank of Canada (BoC) liquidity facilities are still in play, starting in the fall of last year, the BoC began scaling back purchases of Canada treasury bills and discontinuing the Provincial Money Market Purchase program. Just last month, BoC became the first central bank to signal an end to the stimulus brought about during the pandemic and began scaling back the bond purchasing program from CAD $4B to $3B per week.

The Canadian securities lending market has always been in a strong position due to the majority of collateral accepted is non-cash.  This allows borrowers to efficiently manage their balance sheets without having to rely on cash collateral.  The flood of liquidity from the Central Banks has resulted in a lack of specials trading in the Canadian Government Bond (CGB) market.  It has not had an impact on equity specials demand, as the focus on single name stock has continued.  There has been an interest in pledging equities as collateral for CGB’s as borrowers have looked to maintain or upgrade their balance sheets while demonstrating secured financing.  This has given rise to opportunities in the Term market for holders of HQLA assets.

Q: During periods of volatility, communication between stakeholders becomes more important than ever. How did agent lenders tackle the pandemic troubles on behalf of their clients? 

A: Communication is key, specifically during times of significant market events like the Covid 19 pandemic. Northern Trust Securities Lending placed a strong emphasis on communication with our clients, specifically on the impact to the fixed income and equity markets as well as providing assurances around our risk management protocols, counterparty and collateral monitoring processes. Our 40 years of experience as an Agent Lender was key to our success during the pandemic.  The single most important issue we dealt with was ensuring the business was successfully transitioned to a remote work environment without impacting our clients or borrowers. This was happening at the same time our client’s and borrowers were also figuring out how to transition their businesses.  Northern Trust was able to support our clients and our securities lending business throughout the transition period as we moved trading, client relationship management and our operations teams to a remote environment without any business disruption.  Northern Trust remained committed to our client’s revenue and client servicing needs throughout the pandemic and positioned ourselves to take advantage of demand opportunities.   

Q: Looking ahead, economic recovery seems intrinsically linked with the vaccine rollout. What is the broader outlook for Canada going forward and how will this impact the securities finance market? 

A: Canada has always been supported by a strong economy and well-capitalized banks and financial institutions.  Securities lending is a global product and our clients hold diversified portfolios across Canada, US, Europe, and Asia Pacific. It is Northern Trust’s responsibility to make sure we are maximizing securities lending revenue for our clients irrespective of the impact in any specific region. What we have seen is that the vaccine roll out has been different around the globe and how that translates to securities lending demand is not clear.  What is important to our clients and borrowers is to have a regionalized program set up to react to any market demand or events within the securities lending market. Northern Trust has trading desks in London, Toronto, Chicago, Hong Kong, and Sydney to cover all regions for our clients.

Q: There have been rumblings of anti-short selling sentiment (within regulatory bodies, politicians and potential shorter targets) in Canada for sometime but that appears to have developed more recently. What's going on here and do you predict anything substantial will come from this to curb short selling? 

A: Where we see a shift in the market is toward ESG and how that should be implemented at the securities lending level.  Securities lending programs can coexist with ESG principles. There are two main ways clients are addressing ESG in their lending program: through their policy on proxy voting and collateral acceptance. A client’s lending policy should reflect their unique ESG preferences, so this means clients may not choose to lend certain securities because they want to vote their proxies. Another area that we see clients considering ESG is in the types of collateral they hold, whether it be securities collateral or through their investment of cash collateral.  Client may decide to restrict certain areas of investment to reflect their ESG preference.

On a side note, we are glad to see Korea is scheduled to begin lifting their short selling ban at the beginning of May.  Most of the restrictions that were put in place by regulators globally were short lived.

 

George Trapp, Head of Business Management, Securities Finance NA

George Trapp is a Senior Vice President and Head of Business Management, and Client Account Service and Implementation for the securities lending business in North America.

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