Although securities lending revenue remains subdued and beneficial owners are not particularly eager to amplify returns through more aggressive collateral reinvestment, lending in emerging markets could be a growing trend in 2014 and beyond to increase profits, while adding liquidity to these markets.
“I certainly think the trend is everyone is more open to it,” says Patrick Avitable, managing director, global head of product strategy and development, Citi Transaction Services. “I think the reason for that is prior to the crisis, I think some beneficial owners may have been able to look at their collateral as a way to earn additional income. And there’s been a shift since the crisis, and that shift is to be somewhat more conservative. There’s been a greater focus on intrinsic value, which there should be. Now, the question in front of beneficial owners is: How do I add value to my fund? How do I add returns to my portfolios? And clearly one way is to participate in the emerging market space.”
The pickup in these markets, however, is not necessarily a direct cause and effect of investor interest leading to increased activity. Instead, the markets themselves are looking to promote themselves as attractive options for securities finance activities.
“Historically, agents were very dependent on broker-dealers telling them about interest from a hedge fund, prop desk, derivatives desk, etc., as to new markets of interest. This information would basically ignite the flame that would help us to prioritize our research in launching the next new lending market,” says Avitable. “That said, I think securities lending has gained so much popularity globally over the past four to five years and is recognized as an opportunity to increase liquidity in a market to enhance the capital market structure and create foreign investment in a particular market; as a result, we’re now seeing inquiries coming from the local market exchanges.”
For example, over the past several months, Citi has received inquiries and worked with regulators in Indonesia, Nigeria, Morocco and the Philippines to increase foreign participation in these markets. The regulators in these countries, says Avitable, “are looking to us to basically explain to them how the rest of the world does securities lending.”
Specifically, he says, Morocco is considering what changes they need to make to their regulations to facilitate lending for off-shore participation, while Indonesia has contracted KSD (Korea Securities Depository) to act as a consultant to help define the securities lending model for them. And the KSD seems to makes sense consultant, as Avitable has seen Korea as “an extremely hot market this past year.” Elsewhere, Malaysia looks to be a growing market for securities lending, as one major U.S. public pension fund, for example, is considering lending in the country this year. Russia, too, looks to be a growing market for securities lending this year, as Citi extended its securities lending platform to the country last month.
However, other emerging markets such as India and Brazil have a CCP model for securities lending, which could limit the opportunities for foreign activity, because offshore beneficial owners may be less comfortable, or even not legally allowed, to use the CCP model.
“The difference between the traditional model and a CCP structure is being able to attract offshore clients to participate in those markets as they exist today,” says Avitable. “There’s no changing the CCP models in India and Brazil. It is what it is, and if you want to do business in those markets, you need to participate in that market as is. It’s very easy for locals to participate in those markets, because that’s their exchange, and they’re totally comfortable with having the collateral sit there. It’s more difficult for an offshore client who’s accustomed to the traditional lending structure to move away from it to a structure like India and Brazil. Some lenders by regulation can’t do it like an ERISA fund or a ’40 Act fund…so there’s a smaller group that could potentially participate, but again, it’s a different model, and they would have to accept the differences in the lending structure.”
Overall, though, lending in emerging markets seems to be a practical way for beneficial owners to increase revenue. Some markets may require a bit more active engagement from beneficial owners in order to comply with local regulation, but by and large the risk does not increase meaningfully.
“They’re not taking on any additional risk because those risks will be mitigated and managed by the provider like a lending agent…I think the due diligence in opening up a market is up to the lending agent,” says Avitable. “They open up the market and it’s up to us to address all those risks. As an example there may be a transaction tax in a particular market, and the treatment of that tax may be lending securities with a minimum fee and duration. This is just one example of identifying and managing a unique risk, and it’s up to the lending agent to do that and be able to share that information with the beneficial owner.”
Securities Lending in Emerging Markets Is on the Rise
Although securities lending revenue remains subdued and beneficial owners are not particularly eager to amplify returns through more aggressive collateral reinvestment, lending in emerging markets could be a growing trend in 2014 and beyond to increase profits, while adding liquidity to these markets.