Adnan Hussain, Global Head of Agency Lending at BNP Paribas Securities Services, explains the economics behind a lending portfolio and how the macro environment could shape lending in 2019.
With ongoing pressure on management fees, what level of incremental revenue can asset managers expect from engaging in a securities lending programme?
First and foremost, a securities lending programme must be suitable from a risk perspective and the guidelines applied will have an important impact on revenues. If high-quality liquid assets (HQLAs) are lent against HQLA only, the assets will be less attractive for lending purposes when compared to another fund lending the same securities against G7 equities as collateral. The borrower will opt for the latter and will pay a higher fee to reflect the credit mismatch between government and corporate bonds.
Securities lending is an ancillary activity to asset management, and like asset management is market-driven. Holding a lower supplied portfolio – such as a small- or mid-cap equities pool – will always produce a greater return profile than a widely held mainstream index portfolio. As an example, a Russell 3000 portfolio will generally provide a greater return than an S&P 500 portfolio. High-quality government bonds will always provide a consistent return, however, higher-yielding bonds tend to also generate significant income because of their lower liquidity profile.
Collateral and ability to term will always be key considerations. Nevertheless, it is very reasonable to expect at least a 5bps return on a balanced portfolio. That number can vary significantly, for example, a small-cap Asian equity portfolio could generate a 25bps of return to lendable. It is important to acknowledge that typically within a balanced large cap portfolio only 10-15% of securities held will be out on loan at any given time, therefore, return on active loans is exponentially higher, in order to generate 5bps of return on the overall fund. It is also important to highlight the positive impact 5bps of additional income can have on a funds’ performance in this competitive time.
The demand for exchange- traded funds (ETF’s) borrowing remains robust and is rising – particularly when linked to markets that are considered operationally difficult to trade in directly, expensive and have lower liquidity profiles. Politically sensitive regions or sectors like biotech are providing demand, as are start-ups in the technology space through high yield bonds.
In a word, the level of incremental revenue is closely correlated to the composition of the portfolio and the guidelines integrated into the programme by the portfolio manager.
In a market increasingly focused on efficiency, can you discuss recent enhancements to your securities lending platform and how clients will benefit?
Automation is essential for any agent lender because, as volumes continue to increase, there is a very keen focus by borrowers on spread compression. Fee split pressure is also ever present and the costs associated to indemnification continue to rise.
We have developed a trading layer with an embedded analytics tool to more efficiently interact with counterparties and respond to locates, in order to fulfil trades. Where it would have taken us potentially an hour to do this manually, it is now completed in a few seconds – even if we receive 40 locates simultaneously, all 40 are fulfilled within a few seconds. This frees up our traders time for decision-making and for developing counterparty relationships.
We are increasing efficiencies from both perspectives – the lender and the borrower. This includes increased transparency, delivered by technology through the significant shift towards online accessibility of real-time data. Through the reporting portal, lenders are always aware of the securities that are on loan, the collateral received and the rate at which they have been transacted.
As BNP Paribas strengthens its trading capabilities in Asia with the opening of a new trading desk in Hong Kong, what potential are you anticipating in the APAC region?
The APAC region can be a highly bespoke region to trade in. We recognised that it would benefit some of our beneficial owners if we were to cover more of the markets in the Far East directly, but very importantly, to do so with our New York, London, Hong Kong and Sydney trading desks on a single trading platform, using harmonised technology tools. We are protecting our beneficial owners and optimising their return profile by covering as many counterparties globally as possible within a single operating structure.
Do you have a message for new lenders contemplating entering the securities lending market in 2019?
The rise in volatility compared to previous bull-market years, along with rising interest rates and geopolitical tension, all will contribute to what we believe to be a very positive year for securities lending in 2019.
Not only will borrower demand for HQLA assets continue, but 2019 may be the year that returns increase in some portfolios that have not generated levels of revenue or fees over the past five years. For example, large-cap stocks did not see the kinds of return in the past five years that they saw in the prior five. In 2019, that may change.
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