 
May 2011
Securities lending market update - Q1 2011   (6 votes, average: 3.50 out of 5) Loading ...
In our recap of Q1 2011, the low interest rate environment continued to influence securities lending activity in global markets. While demand for equities continued to show signs of improvement throughout the quarter, fixed income activity was limited by the low yield curve. European markets were largely preoccupied by the prolonged impact of the financial crisis and the slow path to recovery. But, in this edition, we explore the increased interest in ‘Evergreen’ opportunities and the benefits that may be derived by lending government issues for term trades. From an Asian perspective, markets were jolted by the catastrophic earthquake in Japan, which had repercussions throughout the latter part of the quarter. Earlier activity in the quarter saw better than average volumes in corporate activity, while in Australia merger and acquisition activity showed an uptick. In our new feature commentary section, we discuss collateral—and how it can help balance varying risk appetites while adhering to a prudent risk management framework. More insights and market coverage are available in this Q1 Securities Lending Market Update. We trust you find this information relevant to your business and, as always, welcome your feedback.
North American markets
Economic indicators & trends Canada: On March 1, 2011, the Bank of Canada announced that it would maintain its target for the overnight rate at 1%. The global economic recovery is proceeding broadly in line with the Bank’s projection, although risks remain elevated. Future rate increases would require careful consideration given that domestic recovery is threatened by the strong Canadian dollar and the uncertainty associated with the ongoing European fiscal crisis. Securities lending insights The low yield curve environment has resulted in limited opportunities for US fixed income issues, especially given the 3% fail cost associated with the lending of US treasuries. A gradual increase in activity with any upward revision to interest rates would be welcome. We see a high demand for trading in non-investment grade corporate bonds, but are most selective before trading this book to ensure sufficient market liquidity exists. The Investment Industry Regulatory Organisation of Canada (IIROC) announced plans to remove restrictions on short selling in falling markets. IIROC published two studies in February 2011 that looked at trends in short selling with results showing little or no negative change in short selling patterns in the Canadian market. IIROC has published a notice for comment of proposed amendments to the regulation of short sales and failed trades to rescind the tick test which had restricted short selling when a company’s stock was falling. IIROC will accept comments from investors, market participants and other interested persons on the proposed amendments until May 26, 2011. As of January 1, 2011, the Specified Investment Flow Through (SIFT) tax effectively levelled the playing field between Trusts and corporations, leaving income trusts with little, if any tax advantage. Q1 saw some of the taxable Trust Units converting back into common shares with the majority maintaining their DRIP discount. Equity activity remained stable throughout the quarter with DRIP stocks, such as the Canadian banks, TransCanada Corporation and Crescent Point Energy generating more interest. Ritchie Brothers Auctioneers, a popular directional name, continued to lead the way outside of the big DRIP payers. The top US name in the quarter was Sears Holdings. Rates on this directional name were supported by strong short interest coupled with diminishing supply and recalls in the market. Demand spiked in the third quarter of 2010 and has remained high throughout the first quarter of 2011. In-demand securities:
European markets
Economic indicators & trends Securities lending insights Q1 marked the beginning of the traditional ‘seasonal demand’ trading period across Europe, which continues through to Q2. The trading desk experienced a high level of interest and focus by the borrower network across most European markets as well as Scandinavian markets. Seasonal demand peaked early in the quarter in comparison to trends from previous years. In particular, high demand for German securities, namely Siemens AG and Thyssenkrupp was prevalent. In each case, dividend yields were higher than 2010 by an average of 59%, but as they were considered special dividend payouts they are unlikely to be indicative of the market as a whole. Merger and acquisition (M&A) activity in Europe continued to awaken from a long slumber in the first quarter. The pace of recovery however remains slow amid lingering worries over the health of the government finances in the region and other threats to the global economy. Outside of seasonal demand, borrow interest for ‘specials’ has been predominantly for solar technologies, which experienced a liquidity squeeze driven by directional interest. In-demand securities:
Asia Pacific markets
Economic indicators & trends Securities lending insights The desk also had increased demand through the Japanese seasonal demand period. While interest was initially strong, the uncertainty created by the earthquake and the potential impact on dividends and falling market impacted final demand. As a result of the earthquake in Japan, RBC Dexia invoked a restriction on lending in certain stocks for two weeks, until the region and markets stabilized. Stocks made unavailable to borrow on a short term basis included Tokyo Electric Power, Kansai Electric, Hitachi, Tohoku Electric Power and Renesas Electronics Corporation. In Australia, the M&A landscape presented some opportunity. The AMP/AXA takeover drove demand for AMP, which was one of the top earners in Australia. The ASX/SGX merger is now expected to fail as Treasurer Wayne Swan is blocking the deal saying it is not in the national interests of Australia. Retail stocks such as Harvey Norman, David Jones & Billabong are all in demand. In Hong Kong and Singapore, there was continued flow off the back of corporate activity, dual listings and convertible bond issues. Trades of interest include continued directional demand for BYD Co. and hedging demand drove interest in Real Gold Mining. March also saw demand for HSBC for the scrip trade. In-demand securities:
Feature commentaryCollateral – A flexible perspective From a non-cash collateral perspective, the widening cost differential between various types of collateral is driving the conversation. Fundamentally, the profitability of the securities lending business depends on demand and from 2008 onwards the cost of collateral has been one of the most significant factors in determining that demand. If it costs a borrower 200 bps to source US treasuries as collateral, it’s irrelevant whether a lender charges 20 bps or 2 bps as a loan fee. The demand simply won’t exist, except for all but the hottest securities. While beneficial owners have to weigh this against their own risk appetite, increasing sophistication in areas such as VaR models, liquidity analysis and stress testing means that low risk and higher returns are not necessarily mutually exclusive. However, for a standard equity portfolio, several recent studies including one from the Risk Management Association have concluded that it’s safer to hold a component of equities as collateral rather than 100% government bonds. The higher correlation and easy liquidity proves beneficial in a default situation, but at the same time it also makes the collateral less expensive and thus more attractive to the borrower. The securities lending market has become an increasingly complex matrix that requires matching lender and borrower requirements while trying to stay compliant with a tightening regulatory landscape. This environment has opened up opportunities for specific trades such as the termed government bond loans mentioned as referred in our European market update, but also demonstrates that additional returns cannot be generated without a certain degree of flexibility. Despite the changing market conditions, there are opportunities available to earn competitive returns while adhering to a prudent risk management framework. Working with your provider is critical to ensuring the risk/return balance of your portfolio is aligned with your strategy and evolves with changing market conditions. For additional information on RBC Dexia’s securities lending capabilities, please contact: Blair McPherson Mary Jane Schuessler Stephen Rudland Trevor Amoils
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