Donia Rouigueb, Head of Sales - Securities Finance and Repo at CACEIS Bank, discusses why volatility means opportunity for clients.
This Thought Leadership article is part of the 2022 Autumn Magazine, which can be accessed here.
Let’s set the scene. What has this year been like for lenders and lending opportunities?
This year should be very good in terms of revenues for our clients.
Market moves have meant more opportunities. Post-Covid volatility, the normalisation of monetary policies, uncertainty regarding the war in the Ukraine, and interest rate hikes to combat high inflation – these are some of the macroeconomic and geopolitical factors that have given rise to these opportunities.
As an example, July and August, which are traditionally quiet months for the securities lending business, have been the best months in terms of revenues so far according to S&P Global, so 2022 should be an exceptional year in many respects.
We are seeing these lending opportunities across most asset classes, often for varying reasons. There has been a comeback of special situations equity linked to extra liquidity injected by central banks up until July but also on the credit side largely due to significant directional shorts. There has been high demand for corporate bonds, which has caused levels to skyrocket, leading the asset class to become best performer this year in terms of revenue.
As normalisation of monetary policies takes place across the globe, we believe spreads between core and peripheral govies, and HQLA
This year, we have also seen certain clients that were more hesitant about securities lending during Covid return to their programmes. Some had to manage their business using an alternate model, such as relying on remote working and were not comfortable with adding the responsibility of monitoring the lending activity of a provider. Others were simply uncertain about the potential of big market moves during the pandemic and the risk of not being able to recall their securities in time if there were a sell-off. Now that the pandemic is largely behind us, they are all returning to the lending programmes.
What are two or three lessons that you have learned this year?
I would say that resilience is the first lesson. What I have learned, and I think what all of us in the industry have, is that we managed to demonstrate to our clients that we have robust set-up, and we can ensure business continuity. Even during the pandemic, we had no issues managing the activity. We were able to adapt to this exceptional situation and maintain excellent client satisfaction throughout.
The second lesson learned relates to client proximity and delivering on client requests. Clients’ behaviour has changed over the past couple of years. They are asking more questions, rightfully reviewing everything, and ever more closely involved in their securities lending programme. As soon as they feel that an issue might be impacting their portfolio management activities, they are more willing to review their programme or even pull the plug entirely. This ongoing volatility also serves as a reminder of why listening to your clients and working in a close partnership with them is key.
The final lesson is more of a general strategic point – and concerns IT. An ongoing programme of investment into IT systems to comply with new regulatory demands is crucial. Just before the pandemic hit, we had to implement the Securities Financing Transactions Regulation (SFTR). More recently, we have had to deal with wide-ranging pieces of legislation like the Central Securities Depositories Regulation (CSDR), which demands a strict settlement regime and close communication between market participants.
Regulatory measures such as these push the industry to develop powerful and flexible tools, together with communication systems between borrowers and lenders which can adapt quickly to the fast-paced and complex working environment. The capacity to invest in technology is key to delivering the service efficiency as demanded by regulators and end-clients.
CSDR is a topic that has been omnipresent in the industry for a while, bringing with it some unanswered questions. Fast forward to now, has this changed? What are some considerations that remain?
CSDR implementation has been the most important topic for the industry in 2022. All market participants expected a revolution but even though some players managed to integrate the new CSDR restrictions better than others, somehow most of the banks and custodians seemed ready on time and adjusted quickly and efficiently. Failed transaction monitoring was a key topic as soon as CSDR came into force, and we saw settlement discipline improve across the industry.
From the clients’ perspective, this is excellent news both because cash transactions settlement became much smoother and because they could benefit from additional revenues associated with fail coverage. The volumes of short-term lending transactions increased dramatically as market participants attempted to cover ever more intra-day shorts to avoid late settlement penalties. There is a huge question mark regarding a possible second wave of CSDR regulation - the automatic buy-in. This aspect could well be the most transformative part of the regulation and would definitely be a market-changing measure if we required to implement it.
