- Chair: Andrew Neil, associate editor, Global Investor/ISF
- Nancy Allen, global product owner of DataLend
- Steve Kiely, head of securities finance sales and relationship management – EMEA, BNY Mellon Markets
- Jørgen Krog Sæbø, chief treasurer, Folketrygdfondet
- Stevce Mojanovski, equity finance trader at Danske Bank
- Dan Murphy, global head of equity finance, Stockholm, SEB
- Per Strömberg, equity finance, Handelsbanken Capital Markets
Andrew Neil: What have agent lenders been doing to maximise client revenues in the Nordics?
Steve Kiely: The Nordics are not that dissimilar from the rest of continental Europe. We're concentrating on high-yielding stocks – intrinsic value lending. Most are focused on the 20% of the loans that make up 80% of the revenue.
We're also encouraging clients to enter into a term contracts so they can preserve their liquidity and get that extra pick-up. Collateral is not king any more. Collateral is only queen, term is king.
Neil: Jørgen, do you see these trends within in your own lending programme?
Jørgen Krog Sæbø: Yes, absolutely. Term trades are increasingly popular and profitable. It used to be one-month and now its three-month term trades. We’re definitely seeing more evergreen structures. It may not be a big proportion of our trades, but we're seeing increased demand for them.
Per Strömberg: I agree. When it comes to maximising revenues we do see the market turning towards longer term trades. It started with the term on cash for different reasons, but now it's more term equities and term fixed income.
Neil: Are these trends reflected in the data you have, Nancy?
Nancy Allen: It's interesting when we look at the Nordics and how the region fits into the global securities lending picture. As of September, the average lendable securities in the region totalled $282bn daily, which is approximately 7% of $3.6trn lendable European securities. To date, the average on-loan in the Nordics is approximately $34bn, which is again roughly 7% of the on-loan that we've seen across Europe.
In the second half of 2015 the Nordic market was roughly 60% to 65% general collateral (GC). So far in 2016, that percentage has dropped to 30% on average, so we've definitely seen an increase in specials trading this year.
Dan Murphy: The Nordics has a lot of specials to offer compared to mainland European countries, which are concentrated in certain sectors and certain markets. The returns are a result of very name-specific and sector-specific stocks. In Finland its construction and mining. In Denmark we’ve seen shipping and construction. Norway has produced energy specials and in Sweden it’s been IT and industrials. Fingerprint, for example, has generated significant revenue for those lending out positions.
You'd expect most mainstream indexes to be filled mainly with GC stocks, but probably only about 50% of the names in the HEX Index could almost be guaranteed to be GC borrows, the rest of them are specials. Participants in this region are in quite a privileged position.
Kiely: 2016 has been a specials-driven revenue year. We've done particularly well in the US. Although volumes have shrunk somewhat, the specials have made up the revenue. In part, the volume declines are due to equity volatility at the start of this year and shrinking balance sheets in general which has subdued equity finance demand.
Murphy: Hedge funds have been more inclined to sit on their cash rather than take any particular view on the market because of the recent unpredictability. There have been a lot of events, both economic and political, this year that have made it a difficult market to invest in – both on the long and short side. Names with intrinsic value have really buoyed up the rest of the market. In the coming months it's going to be interesting to see what the state of the market really is once you scratch away some of those names from the surface and look beneath. Who has got the viable clients, the ones still looking at strategies that will keep the business rolling forward? Or, if you're reliant on lending one name, will your programme struggle going forward?
Neil: Can securities lending still give value-add to large Nordic pension funds in the current environment?
Sæbø: Yes, it can definitely add value. We have a dedicated treasury department that tries to specialise in different types of non-core strategies that take advantage of who we are as an asset manager. One of these strategies is securities lending. I think more pension funds will lend their assets now, especially in this low yield environment. In Norway, there have been some changes in regulation that have made it easier for other pension funds and asset managers to start to lend their assets.
Kiely: In the last couple of months I've spoken to a pension fund in the Nordics and an insurance company in continental Europe that haven't lent before, or certainly haven't lent for quite some time. When asked about their motivations, they responded, very clearly, that the search for yield is everything. In previous years the industry spoke about percentages, not basis points (bps). Now clients are saying even if securities lending returns a few extra bps on the fund, it's worth it. They need something to try and compensate for the natural drags, such as negative interest rates.
