US Beneficial Owners Roundtable 2022: the US environment

US Beneficial Owners Roundtable 2022: the US environment

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Amélie Labbé, Chair: To everyone listening today, welcome to the US Beneficial Owners Roundtable, the first one for 2022. I’m delighted to be joined by a great panel of industry experts to explore some of the latest developments in the US securities lending market. I would like to set the scene before we jump into the discussion. Recent data would suggest that activity in the Americas in 2021 - the US primarily - drove increases in lender revenue. Last year was a strong year on that front. Had we had this conversation potentially earlier this year, we would we probably would have surmised that the volatility that we saw in preceding months and the influence of the global pandemic would have given way to more stable market conditions, and a continuation of the rebound in lending activity. It’s fair to say that wider economic, financial and geopolitical factors are having an influence at the moment. I’m going to turn to you first Monica to summarize some of the recent market movements we have seen.

Monica Damas-Shaw, S&P Global Market Intelligence: To set the scene for 2022 I’d like to mention some of the things that we saw in 2021. Outside of the traditional borrow demand, the European and US markets benefited from corporate events such as the trade deals, the spin-offs and the surge in SPACs, which led to a high performance globally. We did see global lendable balances remain in a steady uptrend since 2017, reaching an all-time high in November peaking at USD 37 trillion. This increase was due to a combination of both market appreciation and new entrants into the market. As you mentioned, we did see high revenues in 2021, at USD 10.9 billion, a 16% increase compared to the previous year. When we look at the factors that contributed to the revenue, we can start with the equity specials balances which surged early in the year, led by the dramatic meme stock craze in January. This was followed by the APAC specials in June, which recorded a 78% increase year-on-year.

Specials as a whole rebounded in 2021, with average balances of USD 27.4 billion, an increase of 11% YoY. We continued to see a great performance from exchange-traded products and corporate bonds, which delivered considerable returns, with more diversification in top earning assets compared to previous years.

In the Americas, the strength in the equity revenues for 2021 was supported by the rise in ETFs and ADR activity. ETFs continued to deliver robust earnings reaching USD 330 million in the second half, a 65% increase year-over-year. This was mainly driven by the sharp increase in average loan balances which topped the USD 100 billion mark, a 57% increase YoY. Also in the second half of 2021, conventional IPOs were the top revenue generating stocks, with Robin Hood leading the way with USD121 million and the ADR Didi Global pulling in $50 million.

In Europe, balances for European equity specials were notably down compared to 2020. This was due to the lack of demand for new short prospects, so there were fewer opportunities for sec lenders to enhance lending revenues. However, we saw a boost in the third quarter from the spinoff transaction in France between Vivendi and Universal Music Group. The spin-off trade in September generated about USD 130 million in revenue, which accounted for 57% of France’s total and almost 20% of the second half total revenue across Europe.

In APAC, equity revenues increased 33% following the short selling bans being lifted in 2020, in part due to the 24% increase in average fees compared to the previous year. China Evergrande topped the list of APAC’s highest revenue generators, with USD25.8 million recorded in the second half.

As we moved to 2022, the revenue for the first two months totalled USD1.6 billion with average loan balances at about USD2.8 trillion. Average utilization this year so far has been around 6.3%, but we did see an all-time low utilization of about 3.2% for global equities in January. ETFs utilization during this period has been around 13%. For corporate bonds demand continues to increase following the 2021 trend, with average balances up 37%, and average fees up 48% YoY. However, for ADRs we have seen a decline in revenue, loan balances and fees in the new year, including February’s steep drop of about 88% YoY, with a total of only USD16 million in revenue, the lowest since October 2020. Lastly, we have also seen an increase in peer-to-peer lending activity. Based on the data we currently have, in the last 18 months, our analysis showed a 200% growth in the number of peer-to-peer loans. This is only 2% of the overall loan volume that we see in the market. We see this loan activity as “additive” to the market and not a replacement for conventional lending.

Chair: I’m going to turn to Amy, John, and Jerry to tell us a bit more about some of general themes and where you see demand coming from this year.

Amy Dunn, J.P. Morgan: I would echo what Monica has said around the European and US markets benefiting from corporate action events as well as inflationary concerns continuing to drive demand for investment grade and high yield corporate bond ETFs. With that said, there has been a notable slowdown and some cancellations for IPOs and SPACs which will reduce the number of revenue opportunities in 2022. I would also add that the widespread volatility hasn’t translated into a significant uptick in specials...

