Taiwan
18 February 2014
Experts discuss why Taiwan鈥檚 potential is being diluted, an onshore and offshore dichotomy, and the impact of Basel III on the Asian markets
Image: Shutterstock
What are the biggest challenges about lending in the Asian markets, and how are you overcoming these obstacles?
Paul Solway: The Asia region is still growing in both depth and breadth, and presents many new exciting opportunities for investors. Education on operational understanding is certainly an area that BNY Mellon is investing a huge amount of time guiding our clients around the Asia Pacific鈥檚 market advantages and nuances. We have a collection of markets all of which are slightly different from a trading and operational perspective. However, as the new markets of South Korea, Taiwan and most recently Malaysia are demonstrating, models are starting to have traits, rules and regulations that are very similar in nature. Liquidity can sometimes be a challenge in certain securities or exchanges but with lending programmes continuing to expand their client base, borrowers/traders are able to invest with more comfort and confidence such that their strategy can be seen through unencumbered.
Tim Smith: There are many types of challenges that affect securities lending in the Asian markets. Firstly, the diversity of approach to securities lending. The approach to securities lending by the countries in the region are more divergent than any other region around the world thus inferring that it is really a 鈥榬egion鈥� on a geographical basis only. From central counterparties (CCPs) to on-shore bans and differing collateral and booking and tax requirements, one of the main challenges is to keep up with the continually changing scene.
Secondly, the geographical and political diversity also presents a challenge as the attitudes by governments towards short selling and securities lending can change at whim. In addition, as much of the business is still conducted in different time zones, the complications of settlements and failure costs can be significant.
Regulators in some countries have adopted a short-term approach, leading to uncertainty, but there are also a few mature markets where business remains more traditional and accepted. This diversity, and the fact that the regulators in the other 鈥榤ore mature鈥� securities lending markets have been tarnished鈥攎aybe unfairly鈥攂y the 2008 crisis, means that regulatory control is front and centre.
There is also the dichotomy between onshore and offshore. The history of securities lending in Asia has been one of a significant contrast between onshore and offshore approaches, depending mostly on the onshore鈥檚 regulatory and fiscal approach to lending. This legacy attitude still causes challenges as the move to onshore becomes a greater priority.
Lastly, as securities markets and economies typically grow in double digits, the additional few basis points earned from securities lending can sometimes be unattractive given perhaps the perceived dangers of the activity. This was certainly the case in 1990s Hong Kong鈥攚hich has now changed鈥攁nd it is hoped that this will change in other markets as well.
Dane Fannin: Challenges relate to the lack of regulatory harmony across regional jurisdictions, specifically the impact of settlement rules to securities lending. While operating an offshore lending business is relatively uncomplicated in markets such as Hong Kong, there are unique challenges in markets where regulation remains complex, such as Taiwan and to a lesser extent South Korea. Typically, this may require lenders to involve clients in more unconventional ways, such as pre-trade notification for example, which ultimately constrains the pace of growth in supply from securities lending within that market.
However, these challenges do positively present revenue opportunities for those lenders and their agents such as Northern Trust who are able to successfully navigate existing rules and achieve first mover advantage, allowing their clients to capitalise on higher spreads. Importantly though, it is essential for lenders to adopt comprehensive risk management policies in such markets, to allow for the maximisation of returns balanced with the mitigation of settlement risk.
Joseph Tan: One of the differences between Asian lending and lending in Europe and the Americas is culture. Banks in Asia have a rich history of relationship banking founded on trust. Still today, large portions of domestic inter-bank cash lending is done on an unsecured basis. However, we are noticing a trend towards greater interaction between US and European firms and even increased intra-Asian lending, where secured forms of collateral are needed to cover exposures. For example, today it is quite common for a Singaporean bank to offer longer-term lending of US dollars to a Japanese bank, which will cover the loan with government bonds (JGBs). Indeed, JGBs remain one of the most liquid and safe asset classes used to cover exposures related to securities lending.
Francesco Squillacioti: The biggest challenges come from the sheer diversity of the markets鈥攈ow they operate and the various characteristics, rules and regulations that define them. We invest a lot of time and resources into our product development process before entering a market, as well as making sure that we have people on the ground who understand the markets we work in and can help our clients and counterparts regionally and globally.
Ed Oliver: There are very few Asian markets that follow a standard securities lending and borrowing framework. Those that do, already have mature securities lending markets and steady supply. Therefore, the biggest challenge in managing the Asian markets is unlocking value in the 鈥渘ewer鈥� opportunities.
Newer markets tend to have complex structures with nuances that lenders may not have seen in more mature markets. For example, many markets require collateral to be held at a CCP and others require pre-sale notifications that lenders may see as a barrier to entry. eSecLending works closely with the market infrastructure providers to understand the processes and rules that apply to each market so we can educate our clients about the intricacies, risks and rewards of each opportunity. eSecLending takes a consultative approach and specialises in providing highly customised programmes which address our clients鈥� specific risk parameters, allowing them to fully participate in the newer Asian markets and capture value from these emerging opportunities.
Lenders are starting to have to work within an evolving regulatory framework. How have you seen this affect their relationship with borrowers?
