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Canadian Securities Lending Panel: A View from Toronto

George Trapp joined other Canada-based securities lending specialists to speak about market outlook, technology, sustainable lending and what will drive their development expenditure moving into 2023.

As seen in Securities Finance Times issue 304 07 June 2022

How do you assess the performance of the Canadian securities lending market over the past 12 months? What have been the key trends driving loan balances, utilisation and revenues?

Demand has continued to be relatively consistent despite the extreme volatility in the market. On the equity side, geopolitical tension created heightened volatility in the markets. As a result, hedge funds looked to de-gross their exposures (cover shorts and sell long positions) resulting in softening borrower demand.

As equity markets declined and hedge funds sold long holdings, borrowers had less access to non-cash collateral financing opportunities. As a result, equity balances versus non-cash collateral dropped as borrowers resorted to using alternative forms of collateral (particularly cash) to source borrows.

Key drivers in generating revenues have been market sectors that have prompted strong borrower demand, including electric vehicles, space infrastructure and fintech. Many of the targeted companies have come to market through Special Purpose Acquisition Companies (SPACs). Additionally, index tracking and high-yield ETFs remained a good source of borrower demand during the year. Dividend record dates, as well as heightened market volatility, also played a large part in driving underlying demand.

On the fixed income front, central bank rhetoric turned hawkish as inflationary concerns took hold, prompting measures to smooth the exit from emergency pandemic support. Central banks have been aggressive in increasing rates and costs to borrow money.

US and CAD treasuries, gilts and European sovereigns remain in demand as central banks taper asset purchase programmes. Corporate bond demand remains robust, given interest rate expectations, while concerns of a slowdown in China, alongside surging energy and commodity prices, are leading to increased activity for emerging market assets. Regulations including the NSFR and Uncleared Margin Rules (UMR) will maintain demand of HQLA, such as CAD and US treasuries and gilts, particularly in term exposures versus equity collateral. Strong demand centred around the Canadian government bond benchmark issues, as well as HQLA collateral upgrade trades in both the term and open space as borrowers continued to focus on more effective balance sheet maintenance.

Clients with greater collateral flexibility will benefit the most as borrowers seek to pledge non-cash collateral, including Japanese government bonds (JGBs), equities, and ETFs.

What investments and adaptations to working practices have you made to sustain and grow your Canadian securities lending activity in this environment?

Working specifically with clients on collateral flexibility, and offering specific trade opportunities for term or open activity, is key to helping our clients achieve their goals. With the increased volatility, risk management has been at the top of our list to ensure that all exposures are fully understood by our clients. A good example is with the recent sanctions and restricted trading in Russian securities.

Which regulatory initiatives will consume most attention for your agency lending and collateral management teams over the coming 12 months?

The SEC’s proposed 10c-1 rule would require that persons “that loan a security on behalf of itself or another person” disclose the terms of such transactions to a registered national securities association, namely the Financial Industry Regulatory Authority (FINRA). The disclosed information would include information about the security, terms of the transaction and must be provided to FINRA within 15 minutes of the transaction. While the goal of the proposal is to improve transparency and provide clear and timely access to pricing and other material information, the proposal may have some unintended consequences, including reducing lender participation in securities lending trades, increasing use of synthetic trades, and creating potential for increased cybersecurity risk as sensitive data fields are collected in centralised databases. This may result in lower lending revenues for agents, broker-dealers and clients, or the possibility that they withdraw from securities lending activity.

In parallel with these developments, a proposed relaxation of SEC Rule 15c3 could trigger a profound shift in the way US firms look to optimise their non-cash asset base. This rule currently prohibits US banks and broker-dealers from providing equities as collateral against securities finance transactions. Having said that, we have been waiting for this change for over 10 years, so this does not appear to be a priority given the recent introduction of Rule 10c-1.

What expectations do your clients have from you as a service provider in supporting their commitment to sustainable lending and borrowing? Have recent market conditions and geopolitical stresses had an impact on demand for ESG-compliant lending solutions?

Sustainability is a core element of ESG investing, and securities lending is important as it brings liquidity to capital markets generally, and enhanced returns to investors who lend. As such, it is important for all parties to understand how firms can integrate their lending programmes and their approach to ESG.

Recent industry surveys, including “RMA Survey Finds ESG Investing and Securities Lending Can Coexist” (Oct 2020), have shown that “ESG principles and securities lending can co-exist and be complimentary, not conflicting.“ Typically, governance is reflected in policies on proxy voting that align with the corporations’ goals. Proxy voting on behalf of the beneficial owner, with the ability to recall ahead of meetings, is key.

Collateral has also come into focus, both on the cash and non-cash collateral side. Collateral can be customised within guidelines to meet specific ESG needs. However, there is a balance between collateral restrictions and what the borrower community is willing to actively manage or pledge. Northern Trust works with clients and borrowers to explain the balance and help the client achieve their best outcome based on their priorities.

How do you assess the outlook for the Canadian securities lending markets for the remainder of 2022 and into 2023?

Northern Trust remains cautiously optimistic as we approach the second half of the year. Securities lending remains an integral part of the capital markets business. The trend we find most notable is the level of sophistication and engagement we have seen from our clients as they look to generate incremental revenue from their portfolios. Northern Trust believes that securities lending will continue to be a positive contributor to revenue, both for the bank and for clients in our securities lending programme.

Currently, overall demand remains moderately strong for securities lending in Canada, with utilisation and on loan balances continuing to grow significantly. Fixed income balances account for most of that increase. Demand has waned somewhat for sourcing general collateral securities. We expect continued volatility in global commodity prices, furthering directional short interest across the oil and mining sectors. We expect also to see dividend yield enhancement and dividend reinvestment trades continue to provide a steady revenue stream throughout the remainder of the year.

A few areas that beneficial owners will want to keep an eye on are collateral expansion, term structures and emerging markets. While we have discussed collateral and term above, emerging markets continue to be an important source of securities lending revenue for beneficial owners. Northern Trust, through our global network of borrowers and trading desks, provides market expertise and access to securities lending in both the developed and emerging markets.

Working specifically with clients on collateral flexibility, and offering specific traded opportunities for term or open activity, is key to helping our clients achieve their goals.

George TrappHead of Business Management, Securities Finance NA, Northern Trust

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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