Allen: Pension funds are increasingly focused on managing their programmes as efficiently as possible. They are open to considering refinements to their programmes, but will do so cautiously to ensure adherence with internal guidelines and corporate governance issues. For example, when considering collateral, a fixed income-only fund may be reluctant to accept equities as collateral as equity securities are not an approved investment type. Some funds may restrict lending to ensure they can vote. Occasionally, that means missing out on opportunities to participate in certain types of profitable trades.
Stevce Mojanovski: I agree to some extent. In conversations I've had with potential lenders they make the point that, based on the total revenue on the books, the returns don’t look significant. The majority of the lenders I've spoken to are willing to lend on an ad hoc basis and try to extract the most value of that specific position only, rather than a full-fledged solution.
Kiely: I'd agree with that. We have a number of custody clients that lend specials as and when they want to but are not in a generic lending programme.
Murphy: The days of the exclusive have gone for the time being. If clients realise that 90% of their revenue is coming from 10% of stocks, why would they put up with the risk of having the whole portfolio out on loan? If five loans go out and make the same amount of money, they're going to be satisfied. As a borrower, in that sense, you can be both happy about that but also a little frustrated because there will be other opportunities, other types of trades, away from just the intrinsic value trades where the payback looks quite low but once you package it all together there's actually quite a decent return to be made.
Kiely: I agree and often try and get that across to the beneficial owner community in order to make them see where the value is for the borrower. I like the Nordics because, with all due respect, you don't hear a ‘no, we don’t want to do that’, you get a ‘we're not doing that until we better understand it’. We have more productive discussions here than in some parts of continental Europe in that respect. Potential clients often revisit their initial uncertainty to lend when they look at the return to lendable, instead of viewing securities as a three or four bps return on the whole portfolio. For example, if you lend out half a dozen specials you're actually getting 3- 4% return to lendable in a trade that is more than 100% collateralised to a very good name in terms of borrower credit. I don't know where else you can get that sort of return on a fully-collateralised basis with such low risk.
Murphy: It’s important for everyone in this industry to consider how we present pricing. Clients often expect a wall of admin before they can get lending and borrowing arrangements started. There's a price for administration. If they look at the headline number, which happens to be half a bp, then straight away they're doing calculations in their heads that show that back office costs are going to be ten times higher and small incremental revenue that might be earned won’t cover that.
Kiely: That's an interesting point for the beneficial owners. If operations become too costly, lending may seem burdensome. Is that a difficult balance?
Sæbø: Yes, absolutely, especially in the last couple of years. We have seen an increased focus on cost saving and we have to look at every new strategy in a cost-benefit type of way. Securities lending can be very heavy operationally and back office intensive, so we have to look at the costs in relation to what we can earn.
Neil: Indemnification appears to be changing the way fee splits are shaped. Is this occurring in the Nordics?
Kiely: The Nordics drive a hard bargain because, by and large, the Nordic beneficial owner tends to be better informed and aware of the detail. Obviously the more information you have puts you in a better bargaining position. It's no secret that all the agent lenders are offering two tier pricing – one fee split if you want indemnification against borrower insolvency and a better fee split if you don't because the indemnification costs in regulatory capital. BNY Mellon has lending clients in this region that are indemnified and others that are unindemnified. The unindemnified clients get a better fee split. They are happy with that risk/reward after having looked at what they’re lending, what their collateral is, who their borrowers are and the governance of the programme.
Murphy: It comes down to the client’s sophistication level – unindemnified clients must be quite sophisticated. In such cases it is probably more important for them to secure a larger fee split when they're quite comfortable with their own internal assessment of the credit risk and counterparty risk when they lend.
Kiely: As Steve said earlier, if you're only putting out a dozen trades a year to earn a couple of million dollars, then you can afford to take that position because of low utilsation. I sometimes think there's a feeling among fund managers that there's a lack of control and that everything is going out.
Mojanovski: We've seen that a lot. Historically, in terms of education, there isn’t a problem. But people still feel that they might lose control because their stock is out. Then again, if you conduct lending on an ad hoc basis, 15 trades a year, for example, you have full control.