Oliver: Although we have not yet seen a noticeable impact, the evolving regulatory framework has certainly been a topic of interest and discussion in recent months. Various industry discussions, articles and commentary concerning the upcoming regulatory changes suggests that the lender-borrower dynamic will have to evolve, and as a result, some difficult discussions may be needed to address trading limits and fees needed to execute a trade. For eSecLending, the impact is anticipated to be limited relative to other lending agents and we do not anticipate major changes to our borrower relationships.
Tan: Evolving regulatory requirements are making an impact, albeit more indirectly. Asia, post-financial crisis, has not seen the direct regulatory measures as taken in Europe (under the European Market Infrastructure Regulation) and in the US (under the Dodd-Frank Act). That said, there is an increasingly important role that foreign firms play when securing liquidity with Asian counterparties. Derivative clearing, for example, requires counterparties doing deals with firms that are bound to EMIR and Dodd-Frank to adhere to these rules. A US regulated firm cannot waive its regulatory obligations surrounding eligible collateral just because it is trading with a firm not bound by the same regulatory requirements. Adherence to the more stringent capital adequacy requirements under Basel III is all-encompassing, and is impacting firms all over the world as they attempt to bolster their reserves and optimise their entire portfolios in the best possible way to continue with their trading/funding strategies.
Andrew McCardle: Regulation is nothing new in Asia. The number of markets with different and changing regulation has meant that this is always a key point for all relationships. It continues to be a key topic of conversation, and I do not expect this to change any time soon. The positive side to the ever-changing regulatory landscape is that it also can provide new opportunities for clients.
Solway: Regulation is certainly flowing downhill and it is clearly affecting both borrowers and lenders. Balance sheet, cost of capital, indemnification, credit and leverage are just some aspects of the that the whole market must assess the impact of future regulation change. As we know, regulators are working hard to give as much information as to what may be coming and this is certainly helping institutions on-manage client expectations. While the challenges for borrowers may be somewhat different from lenders鈥攎ost are intrinsically linked. At BNY Mellon, we are not only thinking of our own road-map ahead but anticipating the paths our clients may take and how we can guide them down the road.
Fannin: Although the extent to which pending global regulation will impact the securities lending business remains uncertain, the industry is already positioning themselves in anticipation of imminent changes, the effects of which are already evident in Asia.
From a borrower perspective and specifically within the context of Basel III effective 2015, the most noticeable change has manifested within the collateral space, as equity finance desks have increasingly been leveraged as the vehicle to drive balance sheet optimisation in an effort to reduce funding costs and minimise capital charges. In practical terms, not only has this demanded increased flexibility from lenders in the types of collateral accepted, it has also driven a change in the nature of trading, such as the growth of 鈥榚vergreen鈥� or termed structures to facilitate financing requirements. Lenders have therefore been tasked with ensuring their capabilities are positioned well to secure both existing and future growth, given that higher utilisation rates are generally afforded to those with greater flexibility. Collateral flexibility also enhances borrower relationships by allowing brokers the luxury of swapping collateral preferences as and when their funding requirements dictate.
Smith: Historically, the 鈥榩ower position鈥� between participants in securities finance has been with the borrowers in terms of knowledge as if there is no demand then no advantageous lending can take place. However, as market data has become more prevalent and the 鈥榲alue鈥� of securities lent has become a known quantity, then the lenders have been able to assert themselves more into the conversation. In addition, the drive by the regulatory authorities on a global basis to ensure greater transparency for the underlying beneficial owners of the securities being lent has meant that both the beneficial owners and their agents have had to attain a higher level of control and understanding.
Are you seeing increased interest in securities lending and borrowing in the Asian markets?
Fannin: From an end-user perspective, we understand that investment growth within the hedge fund industry continues to gather momentum in Asia, largely driven by institutional investors seeking higher returns to offset suppressed fixed income yields in the current environment. However, not all of this growth has necessarily translated into increased securities lending and borrowing activity in Asia, largely a function of the nature of underlying strategies. Long/short funds have remained the most successful strategies to date, and whilst historically they have tended to drive volumes, the majority of these funds maintained a net long bias as markets continued to rally throughout 2013, most notably Japan. Volumes have therefore remained largely flat although there have been some noticeable shifts in focus within the region, making way for a more optimistic 2014.
Changes in demand from Hong Kong securities and into Japanese securities were most noticeable. As the 鈥榗onsensus short鈥� to a slowing Chinese economy dissipated, hedge funds were welcomed by the inception of Abenomics that made way for growth in exposure to Japan, albeit with a long bias. Following a significant market rally, the perception now is that Japan is more conducive for fundamentals based stock picking strategies, rather than mere high beta exposure, which ought to benefit lending activity this year. There are also expectations for increased corporate deal activity, which has already been evident in more frequent capital raising. Beyond Japan, demand has continued to gravitate towards the emerging market space in Asia, most prevalently in Taiwan, which remains the most attractive market from a potential revenue stream perspective. Notably however, regulators in South Korea lifted the covered short sale ban on financial securities in late 2013, having imposed this in the wake of the financial crisis. While this did not stimulate demand in the short term, sentiments are for this to benefit securities lending in the long term as it allows funds to deploy their strategies more effectively.
