The increasing threat of international regulations will be particularly evident at the Canadian Securities Lending Association’s (Casla) conference on May 8, which will bring together both Canadian and non-Canadian securities lending market participants to discuss challenges and opportunities.
As Rob Ferguson, Casla president and senior vice-president of capital markets at CIBC Mellon, says: “Global regulatory change will be the biggest talking point at the conference. There will be some focus on local changes, but they are really dwarfed when you compare them to what else is going on in the world. Most of the regulatory change that has been affecting Canadian market participants has been from the US and, to some extent, Europe, with things like the financial transaction tax (FTT), for example.”
Although the proposed FTT for 11 European member states still has many hoops to jump through before being finalised, Ferguson says it has already had an impact on Canadian lenders.
“The FTT is really putting a damper on demand for European borrowing, which historically has been a very large part of Canadian beneficial owners’ revenue streams. As a result lenders and borrowers are moving their focus away from Europe a little bit and looking at new markets such as Brazil and the Far East to find other opportunities.”
In Canada, regulatory activity has been comparatively light. Ferguson notes the only major change has been to broaden the definition of qualified securities – securities that are allowed to be lent – to include non-Canadian exchange traded funds (ETFs) and real estate investment trusts (Reits).
“It has had a positive impact by including all the exchange-traded assets and therefore creating new supply and demand.”
As global securities lending goes through a rough patch, Canadian agent lenders are doing better than some of their US and European peers. Many Canadian banks weathered the credit crisis with robust balance sheets.
“If you have a relatively stronger balance sheet, then you have an opportunity to grow where others might not be able to or even need to optimise balance sheet usage. As a consequence there has been a push from Canadian banks into the US and some are looking towards Europe and South America.”
Indeed, local banks such as Maple Bank and BMO have increasingly penetrated the US market as the biggest US banks struggle to meet stringent new capital and counterparty exposure rules.
“At a time when everybody is selling, there is a great opportunity to buy, which is where the Canadian banks are today,” adds Ferguson.
Local securities lending agents benefit from strong demand for fixed income lending. Ferguson says: “Demand for Canadian fixed income is high and probably at record highs.”
This trend is partly due to Canadian sovereign debt being one of the few able to hold on to an AAA rating, as the country having weathered the credit crisis much better than most others.
One factor driving demand for Canadian government bonds is fresh calls for high-grade collateral, as OTC derivatives globally are being forced onto central clearing. However, Ferguson says despite much talk about collateral optimisation trades there has not been as much as people expected.
“While demand is indeed growing, collateral optimisation trades need to work for Canadian beneficial owners from a risk-adjusted return basis. As with the Canadian market in general, Canadian beneficial owners are relatively conservative, so adoption of a broader array of collateral options has perhaps taken more time than in some other markets.”
There are signs that this could change in the near future. Ferguson says his Canadian clients are willing to listen to suggestions about taking alternative forms of collateral such as cash and equities, and doing term trades such as evergreen structures.
“Despite the focus on risk in the aftermath of the credit crisis, Canadian programmes were mostly safe and clients still made money, so confidence levels among beneficial owners is very high here. Now their focus is also on generating returns and how they can make their programme more attractive to borrowers.”
There are few Canadian beneficial owners that do not participate in securities lending but Ferguson notes that in the past year his firm has started to hear from people previously not particularly interested in lending.
“They are asking: ‘How can we improve our returns and get more alpha?’ One of the ways to do that is in securities lending and the industry has proven through the past few tough years that it is a relatively lowrisk way of earning incremental income.”