Roundtable participant John Arnesen - head of agency lending, technical sales, Emea and Americas at BNP Paribas Securities Services - talks to Funds Europe about the prospects for 2018.
Funds Europe: Our roundtable participants said 2017 had been very "average" in terms of securities lending demand. What have been the Forces shaping demand? And what about the near Future: are there any headwinds expected For bonds as the ECB eases its stimulus?
John Arnesen, BNP Paribas: Demand has shifted in 2017 from its historic pattern of increasing in the spring months in Europe with regard to equities. What was once regarded as an almost guaranteed demand cycle has changed signiF1cantly and is no longer considered to be stable, reliable or even desirable by some buy and sell-side participants. Corporate action optimisation in the form of utilising the best strategy depending on the options taken by fund managers or investors with regard to cash or stock dividends has taken on a more significant revenue source for our clients.
A number of specials in 2017 were both long-lasting with significant high fees. Cal-Maine. Purple Bricks. Vellourec and Sharp. to name but a few.
The reduction in ECB asset purchasing from €60 billion to €30 billion per month from January 2018 but extended through to September 2018 should, on the face of it, provide additional liquidity to the system. However, this largely depends to what extent the drain in liquidity via the asset-purchasing scheme as a whole found its way back into the market by national central banks participating in lending programmes either directly or via an agent. To establish this, one can refer to data providers to review the historical timeline of balances. Italian debt, for example, has more than doubled in outstanding loan balances in 2017, suggesting the banks is fully engaged in a lending programme. Spreads for term lending across the term curve have remained relatively stable this year. so the decline is the monthly purchasing volume. and in fact the programme itself. has little correlation with the demand currently seen both currently and in the foreseen future. What happens after September 2018 will be of interest.
Funds Europe: Are capital markets efficient at moving collateral From place to place and what changes are we seeing to streamline it?
Arnesen: Efficiency is relatively high if we are referring to interoperability between collateral management providers who have performed this function with increasing better ne cut-offs and greater speed for a number of years. Of more concern I suspect to the market is optimisation processes that ensure the most expensive assets from a regulatory capital standpoint are utilised First and foremost. This may be relatively straightforward for equities when dealing with indices, but fixed income assets carry more complexity when moving from government to credit debt. Those providers that have developed efficient algorithms to deliver the highest optimisation will attract more business in the future. Given the need to collateralise more and more activity, this is likely to be one of the key areas of development spending as demand will dictate it.
Funds Europe: Asset management has seen a spate of large mergers in the past two years. Would securities lending capability ever be a strategic consideration For firms involved in M&A?
Arnesen: It is unlikely a value-added service of any kind will play a material role in the fundamentals of a corporate merger. What will be important are the capabilities of the custodian of each party, assuming they differ, and the importance placed on service capabilities that suit the new combined organisation. At BNP Paribas, we have a wealth of experience in servicing clients who have outsourced ancillary functions to our Asset and Fund Services division as well as appointing us for global custody, FX and securities lending. The complexity of these arrangements can certainly play an important factor in the decision-making process.
Funds Europe: Do you anticipate the day when some ETFswill charge zero fees and instead make revenue on the back of securities lending?
Arnesen: The ETF expense ratios of main index strategies in the US are virtually 0.00%. Schwab and Vanguard impose expense ratios of 0.03% and 0.04% on their popular ETFs such as Large Cap ETF's. Broad Market ETFS and Main Index ETFS CDJIA. SPY), etc. One trend which is rather obvious is the more complex a strategy of an ETF, typically the higher the expense ratio. This is particularly the case in HY bond ETFs, Commodities and Emerging Market ETFs where the cost to execute and even locate is difficult. M1 Finance is clearly bucking that trend with its zero-fee strategy compensated by lending revenue. It appears at face value to be a compelling offer but a 'start-up' only loses that label once it has established itself as a commercially sustainable, viable offer. An interesting concept on which to keep a keen eye.
Funds Europe: Will 2018 be a year in which UCITS funds find the regulatory landscape more or less conducive to securities lending?
Arnesen: UCITS are no more or less conducive to securities lending than any other sector in the market. Holding assets in demand will always drive their lending revenue. All clients have programme parameters and UCITS are no different, but it is certainly true that theirs are set by regulation, which, it can be argued, restrict the full potential of a given portfolio.
One specific point in question is the seven-day callable restriction for all lending transactions, which clearly has an impact on the lending of high-quality liquid assets, given the minimum duration at which borrowers need this asset is 30 days. The disadvantage is therefore the spread between overnight or open loans versus this 30-day-plus duration, which is typically ten basis points for leading European government debt. Couple this with diversification requirements in terms of issuer collateral (20% per issuer) and you have a set of parameters with which one must comply.
At BNP Paribas, we have many UCITS funds in our programme but we work with the requirements and simply structure a lending strategy with them. Many non-UCITS clients have other programme parameters which can have a restrictive effect on revenue. but risk tolerance drives the formation of these guidelines and the UCITS regulation is no different in that respect. Clearly any relaxation of the seven-day callable guideline would be welcomed by the funds and lending industry alike, but its origin was not ill-conceived.
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