Solway: Asia has the benefit of experience of both mature and emerging markets. The old guard of Japan, Hong Kong and Australia contrast with the emerging players of Korea, Taiwan and Malaysia where spreads are still attracting a lot of new interest. In saying that, Japan market performance was a surprise to all investors in 2013 and that looks to continue as a theme in 2014. Volatility, currency moves and tax changes have all contributed to a renewed interest in Japan and given the size of the market鈥攖here are certainly some promising returns on offer. 2013 saw short-selling regulation actually relax in South Korea and Taiwan in contrast to many other global markets. Indonesia looks most likely to be the next market to open its doors to a CCP-style exchange-driven securities lending and borrowing model, which is very exciting indeed.
Oliver: In a period of relatively flat SBL revenues, clients are interested in opportunities that arise from the newer Asian markets. Naturally, clients with larger exposures to these markets are the most interested, but overall interest is region-wide and not necessarily specific to individual markets.
We have seen increased borrower demand across the region. Of course, the vast majority of demand is concentrated in the less developed markets due to the limited availability of securities to borrow. In particular, South Korea, Taiwan and Hong Kong have seen the most activity. Markets where specials are prevalent are more attractive than other markets.
Squillacioti: Among our clients in the region, we certainly continue to see interest in securities lending鈥攂e it in Asian markets or other global, non-Asia markets. The interest is coming from virtually all parts of the region and from a broad array of the institutional investor/beneficial owner base we see represented here. On the other side of that, we also continue to see demand for the mainstay markets in APAC, as well as interest in newer or developing securities lending markets, such as Malaysia.
Tan: Asian lending continues to expand not only inside this region, but also into other geographical areas, such as Europe and the Americas. There is undoubtedly a heightened need for robust, efficient and cost-effective ways to source and mobilise securities for use as collateral. Different markets are at different stages of maturity. Likewise, some are more domestic in focus, while others like Japan and Singapore are truly international.
McCardle: EquiLend has seen usage of the platform locally over its 13-year history, but since opening our office in Hong Kong more than three years ago we have seen increasing interest from the Japanese domestic market along with the Australian domestic market. Both of these domestic markets are well suited to the EquiLend platform, with usage driven by the desire from firms to see the efficiencies and risk mitigation in these domestic markets that they currently enjoy in these markets from an offshore perspective. Already in 2014 we have seen record trading days over the platform, both regionally and globally.
Smith: The figures show that the interest in securities lending has grown significantly even if not in pure value of balances open but rather with an acceptance of the activity and the desire to participate. If you compare the interest level in markets now to where they were say 20 years ago, it certainly has changed and is continually changing. Twenty years ago, the vast majority of lending was undertaken in Japan and Australia. In those days, Hong Kong and Singapore were emerging markets. In the last five years, Hong Kong and Singapore have established themselves as mature lending markets as has Korea and Taiwan to a lesser extent. Interest levels are still growing in Malaysia, India, Thailand with smaller levels if activity in Indonesia, the Philippines, etc.
How are you using the market鈥檚 relative newness as a strength?
Tan: Certain parts of Asia are not nearly as developed as capital markets in Europe. However, one of the strengths here is that there are no legacy rules, regulations nor archaic systems to rework or decommission. Furthermore, another strength of the domestic capital markets in Asia is that they have been doing successful business with each other for decades. While a bank in, for example, South Korea may wish to conduct repo or lending activities with a counterparty in Japan, it will not think twice about the business transaction as it knows its trading partner. However, it may well have concerns around the operational processes required to manage the exposure. This is where a neutral, proven capital market infrastructure provider like Euroclear Bank can add real value. Via our multi-currency global Collateral Highway, the South Korean firm could receive JGBs against its initial loan, and Euroclear would at all times during the lifecycle of the financing transaction ensure that the correct collateral and agreed haircuts are applied. Furthermore, via Euroclear鈥檚 collateral conduit, that Korean firm could re-use its JGBs with a bank in America to secure US dollar funding.
Smith: From a service provider鈥檚 perspective, the newness of the markets and the differing structures provide both challenges and opportunities for us and our clients. In some ways, as the newer markets come on line with securities lending activity, they have learnt from more mature markets鈥� errors and mistakes thus requiring new safeguards, in many cases systematic, to be implemented. This enables us to expand our services to our clients as their business expands into new markets.
McCardle: The newness of these markets enables EquiLend to work very closely with clients to understand the difficulties or nuances within a market. This also enables us to partner with our clients to help provide not just the best solution for them but to work with the whole market to make sure that the solution works for all. This new ground makes it easier to achieve best practices on the system from the start.
Oliver: The challenges of some of the new Asian markets present an opportunity for proactive agents. For example, in those markets that do not generally support a standard SBL process, there is a chance for agents to work with the local market to assist in the development of the securities lending rules and processes. This is an area of strength for eSecLending and our clients recognise that we are adding value by doing so.
Solway: Investors new to an APAC lending programmes are concerned about buy-in risks. But in reality, exchange driven-models are transparent, rule-based, intermediated and structured. All these aspects were created by many of the new bourses to mitigate settlement failure in order to add confidence and liquidity to the market. In Taiwan, for example, a natural long position cannot be sold if it is on-loan or in the process of being returned from loan. Local intermediaries oversee this process, which inspires all parties to be fast, efficient and aware of all stages of the settlement lifecycle. Risk verses return is always a balancing act that investors have to call; APAC is leading the charge in ensuring that operational risks of any lending programme can be vastly reduced.
