In 2020, Global securities lending markets were disrupted by Covid just as much as others. But Q4 saw players coming back. Lynn Strongin Dodds reports on revenues and speaks to agent lenders.
Some securities lenders may have pushed the pause button in 2020 while others simply curtailed their activity, especially in the first half of the year. However, the market infrastructure coped well, while lessons learned during the financial crisis held the industry in good stead.
Unsurprisingly, profitability has suffered against the backdrop of the pandemic. IHS Markit’s third quarter ‘report card’ shows that global securities revenues for the first nine months dropped US$6.98 billion (€5.7 billion). This was 8.7% below the same period last year.
The third quarter alone slid by 16% to $2.2 billion, which marked the lowest quarterly return since the first quarter of 2017. The figure was similar to the first three months of 2020 – $2.3 billion – but not as low as the second quarter’s $2.5 billion, which reflected the dive many global stock markets took in March and April.
For example, in the first three months alone, the Dow Jones Industrial Average fell 23.2% – its worst first quarter ever – while the S&P 500 dropped 20%, its weakest performance since the 2008 market crash. Meanwhile, in the UK, the FTSE 100 plunged by 25%, the biggest quarterly contraction since the aftermath of Black Monday in 1987.
Samuel Pierson, director of securities finance at IHS Markit, says that through September, most asset classes experienced at least some period of underperformance compared with 2019. Securities lending revenues were mainly hit by lower market valuations and short-selling bans in Asia and Europe, which have mostly run their course. They were imposed by regulators to curb the spikes in volatility caused by the pandemic. Europe and the UK were also affected by dividend cuts which are still in play. ;
“It was not a one-size-fits-all type of market,” says David Lewis, senior director of FIS. “If you look at the market from a high level, it was a mixed bag. There was a rush to quality, which always happens when the foundations are shaken, and more focus on collateral and liquidity on balance sheets.”
This helps explain why US government securities and ETFs were, and continue to be, the bright spots, according to Bill Kelly, global head of agency securities lending at BNY Mellon. “The contribution of equity lending to overall market performance was soft for most of the year and continued to soften through Q3,” he says. “Cash collateral investment began to settle at the new, lower interest rate levels following global coordination on monetary policy during March and April, which resulted in narrower spreads for cash loans.”
Crunching the numbers further, IHS figures show government bond lending revenue jumped by 10% year on year through October while US equity revenues rose by 6.4%. ETF revenues were up 40% during the same time period, although appetite for the fixed income variety dropped during the credit recovery in the second quarter. Meanwhile, the lending of equity ETFs increased in the third quarter, resulting in a higher plateau for revenues compared with pre-Covid, but still well below the peak in the first quarter.
Market participants noted that ‘specials’ have been far and few between this year, with the notable exception of German-based fintech giant Wirecard, which had been a frequent favourite of short sellers for nearly a decade. However, over the past year, interest piqued, with utilisation rates soaring to around 80% in June right before the company collapsed, according to analysis by Ortex, an equity data analytics firm.
It definitely has been a challenging year,” says Ben Challice, managing director and global head of Collateral Management & Agency Lending at JP Morgan, “If you look at the macro reasons, there was an unprecedented injection of liquidity from the central banks which made it a difficult macro environment to run sustained short positions. This, together with the sell-side’s reduced need for stringent liquidity hedges coupled with the lack of corporate activity such as mergers and acquisitions, as well as short selling restrictions led to deleveraging overall.”
Kelly also notes that while the monetary and fiscal policy actions taken during the height of market volatility led to equity markets rising almost immediately following the sell-off during the spring crisis, this resulted in fundamental long/short strategies being challenged, reducing the number of hard-to-borrow securities in the market.
He agrees that the diminished number of event-driven opportunities had an impact. “Although we did see some developing interest in credit products, this did not fill the earnings void left by lower borrowing demand for equities,” he adds.
As the pandemic took hold, central banks pulled several of their liquidity levers and by the end of the second half, a report from McKinsey shows that a staggering $10 trillion was pumped into the system. As for M&A, volumes slumped by a third in the first half of the year compared to the same period in 2019, while values dropped by more than half to $901.6 billion.
Tech help
The secret of success over the past year was a mixture of the right technology, flexibility and strong relationships as the industry was forced to change its working habits. Seemingly overnight, industry participants had to switch from an office to a remote working environment.
“The infrastructure and markets held up well despite the unprecedented market volatility,” says Challice. “Technology facilitated the process and there was rapid adopting of video calling, e-signatures and other digital tools. If this happened five years ago, the industry would not have coped as well.”
However, he also notes that flexibility and the ability to adjust lending and collateral programmes according to a client’s risk/return profiles is a key factor in JP Morgan’s ability to serve its clients. The firm has also expanded the collateral sets it offers to sell-side clients to support their balance sheet and liquidity requirements.”
Andrew Geggus, global head of securities lending at BNP Paribas Securities Services, also notes that having a broad borrower base with many distribution channels and flexible collateral parameters is crucial to protecting revenue when demand softens. At the onset of the pandemic, demand for high-quality liquid assets (HQLAs) spiked, offering “an opportunity for agent lenders to capture some upside revenue while they worked with beneficial owners to ensure stability of supply and comfort around their risk tolerances in the volatile market conditions”, he says.
“As more liquidity was injected into the market on the back of the asset purchase programmes, the spreads and demand for HQLA began to decrease and we saw levels reach significant lows in comparison to previous years,” he adds.
Pierson echoes these sentiments. “A perpetual key to increasing balances is lending-programme flexibility, both regarding acceptance of different types of non-cash collateral as well as reinvestment of cash collateral,” he says.
Robert Lees, regional head of securities lending and global head of securities lending trading at Brown Brothers Harriman (BBH), also notes that “the pandemic emphasised the need for a defined data-driven strategy which is transparent and offers a real-time view of the activity of a lending programme. You also need to ensure that the securities lending programme is aligned with the investment management strategy as well as the distribution teams. There is much more interest in the details of the programme, such as where the returns are being generated, how balances are being created and increasingly, where is the intersection with ESG principles.”
Relationship business
Alliances should not be underestimated, according to Lewis. “Despite the increase in automation, this industry is a stubbornly relationship business and that also came to the fore during this past year,” he notes. “For example, counterparties were able to rely on each other for liquidity during March and April when markets were at their most volatile.”
Looking ahead, the general consensus is that while there will continue to be an abundance of supply in the market, interest is growing in securities lending. “We saw a significant deleveraging among the borrower community which adversely impacted lending demand,” says Kelly. “More recently, however, we’ve seen some of this borrowing appetite return in Q4 following the US election, with financing trades increasingly presenting an opportunity.”
Jérôme Cazaux, liquidity management director at Societe Generale Securities Services, also believes that the ultra-low-to-negative interest rates, seen in many countries, will generate new opportunities. “Since July, the markets have normalised and the buy-side firms who paused their programmes started to lend again. I think we will also see newcomers among insurance companies, pension funds and some sovereign wealth funds willing to use securities lending to enhance revenues on their portfolios in this environment,” he says.
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