Allen: In many ways it's about the bottom line. If revenue is significant enough, a beneficial owner may feel comfortable investing in its own oversight and therefore may elect to forgo agent lender indemnification in favour of a preferable fee split. However, if the beneficial owner doesn’t have the resources to invest in a certain level of internal oversight, then it may choose to keep the agent’s indemnification, and the fee split could be reflective of that additional protection.
Kiely: It certainly depends how active the lender is. We've had some lenders recently phone up and pull borrowers from their approved borrower list. A few years ago, or pre-crisis even, that would never happen, they'd just leave that up to the agent lenders especially when they were indemnified. There's undoubtedly more active participation.
Murphy: I totally understand that from the agent lenders' perspective, the off balance sheet exposure that indemnification creates needs to be accounted for and is something that you have to put a price on.
Kiely: Going forward, I see securities lending programmes becoming more fragmented and more diverse – at the moment a client may have a fee split of 80/20 across the whole programme. They are either indemnified against borrower insolvency or they're not. These things are very binary, very black and white. However, I believe we may get to a stage pretty soon where a certain fee split exists for one type of trade and another fee split for a different type of trade. Some trades are indemnified, others aren’t. This borrower is indemnified, that borrower isn't.
Then, if that client uses a CCP for certain trades, they might take the view that they don't need indemnification. That's a lot of IT development for the market but that's the way I believe it's going to go.
Murphy: It’s certainly a lot of IT work. But compare that with no change. If the asset managers consider that the fee splits are increasingly moving away from being in their favour, they're going to look at other routes rather than via an agent lender. They might explore peer-to-peer lending, for example, or take on extra work internally and lend on a principal basis.
Allen: Automation and technology are critical as they provide efficiencies and in the long run reduce cost. Lending programmes are becoming more expensive to run as capital charges increase and programmes become more fragmented.
Neil: Are you starting to see more interest in peer-to-peer securities finance transactions?
Kiely: The house view at BNY Mellon is that peer-to-peer trades will be an added extra, starting with internalised trades. Situations, for example, where an asset manager is long cash but his treasury department is short cash and between them they can't optimise that because of their legal entity structure. Generally, liquidity concerns will push the industry towards all sorts of different avenues and peer-to-peer lending is one of them.
Neil: Is there increasing interest in the Nordics for central clearing?
Sæbø: I would say no. I haven't seen much talk about CCPs in the Nordics and for us it's more up to the banks to drive adoption. We're comfortable with the counterparties we have. It’s not that beneficial for us to use a CCP at the moment.
Murphy: It will depend on volumes. If, as we mentioned earlier, funds are focused on trading a limited number of names and intrinsic value lending then the business isn't going to go with CCPs. I don't see widespread CCP adoption happening any time soon, especially in the Nordics. Perhaps it will in markets where there's considerable GC flow or significant financing trades running through the books.
Allen: EquiLend has always said that when the market is ready to use CCPs, we would be ready to support them. We've been hearing from the market the need now exists. As a result, we now provide connectivity to Eurex Clearing in Europe, and we also recently acquired AQS, which provides connectivity to the OCC’s stock loan central clearing service in the US. We have seen considerable interest in the new EquiLend Clearing Services business. DataLend is well positioned to start reporting on CCP trades and will be able to provide price transparency across CCP and non-CCP trades, allowing the market to quantify the benefits of a CCP.
Kiely: Yes, that would paint a useful picture for the client. In my experience, beneficial owners with a knowledge of CCPs in other markets are more comfortable. If a beneficial has never used a CCP, then it's a brave new world.
Mojanovski: From a data intelligence point of view, Nancy, have you seen greater interest in CCPs in Europe compared to the Nordics?
Allen: We have seen significant interest from a number of clients, but there are some technological obstacles that they need to overcome before going live.
Kiely: We are looking to conduct test trades before the end of the year with Eurex and are aiming to be live in the first quarter of 2017. We're currently looking at four CCPs, two in the US and two in Europe.
Neil: SFTR could be incredibly costly and time-consuming for the securities finance market to implement. What are your thoughts on the requirements and the work involved?