Are you seeing a broadened asset demand, or do equities still dominate?
Squillacioti: In terms of the demand we are seeing from our borrower base in APAC, it is still largely equity-driven. However, while equities have historically dominated in this region, we do see indications that fixed income is becoming a greater area of interest 鈥� both from our borrowers and from the beneficial owners we service. There seems to be growing demand for a few markets, including Australian government bonds, JGBs and Singapore.
Solway: The domination of equities does indeed continue, but fixed/convertible flows are on the rise, which is evidenced by new roles and flows emanating from APAC securities finance desks. Certainly at BNY Mellon, we are now open for lending over any global lendable asset class in the Asian time-zone and this has already made a real difference for our client base. Co-ordination is key naturally and institutions with a truly global reach and capability, ultimately have an advantage. ETF capabilities continue to expand across the region, as exemplified by India鈥檚 National Stock Exchange of India (NSE), which introduced trading in exchange-traded funds in its securities lending and borrowing segment (September 2013).
Tan: Regional equities remain at the forefront and main revenue generator in the securities lending realm for beneficial owners here in Asia. However, there are signs of a pick-up of fixed-income activity but this activity is still lagging behind equities, owing to the fact that debt capital markets in Asia are not as well developed. Much of this is due to the cultural norms inherent in the banking industry in Asia, where there is little need to access the capital markets for funding. Owing to a high savings base, there is ample liquidity for banks to utilise, and as a result, no compelling reason to seek external funding in the form of debt.
Oliver: Although many cite fixed income as the preferred investment class, our programme shows a stronger bias towards equities. In addition, equities remain the desired asset class for borrowers. It will be interesting to see how equities react in 2014 due to current speculation that the returns experienced in recent months/years will not continue and some investors may shift out of equities and into fixed income. Conversely, eSecLending looks for increased demand for equities in 2014 and are poised to capitalise by continuing to work on increasing supply and opening new markets.
McCardle: We have seen a greater interest regionally in BondLend for fixed income trading, but we still see equities as the predominant asset traded on our platform. With more firms having a fixed income presence in the region, we expect the interest in this side to continue to increase throughout the year.
Fannin: Undoubtedly, equities remain the dominant asset class from a securities lending perspective in Asia, and this is likely to remain the case for some time to come. However, demand for fixed income securities is growing and is likely to gather momentum as global regulation begins to materialise. Basel III is driving borrowers to optimise their balance sheets and pursue the collateral transformation ethos, which is encouraging increased demand for fixed income financing transactions out of the region. Whilst activity remains modest in its current form, this is likely to gather prominence over the next few years ahead of Basel鈥檚 implementation. Demand for regional fixed income coverage is also being driven by increased Asia-based hedge fund flows, which require trade execution during local hours rather than via London at a later time.
Which of the emerging markets is proving the most interesting and why?
Dane Fannin: Of those markets which are operational, Taiwan continues to offer the most attractive returns for clients on a relative basis, although spreads have recently been eroded for two primary reasons. Firstly, Taiwan鈥檚 supply curve continues to mature as agent lenders pursue the launch of new clients into the market, thus diluting overall fees. Secondly, restrictive short sale quota rules have constrained the ability for hedge funds to deploy selected strategies in scale, largely relative value type funds.
Indonesia is attracting attention too. The Indonesian Clearing and Guarantee Corp are making strides in developing a viable platform, they hope to be able to launch next year. Borrower demand is indicatively robust and ought to be a lot deeper than other less developed markets, largely because Indonesia offers greater liquidity to hedge funds, allowing them to better deploy strategies effectively.
Oliver: That is a tough question to answer because there are so many emerging markets that are interesting right now, in Asia and elsewhere. These range from Malaysia, where the negotiated transaction is opening up the market for lenders, to Brazil and India where the use of a CCP is still a challenge. For those lenders that can partner with clients to structure a functional approach to these markets, there is a significant revenue opportunity.
McCardle: We currently see the strongest interest in working to get South Korea, Taiwan and Thailand set up and traded over the EquiLend system. As clients in the region have become more familiar with the system, they see the opportunity to use a platform such as EquiLend to bring the efficiencies that are needed.
Smith: The emerging market that would appear to have been generating the most interest with our clients is India. This is not because of the size of the book already being generated but rather because of the challenges that the regulations and the processes require. Whilst still a long way to go, there is always that continual watchfulness by our clients and ourselves as to how the market in securities lending will travel.
Solway: At BNY Mellon, we see Japan, Korea, Taiwan and Thailand as the markets of most interest heading into 2014 purely due to their relative evolution and subsequent return potential.
Tan: This is a very difficult question to answer, and depends where you sit. Capital markets across the Asian-Pacific rim differ remarkably. In Australia and New Zealand, financial firms have long been used to operating according to US or European collateral management norms. Domestic capital market firms are using Australian government and corporate debt to secure foreign hard currency funding with increasing regularity. The flipside to this is that US and European firms are happy to diversify the collateral taken with such assets, which are seen as highly liquid and considered 鈥榞lobal-crisis remote鈥�.
