The global securities lending industry was arguably one of the hardest hit by the COVID-19 pandemic in 2020. Suspension of dividend payments and short selling bans enacted across Europe and Asia in order to combat the spike in volatility across global markets meant the securities lending market significantly dried up.
According to figures from DataLend, revenues in the global securities lending market fell by over 11% to $7.66 billion. However, many in the industry feel that the events of last year were a one- off, and new opportunities in the market will help fuel a resurgence in securities lending. Global Custodian spoke to Brown Brothers Harriman’s (BBH) global co-heads of securities lending, Thomas Poppey and Marney McCabe, about how asset managers are approaching securities lending in 2021, and how the custodian is utilising technology to enhance its services.
GC: The securities lending industry was particularly hit hard by the pandemic last year. What factors particularly hit revenues hard?
Thomas Poppey: We saw lending revenues down across the industry anywhere between 7-15%. However, from our perspective it was a series of extraordinary events that created multiple headwinds for the lending industry. These included regional short selling bans for long or short periods of time, European companies suspending cash dividends, and central bank easing in the US – all of which pushed to long-bias investing and reduced short selling sentiment.
However, there were some silver linings as we started to see supply coming in and we saw some lucrative specials and corporate event transactions that created new revenue opportunities.
Marney McCabe: Returns from sec lending are somewhat cyclical, and we continue to believe 2020 was one of the resetting years as firms adjusted to low interest rates and the environment.
GC: So there is optimism that securities lending revenues will bounce back in 2021?
MM: We believe we are putting those headwinds from 2020 in the rear-view mirror. Short selling bans – except in Korea which will be reviewed in March – have been removed and we think that markets will start trading more on fundamentals as the rally cannot last forever. There will eventually be more interest in alternatives which will fuel short selling and securities lending demand. In addition, increases in corporate events, mergers and acquisitions, and cash dividends will drive more arbitrage opportunities, which will again lead to increased sec lending.
TP: Our position is that we believe a lot of what happened in 2020 was cyclical and in response to the pandemic as regulators and governments sought to prop up economies. There won’t be any lasting impacts and 2021 will be a year for recovery.
GC: How are your asset manager clients looking to approach securities lending?
TP: Clients won’t be taking any extraordinary steps to change their strategies, and many already have good business practices. There are some that see robust opportunities in the corporate reorganisation space – i.e. spin offs, mergers, etc. The sentiment among clients is optimistic – people understand there are cyclical periods and most know these are temporary and a return to normalcy will follow.
MM: We are seeing increased relevance of securities lending to investors globally. A recent C-Suite survey we conducted of 50 asset managers about the current environment and their operating model validated that investors remain keenly focused on performance, expense management and operational efficiency. Securities lending can provide benefits in all three areas. Whether we are speaking to existing clients or a prospect looking to enter the market, they remain engaged and open to finding ways to optimise their securities lending programmes, whether through new launches or cross-border funds or into new asset classes.
One caveat is that our client base is primarily asset managers, and we find there is a tolerance around optimisation and being able to extract as much out of their portfolio as possible, but clients remain dedicated to their risk profile. We have not seen asset managers aggressively look to take on more risk, but are they are open to conversations around optimisation.
TP: There continues to be a focus on cost reduction and competition – every basis point matters, so anything we can bring to aid them will appeal to asset managers. Data [from the survey] showed asset managers leaders are looking to grow their securities lending activities. However, it can be complex and expensive to run a lending desk, so there could be some asset managers reconsidering the use of third-party providers for their lending programmes. What degree that will be in 2021, time will time.
GC: Sentiment around peer-to-peer activities in securities lending has increased significantly over the past year. What is your take on it?
TP: There is no doubt that the concept of peer-to-peer is growing, and there are plenty of new routes to the securities lending market. With our business, asset managers are watching this develop before jumping in – and many still see the agent lender as a credible intermediary. We see the peer-to-peer model is most relevant for the general collateral lenders, and to broaden distribution channels that are the most liquid. We are a high value provider and we trade in higher fee space, so therefore we are less involved. But I would say it is here to say, and it will co-exist with some of the more traditional lending models.
MM: Asset managers have to consider a number of things for their securities lending programmes; mainly back- office support and indemnification. There is a lot of support and operational efficiency that is applied to a securities lending transaction, and that doesn’t go away in a peer-to-peer model. They would also have to solve the indemnification problem – they would have to figure out who is providing indemnification if the agent lender is removed.
TP: Peer-to-peer is a core disintermediation model, but what doesn’t go away is all the infrastructure necessary to process loans, fees, settlement, corporate actions etc, so there will continue to be a robust role for custodians to maintain this infrastructure.
GC: How is the securities lending industry looking to utilise technology to meet the evolving needs of clients?
TP: For our business, we will see the increasing impact of technology in execution as trading moves from voice to electronic, so our objective is to support this transition in a way that doesn’t erode our value proposition. We are also introducing new decision support tools, particularly around environmental, social and governance (ESG) strategies and we are starting to road test this with clients to help them make smarter decisions.
MM: We continue to invest in our technology with two goals in mind: can it improve our own operating model? And can it improve how we connect to clients and trading counterparts? We look to technology that can provide an enhanced experience that helps service the data they need to remain educated and sophisticated when providing oversight of their programmes and making decisions around how their programmes is integrated with their investment strategy.
For example, our ESG prototype involves being to provide the necessary securities lending data that can be married with clients’ broader corporate governance/ESG investment strategies, allowing them to make more educated decisions. Elsewhere, we see a lot of benefits of artificial intelligence in electronic trading, and are creating different types of algos that can respond much quicker to market dynamics, that can make lendable assets more attractive, and can connect to borrowers as quickly and automated as possible.