For the first two months of this year, hedge funds have been in a risk off mode. Many sitting on the side-lines, lacking conviction in single stock names. We are beginning to see the short side slowly increase. Hedge funds are beginning to take positions on certain names and sectors, namely electric vehicles, mining and energy. Despite geopolitical events, there has not been a flight to quality. This is largely due to the ample supply in the US Treasury market and the excess liquidity in the system. Another theme for this year will be focused on actions taken by the Fed. With this being the first rate hike in three years, we will continue to work with our clients to ensure they understand what this means for their reinvestment portfolio and associated funding costs. Finally, in terms of the reinvestment demand, issuers are taking advantage of cross currency swaps, allowing them to secure cheaper funding and creating more reinvestment opportunities for our clients.

John Fox, BNY Mellon: dovetail nicely into some initial thoughts I had. Given that a Fed rate hike is imminent – and it’s been four or five years since we have had a Fed interest rate tightening cycle – we have been and will continue to reacquaint beneficial owners that take duration risk with cash collateral with the dynamics of those tightening events.

Going forward, I think it’s all about making clients and prospects aware of what types of assets are truly additive and important to securities lending activity. If we had a bumper sticker in our industry, it would be: Not all assets are created equal. I know that sounds a little obvious. But equities, and the types of equities that beneficial owners or prospects have, were very keen to look at and analyze, particularly given the risk profile that they want to subject this activity to by a securities lending agent. And then, almost at the opposite end of the risk pyramid: small cap equities, ETFs, high yield corporate bonds, and stats that Monica mentioned in her opening comments, certain markets like Korea and Taiwan, where we understand the returns were up 400% in 2021 versus 2020 are also very attractive to securities lending agents.

Another point I would make would be that client flexibility, which is a recurring theme, continues. A little bit of flexibility can mean a lot. There continue to be additional opportunities and new types of collateral sets that are presenting themselves for the clients that can permit that on the non-cash collateral side. Continuing to be engaged with beneficial owners, and those opportunities presenting themselves, is something that’s very important throughout the remainder of this year.

Jerry May, OPERS: We are monitoring closely the macroeconomic environment. Does the Fed have room to move? If so, how much and how fast? Because if you look at the numbers, it does appear that we are not recessionary but certainly in a slowdown. It’ll be interesting to see with the environment slowing down economically and with the Fed on the move and inflation high, what the market holds in that regard. It’s important to remember, at least for us and for other beneficial owners who do securities lending versus cash collateral, that it’s an asset liability management tool. With that, you get to manage both sides of the equation. The liability has not gone up significantly in terms of the rebate rate that you would pay a borrower. But on the asset side, we are seeing opportunities on the reinvestment of cash. There are opportunities in the market right now and significant ones if you’re cognizant of the risk that you’re taking in that regard.

Robert Goobie, HOOPP: From a business line perspective, I take a view from multiple lenses - equity financing, traditional security lending, FX basis, fixed income repo, and reinvesting cash in money market. For the equity funding business, 2021 was a year where the market continued to rally. Bank balance sheets were constrained, and prime brokers were also constrained. As a result, we saw funding levels for equities at Fed Fund plus 40 on average, which was a better place to invest than in reverse repo which was at sub-Fed Fund levels.

At year-end, equity funding spreads widened as much as Fed Fund plus 135 to 145 for one month, creating Alpha-generating opportunities. What do we expect in 2022? So far, we see equity funding at Fed Fund plus 15-20, which is a big reduction from the year-end levels. Ultimately, this means limited opportunities to generate Alpha in the equity financing space. If the market continues to sell off and remain volatile, spreads will continue to compress in 2022, and it will remain challenging to continue generating Alpha in this area of the business. In terms of the securities lending market, I am uncertain about what the future holds, but specials are very limited and the GC business is steady to slow.

With that in mind, buy-side organizations will need to be very nimble and take advantage of opportunities where they can. For example, market participants may consider looking at the FX basis more closely. We recently saw the basis between JPY and USD widening, creating opportunities there. In terms of commercial paper, we saw spreads compress in 2021. They are widening now, as Jerry mentioned, which means there are opportunities to reinvest the cash. And as Amy mentioned, there are anticipated rate hikes, so we could potentially take views on that. It means perhaps taking on more credit risk and interest rate risk now in the short end.

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