JGBs remain a highly sought-after asset class used extensively in the Asian region, and also further afield. But other government paper is rapidly catching up. We are increasingly hearing from our clients of the attractiveness of Malay and Thai government securities as benchmark assets.
Paul Solway: The Asia region is still growing in both depth and breadth, and presents many new exciting opportunities for investors. Education on operational understanding is certainly an area that BNY Mellon is investing a huge amount of time guiding our clients around the Asia Pacific鈥檚 market advantages and nuances. We have a collection of markets all of which are slightly different from a trading and operational perspective. However, as the new markets of South Korea, Taiwan and most recently Malaysia are demonstrating, models are starting to have traits, rules and regulations that are very similar in nature. Liquidity can sometimes be a challenge in certain securities or exchanges but with lending programmes continuing to expand their client base, borrowers/traders are able to invest with more comfort and confidence such that their strategy can be seen through unencumbered.
Tim Smith: There are many types of challenges that affect securities lending in the Asian markets. Firstly, the diversity of approach to securities lending. The approach to securities lending by the countries in the region are more divergent than any other region around the world thus inferring that it is really a 鈥榬egion鈥� on a geographical basis only. From central counterparties (CCPs) to on-shore bans and differing collateral and booking and tax requirements, one of the main challenges is to keep up with the continually changing scene.
Secondly, the geographical and political diversity also presents a challenge as the attitudes by governments towards short selling and securities lending can change at whim. In addition, as much of the business is still conducted in different time zones, the complications of settlements and failure costs can be significant.
Regulators in some countries have adopted a short-term approach, leading to uncertainty, but there are also a few mature markets where business remains more traditional and accepted. This diversity, and the fact that the regulators in the other 鈥榤ore mature鈥� securities lending markets have been tarnished鈥攎aybe unfairly鈥攂y the 2008 crisis, means that regulatory control is front and centre.
There is also the dichotomy between onshore and offshore. The history of securities lending in Asia has been one of a significant contrast between onshore and offshore approaches, depending mostly on the onshore鈥檚 regulatory and fiscal approach to lending. This legacy attitude still causes challenges as the move to onshore becomes a greater priority.
Lastly, as securities markets and economies typically grow in double digits, the additional few basis points earned from securities lending can sometimes be unattractive given perhaps the perceived dangers of the activity. This was certainly the case in 1990s Hong Kong鈥攚hich has now changed鈥攁nd it is hoped that this will change in other markets as well.
Dane Fannin: Challenges relate to the lack of regulatory harmony across regional jurisdictions, specifically the impact of settlement rules to securities lending. While operating an offshore lending business is relatively uncomplicated in markets such as Hong Kong, there are unique challenges in markets where regulation remains complex, such as Taiwan and to a lesser extent South Korea. Typically, this may require lenders to involve clients in more unconventional ways, such as pre-trade notification for example, which ultimately constrains the pace of growth in supply from securities lending within that market.
However, these challenges do positively present revenue opportunities for those lenders and their agents such as Northern Trust who are able to successfully navigate existing rules and achieve first mover advantage, allowing their clients to capitalise on higher spreads. Importantly though, it is essential for lenders to adopt comprehensive risk management policies in such markets, to allow for the maximisation of returns balanced with the mitigation of settlement risk.
Joseph Tan: One of the differences between Asian lending and lending in Europe and the Americas is culture. Banks in Asia have a rich history of relationship banking founded on trust. Still today, large portions of domestic inter-bank cash lending is done on an unsecured basis. However, we are noticing a trend towards greater interaction between US and European firms and even increased intra-Asian lending, where secured forms of collateral are needed to cover exposures. For example, today it is quite common for a Singaporean bank to offer longer-term lending of US dollars to a Japanese bank, which will cover the loan with government bonds (JGBs). Indeed, JGBs remain one of the most liquid and safe asset classes used to cover exposures related to securities lending.
Francesco Squillacioti: The biggest challenges come from the sheer diversity of the markets鈥攈ow they operate and the various characteristics, rules and regulations that define them. We invest a lot of time and resources into our product development process before entering a market, as well as making sure that we have people on the ground who understand the markets we work in and can help our clients and counterparts regionally and globally.
Ed Oliver: There are very few Asian markets that follow a standard securities lending and borrowing framework. Those that do, already have mature securities lending markets and steady supply. Therefore, the biggest challenge in managing the Asian markets is unlocking value in the 鈥渘ewer鈥� opportunities.
Newer markets tend to have complex structures with nuances that lenders may not have seen in more mature markets. For example, many markets require collateral to be held at a CCP and others require pre-sale notifications that lenders may see as a barrier to entry. eSecLending works closely with the market infrastructure providers to understand the processes and rules that apply to each market so we can educate our clients about the intricacies, risks and rewards of each opportunity. eSecLending takes a consultative approach and specialises in providing highly customised programmes which address our clients鈥� specific risk parameters, allowing them to fully participate in the newer Asian markets and capture value from these emerging opportunities.
Lenders are starting to have to work within an evolving regulatory framework. How have you seen this affect their relationship with borrowers?
Oliver: Although we have not yet seen a noticeable impact, the evolving regulatory framework has certainly been a topic of interest and discussion in recent months. Various industry discussions, articles and commentary concerning the upcoming regulatory changes suggests that the lender-borrower dynamic will have to evolve, and as a result, some difficult discussions may be needed to address trading limits and fees needed to execute a trade. For eSecLending, the impact is anticipated to be limited relative to other lending agents and we do not anticipate major changes to our borrower relationships.