So in summary, CSDR at first appeared to be a game-changer for our industry but we are not out of the woods yet!
Another big theme for the securities lending industry is ESG and its compatibility with the activity. What are some of the areas to consider?
Securities lending is recognised by regulators as an essential tool for bringing liquidity to the markets. We have to keep this in mind, because it makes little sense to debate its compatibility with ESG principles if you do not establish this premise from the outset.
Up until two years ago, ESG was vague concept but today, portfolio managers have clear frameworks, eco-labels, and sometimes even dedicated ESG teams. The topic is being properly addressed.
Discussions are taking place with regards to securities lending’s compatibility with sustainability investment principles along various lines.
The most important one is voting rights because investors consider they need to be involved with the stocks in which they are investing. This is not possible while they lend their stock, as the right to vote passes to the borrower. Beneficial owners are therefore worried that securities might be borrowed with an intent that doesn’t necessarily align with their own ESG objectives.
The second important topic is collateral. If you have restrictions on investing in companies in the oil sector, for instance, some clients may think that you will not accept these types of securities as collateral. Others will take the position that the collateral is not yours unless your counterpart defaults. However, there is also a debate on the extent of collateral restrictions.
A key feature to the debates about collateral is the impact that restrictions can have on lending revenues and the feasibility of implementing such restrictions. For instance, CACEIS, as a service provider, has tools to manage restrictions but there are limits to the system itself. Clients may require very complex limitations which are not replicable in our systems. Regarding revenues, it must be understood that any restriction will automatically impact the lending performance of the portfolio. Decisions are always the clients’ to make but it is in their best interest not to limit revenue generation capacity needlessly through excessive restrictions.
In summary, it is essential to discuss such matters with your service provider to strike the right balance between ESG policies compliance and lending revenues. Clients have to understand what is feasible in such situations. It is important to be realistic, because with ESG, you can open the door to unlimited debate. We in the securities lending industry have the same experience with ESG issues as portfolio managers: it is a very broad topic which touches upon many areas of activity.
What is the outlook for the remainder of the year, but also looking ahead to 2023 and beyond?
I wish I knew what was going to happen next year!
The geopolitical and economic situation is still very uncertain: US mid-terms, the war in Ukraine, energy issues, inflation. Central banks are trying to intervene but as yet not as strongly as the markets want.
For the securities lending community, volatility means opportunities for our clients. Almost all asset classes can benefit from it. So far, we have had exceptional revenues across equities and corporate bonds while returns generated on govies were a bit disappointing. We believe the trend will change during Q4 2022 and throughout 2023. We already noticed a slow-down in the equities and credit spaces in September.
Government bonds and general collateral
Despite the uncertainties of the future, it is important to emphasise that our traders are fully-equipped and have extensive experience of managing the liquidity of the securities we lend to benefit from revenues associated with securities lending without impacting the liquidity of the underlying asset that is lent.
On the financing side, rate hikes will be important to watch for several reasons. We have been in an environment where there was a lot of cheap cash so with the return of positive interest rates, we might see increased demand for financing and cash reinvestment opportunities.
Regarding the industry more generally, the markets have benefited from a long period, almost 10 years, of low interest rates and whatever the reasons behind this return to reality on the markets, our clients will need to remain agile and seek out added value wherever possible. 2023 will be a challenging year for the securities lending industry, and it will need to keep its longstanding promise of providing low-risk additional returns in the background while beneficial owners maintain focus on their portfolio management strategy.
In conclusion, volatility is definitely a source of revenue opportunities for clients using our securities lending programmes. Establishing the right approach in terms of stock liquidity, understanding current market regulations, and designing the optimal set-up are key steps in creating a bespoke lending programme to suit the current environment.
Our in-depth expertise and willingness to understand our clients’ needs have enabled us to become a key player in the securities lending industry, and our professional staff are on hand to ensure you can benefit from market opportunities in a low-risk environment.
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