Sæbø: Any transparency is good for the business in general. Of course, you have to weigh it up against the costs and I'm not that familiar with how much the cost is under SFTR. But I do think the benefits could outweigh the costs.
Kiely: This is one of those services that beneficial owners expect the agent lender to provide. We will do everything we can, as one of the world's largest custodians and agent lenders, to help our clients.
Allen: Conversations around SFTR are similar to the original discussions around CCPs. Our clients are asking us about potential solutions. From a data perspective, the transparency will be significant and really enhance the market performance measurement tools that are available today.
Neil: Is EquiLend looking at providing a trade repository solution for SFTR?
Allen: While EquiLend is not planning to become a trade repository itself, we are working on a solution to streamline the SFTR reporting process for our clients. Given EquiLend’s position as a front-to-back service provider spanning trading, post-trade and market data, we are in a unique position and feel we are the best-placed service provider to support clients in their SFTR reporting.
Murphy: It isn’t a major surprise that this regulation has come about. In some jurisdictions SFTR-style reporting already exists so that the authorities have a good idea of what trades are being printed and in what kind of volumes. That being said, people shouldn't underestimate how big SFTR is. At SEB, we have a much more centralised view on regulation. The group that is handling all our MiFID requirements also has SFTR on its radar.
Mojanovski: I fully agree with what's been said here. It is not surprising this regulation is arriving now. It’s another one on top of the others. It makes sense, because it brings transparency to the securities finance market, which is still regarded as opaque by some outsiders.
Neil: What’s the current state of the Nordic hedge fund industry? What trends are you witnessing in terms of launches, strategies and returns?
Murphy: We see a pretty healthy pipeline of launches. Moreover, the funds that have been set-up for a couple of years are starting to build a little bit of a track record and are attracting more investments. This is obviously good, not just for them and us, but for the market generally. There is a niche in the market for hedge funds, especially with the lack of available yield at the moment.
Strömberg: We've seen a lot more demand lately, especially around synthetic needs as opposed to classic borrowing.
Neil: There has been a big focus on dividend arbitrage trades in Denmark lately. Will these types of trades be fully phased out now?
Murphy: From what we hear in the market there has been less and less appetite for these types of transactions for the past few years. Intrinsic specials are very much in vogue and, to be honest, that's a good trend from our point of view as it matches our business model.
Mojanovski: Yes, I definitely agree. From a trade perspective the environment is changing, the world is changing and we're changing. Many years ago people thought there was going to be some kind of tax harmonisation in Europe, while obviously that hasn't happened now the local authorities are doing something about it. That's a fresh way of looking at it.
Kiely: Certain types of trades have come under a number of pressures. For example, there have been some fraudulent activities which are nothing to do with this market but unfortunately have tainted it. This is especially true in the Nordics and all these things accumulate to depress the whole market. PR and bad press affects thinking in the Nordics quicker and deeper than it does in the rest of Europe.
Neil: Lastly, what’s your outlook for the Nordic securities finance market?
Sæbø: This year has been an extremely good year for us with many specials and good volumes. We’re also a favourable counterparty for banks. We’re optimistic about our business going forward.
Murphy: I'm also positive. There's still a strong demand for securities finance. Even after some of the events this year, clients are looking to do more business. The willingness of international hedge funds to speak to Nordic counterparties and Nordic hedge funds’ forays into the European specials market are both good trends.
Allen: The search for alpha combined with a successful revenue year has brought new participants to the market. Those that have had a good year will be looking to do more with their programme in the future.
Kiely: We've been through a lot in 2016. A lower oil price has become the new normal. There was incredible equity market volatility in the first quarter and political shocks, such as Brexit, in the second quarter. For the short to medium term, interest rates are not going to go anywhere. And yet, despite all of the above, the securities finance market is still looking very healthy. We're seeing more business, especially from the Nordic region. Moreover, as the financial crisis of a few years' ago moves further away in the rear view mirror, people are gaining confidence. We can weather some of these market events because the right structure is in place in terms of risk management.
Strömberg: It's been a good year and volumes will keep going up. The focus is trying to add more IT aspects. There’s a trend for people to focus on analysis and automation to get in the best position to service clients.