Tan: Evolving regulatory requirements are making an impact, albeit more indirectly. Asia, post-financial crisis, has not seen the direct regulatory measures as taken in Europe (under the European Market Infrastructure Regulation) and in the US (under the Dodd-Frank Act). That said, there is an increasingly important role that foreign firms play when securing liquidity with Asian counterparties. Derivative clearing, for example, requires counterparties doing deals with firms that are bound to EMIR and Dodd-Frank to adhere to these rules. A US regulated firm cannot waive its regulatory obligations surrounding eligible collateral just because it is trading with a firm not bound by the same regulatory requirements. Adherence to the more stringent capital adequacy requirements under Basel III is all-encompassing, and is impacting firms all over the world as they attempt to bolster their reserves and optimise their entire portfolios in the best possible way to continue with their trading/funding strategies.
Andrew McCardle: Regulation is nothing new in Asia. The number of markets with different and changing regulation has meant that this is always a key point for all relationships. It continues to be a key topic of conversation, and I do not expect this to change any time soon. The positive side to the ever-changing regulatory landscape is that it also can provide new opportunities for clients.
Solway: Regulation is certainly flowing downhill and it is clearly affecting both borrowers and lenders. Balance sheet, cost of capital, indemnification, credit and leverage are just some aspects of the that the whole market must assess the impact of future regulation change. As we know, regulators are working hard to give as much information as to what may be coming and this is certainly helping institutions on-manage client expectations. While the challenges for borrowers may be somewhat different from lenders鈥攎ost are intrinsically linked. At BNY Mellon, we are not only thinking of our own road-map ahead but anticipating the paths our clients may take and how we can guide them down the road.
Fannin: Although the extent to which pending global regulation will impact the securities lending business remains uncertain, the industry is already positioning themselves in anticipation of imminent changes, the effects of which are already evident in Asia.
From a borrower perspective and specifically within the context of Basel III effective 2015, the most noticeable change has manifested within the collateral space, as equity finance desks have increasingly been leveraged as the vehicle to drive balance sheet optimisation in an effort to reduce funding costs and minimise capital charges. In practical terms, not only has this demanded increased flexibility from lenders in the types of collateral accepted, it has also driven a change in the nature of trading, such as the growth of 鈥榚vergreen鈥� or termed structures to facilitate financing requirements. Lenders have therefore been tasked with ensuring their capabilities are positioned well to secure both existing and future growth, given that higher utilisation rates are generally afforded to those with greater flexibility. Collateral flexibility also enhances borrower relationships by allowing brokers the luxury of swapping collateral preferences as and when their funding requirements dictate.
Smith: Historically, the 鈥榩ower position鈥� between participants in securities finance has been with the borrowers in terms of knowledge as if there is no demand then no advantageous lending can take place. However, as market data has become more prevalent and the 鈥榲alue鈥� of securities lent has become a known quantity, then the lenders have been able to assert themselves more into the conversation. In addition, the drive by the regulatory authorities on a global basis to ensure greater transparency for the underlying beneficial owners of the securities being lent has meant that both the beneficial owners and their agents have had to attain a higher level of control and understanding.
Are you seeing increased interest in securities lending and borrowing in the Asian markets?
Fannin: From an end-user perspective, we understand that investment growth within the hedge fund industry continues to gather momentum in Asia, largely driven by institutional investors seeking higher returns to offset suppressed fixed income yields in the current environment. However, not all of this growth has necessarily translated into increased securities lending and borrowing activity in Asia, largely a function of the nature of underlying strategies. Long/short funds have remained the most successful strategies to date, and whilst historically they have tended to drive volumes, the majority of these funds maintained a net long bias as markets continued to rally throughout 2013, most notably Japan. Volumes have therefore remained largely flat although there have been some noticeable shifts in focus within the region, making way for a more optimistic 2014.
Changes in demand from Hong Kong securities and into Japanese securities were most noticeable. As the 鈥榗onsensus short鈥� to a slowing Chinese economy dissipated, hedge funds were welcomed by the inception of Abenomics that made way for growth in exposure to Japan, albeit with a long bias. Following a significant market rally, the perception now is that Japan is more conducive for fundamentals based stock picking strategies, rather than mere high beta exposure, which ought to benefit lending activity this year. There are also expectations for increased corporate deal activity, which has already been evident in more frequent capital raising. Beyond Japan, demand has continued to gravitate towards the emerging market space in Asia, most prevalently in Taiwan, which remains the most attractive market from a potential revenue stream perspective. Notably however, regulators in South Korea lifted the covered short sale ban on financial securities in late 2013, having imposed this in the wake of the financial crisis. While this did not stimulate demand in the short term, sentiments are for this to benefit securities lending in the long term as it allows funds to deploy their strategies more effectively.
