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US Securities Lending: Tapping into Pockets of Opportunity
Mark Coker joined the Securities Finance Times panel to discuss key trends in the US securities lending market including markets performance, regulatory impacts, sustainable lending demands and opportunities moving into 2022.
As featured in Securities Finance Times, Issue 287
How do you assess the performance of US securities lending markets during 2021 to date? What trends have you noted in terms of loan balances and lending fees? What have been the high earners - and the weak performers?
US equity securities lending balances have risen through 2021, predominantly due to mark-to-market adjustments as equity markets continued to rally. This market dynamic, supported by Fed stimulus and lower interest rates, has resulted in a softer specials space. The rise of retail trading groups has also added borrower caution on highly shorted securities. High earners have generally come from new issuances (IPO / SPACs) or the exchange-traded fund (ETF) sector.
Strong performance in the US fixed income securities lending space has come with the flight to quality and renewed demand for high-quality liquid assets. Loan balances increased in 2021 relative the previous year due, in part due to the abundance of US dollar cash in the market. We have seen a general increase in lending spreads, driven in large part by lower rebate rates on loans versus cash collateral and demand for benchmark securities.
Which regulatory projects will have the greatest impact on your lending programme over the 12 months ahead? What adaptation challenges will these present?
The most poignant of topics is The Central Securities Depositories Regulation (CSDR), which introduces new measures for the authorization and supervision of EU Central Security Depositories (CSDs) and sets out to create a common set of prudential, organizational, and conduct of business standards at a European level. CSDR applies to all European CSDs and to all market operators in the context of securities settlement – which will need to directly comply with the measures the regulation introduces related to mandatory buy-in regime and cash penalties for settlement failures. Therefore, the scope of the regulation also includes, and impacts, US and Canadian clients and borrowers that trade European Securities (equities and fixed income). It will be particularly important for agent lenders to have strong operational foundations, such as those present at Northern Trust with our global custody business coupled with a robust procedural control ecosystem to successfully navigate CSDR penalty regimes.
The Q4 19 repo spike in the US was followed in early 2020 by the COVID-19 crisis. How did the market react? What lessons (if any) did you learn from this period that you will carry forward?
The repo spike in late 2019, and the Federal Reserve response to the COVID crisis in March and April of 2020, both relate to the same market function – the level of excess reserves. What was a deficit of reserves in 2019, which increased rates, now dominates the story line as a surplus of reserves which is depressing yields.
Demand in fixed income was characterized by a flight-to-quality bid, with market participants looking to source High Quality Liquidity Assets (HQLA), particularly in term maturity exposures versus lower-rated or less liquid collateral. In the credit space, initial demand for corporate bonds was correlated with those industries most exposed to the COVID-19 impact such as leisure, travel, retail and autos. Markets quickly calmed through the second quarter, with central bank actions providing comfort to market participants to re-engage across markets and trade structures.
What are the key issues for the US securities lending community in promoting high ESG standards across the SLB transaction value chain? How will this impact the range of assets included in the lending programme? And screening of collateral?
Recent Industry surveys have shown that ESG principals and securities lending can co-exist, so the range of assets used within the securities lending program are not typically impacted by ESG. The challenge to the lending agent is to ensure it can support clients’ needs by ensuring the lending activity is aligned with their corporate objectives. Transparency around short-selling, borrowing practices and recall policies is being supported by the introduction of regulation in some regions (such as SFTR). Proxy voting on behalf of the beneficial owner, with the ability to recall ahead of meetings, is key alongside the ability to restrict and screen collateral based upon clients’ ESG needs. This extends to cash collateral reinvestment.
There is a need for refinement around ESG to ensure the continued efficiency of securities lending – for example, adding pressure to secure more timely disclosure of proxy information by companies (to fully support the timing of the recall) and providing clear definition of ESG parameters, which will assist with the creation of standardized ESG collateral sets.
Whilst we focus on the challenges, there are also opportunities within securities lending. For example, the recent issuance of Green Bonds has created new revenue opportunities via an improved ‘greenium’ (the premium on green bond prices). This is currently a watch item as we see how demand evolves.
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