The wild, wild east
05 August 2014
The securities borrowing and lending markets in the Asia-Pacific and Japan region have undergone steady growth. Where has that growth come from and, more importantly, will it continue, asks Richard Allin of SunGard鈥檚 Astec Analytics
Image: Shutterstock
Why are stakeholders in the securities borrowing and lending industry devoting more time and resources to Asia? Simply put, their clients want to be able to lend out the securities they hold in these regions, and lenders want to keep their clients happy.
Lending agents also like to be seen as forward thinking, truly global and different from their competitors. Naturally, lending cannot take place in a vacuum. It requires demand, and brokers see the potential demand and want the opportunity to offer these securities to the hedge funds in the region and beyond.
The revenue opportunities that exist are a big driver for firms, as one would expect, and the history of securities lending over the last 25 years has shown that the greatest profits are realised by those that are first to market. Those that are looking to get involved want to be one of the first to start reaping the rewards. This is especially important since these rewards decline towards mature market levels at an increasing rate.
There are many more 鈥榟igh-end specials鈥� in Asia compared to the rest of the world and, somewhat surprisingly, those specials are not just comprised of equities, but fixed income securities, too. The mix of equities versus fixed income is considerably higher than in Europe and North America, which may also help account for the higher average fees we see in the region. This region, more than any other, is one of an intrinsic value-based system of securities lending.
Australia and Japan remain two of the largest markets in the region. However, most would agree they are not the most interesting to the participants therein, as they are often the most transparent in terms of what鈥檚 going on in the securities borrowing and lending market and usually don鈥檛 have a large number of specials occurring at any one time.
It鈥檚 no surprise then that the average borrow rates in the emerging securities borrowing and lending markets are often much higher than those in the more established markets, with some as high as 4 percent on an annualised basis. That is in comparison to the market average rates of below 1 percent in many of the more established markets in the region. Malaysia, Taiwan and South Korea have some of the highest average borrowing costs in the region, which means that these smaller emerging markets have some of the highest income potential for the participants that choose to get involved.
We have seen new markets enter the mix and fully expect others to continue this trend, but at what pace have they entered the market and what are the barriers to entry?
While it鈥檚 easy to look at the newer markets that are experiencing rapid growth and think, 鈥渨ow, that was quick鈥�, it actually wasn鈥檛. It took a considerable amount of time and a lot of effort to get them off the ground and achieve that growth. Even then, it鈥檚 only after several years that this growth has really been noticeable.
One of the main reasons time-to-market is so long is that these emerging markets and their regulatory bodies realise the consequences of getting it right the first time, and they are increasingly taking their time and doing their homework. They want to establish the 鈥榬ight鈥� models before moving forward. One thing in their favour is that they have the opportunity to learn from those that have gone before them. They can pick and choose the way they want to develop their securities borrowing and lending programme, avoiding the pitfalls that the others might have experienced. On the other hand, they have to remember that while they want their securities borrowing and lending markets to be safe, they don鈥檛 want to make the barriers to entry too onerous or costly.
While firms continue to be open to exploring most, if not all, of the new markets, they remain very cautious. They have many regulatory hurdles to clear in order to participate in each market, which can take a considerable amount of time, effort and cost. As a result, they must seriously consider their options before jumping in. Additionally, they need to show that there is demand and that it will be profitable to enter any said market.
There is a host of additional challenges for these participants, starting with the geographical and political diversity of the markets in the region. It is an increasingly complex region in which to do business and the rules seem to be changing on an almost daily basis. Participants must continually keep up with the latest news in each of these regions.
Firms also have to deal with multiple regulatory bodies, the reputation of securities lending, central counterparties, onshore bans and differing collateral and booking and tax requirements. They also have to understand the differences between the onshore and offshore approaches to the business and weigh the risk associated with getting involved in these markets to make sure it makes sense for their firms.