Solway: Asia has the benefit of experience of both mature and emerging markets. The old guard of Japan, Hong Kong and Australia contrast with the emerging players of Korea, Taiwan and Malaysia where spreads are still attracting a lot of new interest. In saying that, Japan market performance was a surprise to all investors in 2013 and that looks to continue as a theme in 2014. Volatility, currency moves and tax changes have all contributed to a renewed interest in Japan and given the size of the market鈥攖here are certainly some promising returns on offer. 2013 saw short-selling regulation actually relax in South Korea and Taiwan in contrast to many other global markets. Indonesia looks most likely to be the next market to open its doors to a CCP-style exchange-driven securities lending and borrowing model, which is very exciting indeed.
Oliver: In a period of relatively flat SBL revenues, clients are interested in opportunities that arise from the newer Asian markets. Naturally, clients with larger exposures to these markets are the most interested, but overall interest is region-wide and not necessarily specific to individual markets.
We have seen increased borrower demand across the region. Of course, the vast majority of demand is concentrated in the less developed markets due to the limited availability of securities to borrow. In particular, South Korea, Taiwan and Hong Kong have seen the most activity. Markets where specials are prevalent are more attractive than other markets.
Squillacioti: Among our clients in the region, we certainly continue to see interest in securities lending鈥攂e it in Asian markets or other global, non-Asia markets. The interest is coming from virtually all parts of the region and from a broad array of the institutional investor/beneficial owner base we see represented here. On the other side of that, we also continue to see demand for the mainstay markets in APAC, as well as interest in newer or developing securities lending markets, such as Malaysia.
Tan: Asian lending continues to expand not only inside this region, but also into other geographical areas, such as Europe and the Americas. There is undoubtedly a heightened need for robust, efficient and cost-effective ways to source and mobilise securities for use as collateral. Different markets are at different stages of maturity. Likewise, some are more domestic in focus, while others like Japan and Singapore are truly international.
McCardle: EquiLend has seen usage of the platform locally over its 13-year history, but since opening our office in Hong Kong more than three years ago we have seen increasing interest from the Japanese domestic market along with the Australian domestic market. Both of these domestic markets are well suited to the EquiLend platform, with usage driven by the desire from firms to see the efficiencies and risk mitigation in these domestic markets that they currently enjoy in these markets from an offshore perspective. Already in 2014 we have seen record trading days over the platform, both regionally and globally.
Smith: The figures show that the interest in securities lending has grown significantly even if not in pure value of balances open but rather with an acceptance of the activity and the desire to participate. If you compare the interest level in markets now to where they were say 20 years ago, it certainly has changed and is continually changing. Twenty years ago, the vast majority of lending was undertaken in Japan and Australia. In those days, Hong Kong and Singapore were emerging markets. In the last five years, Hong Kong and Singapore have established themselves as mature lending markets as has Korea and Taiwan to a lesser extent. Interest levels are still growing in Malaysia, India, Thailand with smaller levels if activity in Indonesia, the Philippines, etc.
How are you using the market鈥檚 relative newness as a strength?
Tan: Certain parts of Asia are not nearly as developed as capital markets in Europe. However, one of the strengths here is that there are no legacy rules, regulations nor archaic systems to rework or decommission. Furthermore, another strength of the domestic capital markets in Asia is that they have been doing successful business with each other for decades. While a bank in, for example, South Korea may wish to conduct repo or lending activities with a counterparty in Japan, it will not think twice about the business transaction as it knows its trading partner. However, it may well have concerns around the operational processes required to manage the exposure. This is where a neutral, proven capital market infrastructure provider like Euroclear Bank can add real value. Via our multi-currency global Collateral Highway, the South Korean firm could receive JGBs against its initial loan, and Euroclear would at all times during the lifecycle of the financing transaction ensure that the correct collateral and agreed haircuts are applied. Furthermore, via Euroclear鈥檚 collateral conduit, that Korean firm could re-use its JGBs with a bank in America to secure US dollar funding.
Smith: From a service provider鈥檚 perspective, the newness of the markets and the differing structures provide both challenges and opportunities for us and our clients. In some ways, as the newer markets come on line with securities lending activity, they have learnt from more mature markets鈥� errors and mistakes thus requiring new safeguards, in many cases systematic, to be implemented. This enables us to expand our services to our clients as their business expands into new markets.
McCardle: The newness of these markets enables EquiLend to work very closely with clients to understand the difficulties or nuances within a market. This also enables us to partner with our clients to help provide not just the best solution for them but to work with the whole market to make sure that the solution works for all. This new ground makes it easier to achieve best practices on the system from the start.
Oliver: The challenges of some of the new Asian markets present an opportunity for proactive agents. For example, in those markets that do not generally support a standard SBL process, there is a chance for agents to work with the local market to assist in the development of the securities lending rules and processes. This is an area of strength for eSecLending and our clients recognise that we are adding value by doing so.
Solway: Investors new to an APAC lending programmes are concerned about buy-in risks. But in reality, exchange driven-models are transparent, rule-based, intermediated and structured. All these aspects were created by many of the new bourses to mitigate settlement failure in order to add confidence and liquidity to the market. In Taiwan, for example, a natural long position cannot be sold if it is on-loan or in the process of being returned from loan. Local intermediaries oversee this process, which inspires all parties to be fast, efficient and aware of all stages of the settlement lifecycle. Risk verses return is always a balancing act that investors have to call; APAC is leading the charge in ensuring that operational risks of any lending programme can be vastly reduced.
Are you seeing a broadened asset demand, or do equities still dominate?
Squillacioti: In terms of the demand we are seeing from our borrower base in APAC, it is still largely equity-driven. However, while equities have historically dominated in this region, we do see indications that fixed income is becoming a greater area of interest 鈥� both from our borrowers and from the beneficial owners we service. There seems to be growing demand for a few markets, including Australian government bonds, JGBs and Singapore.
Solway: The domination of equities does indeed continue, but fixed/convertible flows are on the rise, which is evidenced by new roles and flows emanating from APAC securities finance desks. Certainly at BNY Mellon, we are now open for lending over any global lendable asset class in the Asian time-zone and this has already made a real difference for our client base. Co-ordination is key naturally and institutions with a truly global reach and capability, ultimately have an advantage. ETF capabilities continue to expand across the region, as exemplified by India鈥檚 National Stock Exchange of India (NSE), which introduced trading in exchange-traded funds in its securities lending and borrowing segment (September 2013).
Tan: Regional equities remain at the forefront and main revenue generator in the securities lending realm for beneficial owners here in Asia. However, there are signs of a pick-up of fixed-income activity but this activity is still lagging behind equities, owing to the fact that debt capital markets in Asia are not as well developed. Much of this is due to the cultural norms inherent in the banking industry in Asia, where there is little need to access the capital markets for funding. Owing to a high savings base, there is ample liquidity for banks to utilise, and as a result, no compelling reason to seek external funding in the form of debt.
Oliver: Although many cite fixed income as the preferred investment class, our programme shows a stronger bias towards equities. In addition, equities remain the desired asset class for borrowers. It will be interesting to see how equities react in 2014 due to current speculation that the returns experienced in recent months/years will not continue and some investors may shift out of equities and into fixed income. Conversely, eSecLending looks for increased demand for equities in 2014 and are poised to capitalise by continuing to work on increasing supply and opening new markets.
McCardle: We have seen a greater interest regionally in BondLend for fixed income trading, but we still see equities as the predominant asset traded on our platform. With more firms having a fixed income presence in the region, we expect the interest in this side to continue to increase throughout the year.
Fannin: Undoubtedly, equities remain the dominant asset class from a securities lending perspective in Asia, and this is likely to remain the case for some time to come. However, demand for fixed income securities is growing and is likely to gather momentum as global regulation begins to materialise. Basel III is driving borrowers to optimise their balance sheets and pursue the collateral transformation ethos, which is encouraging increased demand for fixed income financing transactions out of the region. Whilst activity remains modest in its current form, this is likely to gather prominence over the next few years ahead of Basel鈥檚 implementation. Demand for regional fixed income coverage is also being driven by increased Asia-based hedge fund flows, which require trade execution during local hours rather than via London at a later time.
Which of the emerging markets is proving the most interesting and why?
Dane Fannin: Of those markets which are operational, Taiwan continues to offer the most attractive returns for clients on a relative basis, although spreads have recently been eroded for two primary reasons. Firstly, Taiwan鈥檚 supply curve continues to mature as agent lenders pursue the launch of new clients into the market, thus diluting overall fees. Secondly, restrictive short sale quota rules have constrained the ability for hedge funds to deploy selected strategies in scale, largely relative value type funds.
Indonesia is attracting attention too. The Indonesian Clearing and Guarantee Corp are making strides in developing a viable platform, they hope to be able to launch next year. Borrower demand is indicatively robust and ought to be a lot deeper than other less developed markets, largely because Indonesia offers greater liquidity to hedge funds, allowing them to better deploy strategies effectively.
Oliver: That is a tough question to answer because there are so many emerging markets that are interesting right now, in Asia and elsewhere. These range from Malaysia, where the negotiated transaction is opening up the market for lenders, to Brazil and India where the use of a CCP is still a challenge. For those lenders that can partner with clients to structure a functional approach to these markets, there is a significant revenue opportunity.
McCardle: We currently see the strongest interest in working to get South Korea, Taiwan and Thailand set up and traded over the EquiLend system. As clients in the region have become more familiar with the system, they see the opportunity to use a platform such as EquiLend to bring the efficiencies that are needed.
Smith: The emerging market that would appear to have been generating the most interest with our clients is India. This is not because of the size of the book already being generated but rather because of the challenges that the regulations and the processes require. Whilst still a long way to go, there is always that continual watchfulness by our clients and ourselves as to how the market in securities lending will travel.
Solway: At BNY Mellon, we see Japan, Korea, Taiwan and Thailand as the markets of most interest heading into 2014 purely due to their relative evolution and subsequent return potential.
Tan: This is a very difficult question to answer, and depends where you sit. Capital markets across the Asian-Pacific rim differ remarkably. In Australia and New Zealand, financial firms have long been used to operating according to US or European collateral management norms. Domestic capital market firms are using Australian government and corporate debt to secure foreign hard currency funding with increasing regularity. The flipside to this is that US and European firms are happy to diversify the collateral taken with such assets, which are seen as highly liquid and considered 鈥榞lobal-crisis remote鈥�.
JGBs remain a highly sought-after asset class used extensively in the Asian region, and also further afield. But other government paper is rapidly catching up. We are increasingly hearing from our clients of the attractiveness of Malay and Thai government securities as benchmark assets.
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