The securities borrowing and lending markets of the Asia Pacific and Japan are the wild, wild east, where the risks are high鈥攂ut so are the rewards. There is growth potential and large profit margins, but the barriers to entry can be rigorous and fraught with danger. Firms that manage to get it right, however timely or costly it may be, could be well rewarded.
Lending agents also like to be seen as forward thinking, truly global and different from their competitors. Naturally, lending cannot take place in a vacuum. It requires demand, and brokers see the potential demand and want the opportunity to offer these securities to the hedge funds in the region and beyond.
The revenue opportunities that exist are a big driver for firms, as one would expect, and the history of securities lending over the last 25 years has shown that the greatest profits are realised by those that are first to market. Those that are looking to get involved want to be one of the first to start reaping the rewards. This is especially important since these rewards decline towards mature market levels at an increasing rate.
There are many more 鈥榟igh-end specials鈥� in Asia compared to the rest of the world and, somewhat surprisingly, those specials are not just comprised of equities, but fixed income securities, too. The mix of equities versus fixed income is considerably higher than in Europe and North America, which may also help account for the higher average fees we see in the region. This region, more than any other, is one of an intrinsic value-based system of securities lending.
Australia and Japan remain two of the largest markets in the region. However, most would agree they are not the most interesting to the participants therein, as they are often the most transparent in terms of what鈥檚 going on in the securities borrowing and lending market and usually don鈥檛 have a large number of specials occurring at any one time.
It鈥檚 no surprise then that the average borrow rates in the emerging securities borrowing and lending markets are often much higher than those in the more established markets, with some as high as 4 percent on an annualised basis. That is in comparison to the market average rates of below 1 percent in many of the more established markets in the region. Malaysia, Taiwan and South Korea have some of the highest average borrowing costs in the region, which means that these smaller emerging markets have some of the highest income potential for the participants that choose to get involved.
We have seen new markets enter the mix and fully expect others to continue this trend, but at what pace have they entered the market and what are the barriers to entry?
While it鈥檚 easy to look at the newer markets that are experiencing rapid growth and think, 鈥渨ow, that was quick鈥�, it actually wasn鈥檛. It took a considerable amount of time and a lot of effort to get them off the ground and achieve that growth. Even then, it鈥檚 only after several years that this growth has really been noticeable.
One of the main reasons time-to-market is so long is that these emerging markets and their regulatory bodies realise the consequences of getting it right the first time, and they are increasingly taking their time and doing their homework. They want to establish the 鈥榬ight鈥� models before moving forward. One thing in their favour is that they have the opportunity to learn from those that have gone before them. They can pick and choose the way they want to develop their securities borrowing and lending programme, avoiding the pitfalls that the others might have experienced. On the other hand, they have to remember that while they want their securities borrowing and lending markets to be safe, they don鈥檛 want to make the barriers to entry too onerous or costly.
While firms continue to be open to exploring most, if not all, of the new markets, they remain very cautious. They have many regulatory hurdles to clear in order to participate in each market, which can take a considerable amount of time, effort and cost. As a result, they must seriously consider their options before jumping in. Additionally, they need to show that there is demand and that it will be profitable to enter any said market.
There is a host of additional challenges for these participants, starting with the geographical and political diversity of the markets in the region. It is an increasingly complex region in which to do business and the rules seem to be changing on an almost daily basis. Participants must continually keep up with the latest news in each of these regions.
Firms also have to deal with multiple regulatory bodies, the reputation of securities lending, central counterparties, onshore bans and differing collateral and booking and tax requirements. They also have to understand the differences between the onshore and offshore approaches to the business and weigh the risk associated with getting involved in these markets to make sure it makes sense for their firms.
The securities borrowing and lending markets of the Asia Pacific and Japan are the wild, wild east, where the risks are high鈥攂ut so are the rewards. There is growth potential and large profit margins, but the barriers to entry can be rigorous and fraught with danger. Firms that manage to get it right, however timely or costly it may be, could be well rewarded.
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