Roundtable: Nordic Securities Finance

Roundtable: Nordic Securities Finance

Market participants met in Copenhagen in September for the 2018 Nordic Securities Finance Roundtable.

Participants:

  • Chair: Hugo Cox, Global investor/ISF
  • Clare Bromiley-Carmen, Global Securities Lending Relationship Management, BNY Mellon Markets, London
  • Paul Wilson, Global Head of Securities Finance, IHS Markit, London
  • Tobias Bjorklund, Sales and Trading, Danske Bank, Stockholm
  • Per Strömberg, Securities Finance, Handelsbanken, Stockholm

Chair: What does the data tell us about the changing size of the Nordic lending pool and how much it is being used?

Wilson: 2016 was a banner year for Nordic securities driven by a number of particularly deep equity specials including Fingerprint Cards in Sweden, Seadrill in Norway and Flsmidth here in Denmark. Based on this, 2017 revenue was always going to be lower than 2016, but so far 2018 has been pretty good, with gross revenues up about 5% to $275m.  Significantly, the lendable base is up 27% versus 2016. Global investors are committing more securities to Nordic lending markets, and even after factoring out rises in equity valuations, available shares are up 20%.  On-Loan balances are up 23% versus 2017. Utilisation has been strong across all asset classes – up around 14%. The number of global funds that are lending in the region is up 5%.

For equities, lendable values are up 33% versus 2016 (without rises in equity markets this is up 17%) and up 14% versus 2017. Interestingly, on the fixed income side, the lendable base shrunk by 10% versus 2016. However, the total value of fixed income securities on loan is up 70%, with revenues dominated by Swedish government bonds.

Bromiley-Carmen: I wonder whether the supply on the fixed income side has decreased because beneficial owners now have to pledge these assets as margin for collateral transformation. There is a huge demand for this: at BNY Mellon we are constantly asked for clients to commit to term either with full right of substitution or on hard term. In addition, we are starting to see the first wave of demand related to initial margin, which is going to get bigger and bigger. People are starting to think whether or not to use assets for margin, which previously they may have lent. The other trend we’re seeing in Europe related to this is around checks that the collateral that you take fits in with your investment ethics. This trend, which is considered a feature of the Scandinavian and Dutch models, is now become wider practice in the UK. 

Wilson: Just to wrap up, the YTD total revenue from Sweden is broadly the same as Denmark, Norway and Finland combined. Revenue in Denmark YTD is up 15%, Finland up 28%, Norway up 13%, whilst Sweden is down 1%. Focusing on Nordic domiciled funds there has been a 20% increase in lending in the last two years. The number of Nordic funds participating in term trades in Nordic securities has fallen dramatically, such that there was virtually no activity this year in any asset class. The volume of term loans across all borrowers for Nordic securities in any term structure globally has increased by 50% over the last two years.

In terms of newsworthy names, Danske Bank  is quite interesting where the short interest in this stock is 0.36% of the free float. To put this in perspective, the equivalent short interest on top tier Danish equities is, on average, 2.58%. For the most widely shorted Danish stock, Flsmidth, it is roughly 7% of the float. Consider too, Danske Bank’s peer group: for Nordea, short interest is 2.1% of float, Swedbank is 1.89%, and DNB is 0.71%. So, while short selling often gets the blame for declines in share prices, there is no evidence to support that in the case of Danske Bank.

Paul Wilson, IHS Markit

Chair: Are funds showing greater willingness to lend out their securities?

Bjorklund: Shorting has always been a word with some negative associations. Obviously, the media coverage with regards both to distressed companies and to larger ones such as H&M doesn't help. A lot of fund managers are obliged to own these securities since they are trackers, making them reluctant to be part of lending pools: they don’t want to facilitate any down pressure on the share price.

Bromiley-Carmen: Sometimes this is driven by corporate governance considerations – funds not wanting to account to their board that they are doing this, from a PR perspective. We see this some pension funds: they simply don’t want to have that perceived difficult conversation with their trustees.

Bjorklund: We're all part of the same industry. We have had the talks with the clients and we believe that is positive for markets: it makes price discovery more exact and precise. In some cases, managers might buy into these arguments but they still just don’t want to participate – as Clare says, they feel they can’t justify this to their trustees so they would rather opt out. In the Nordics these choices have a bigger impact on the market since the total pool of assets is smaller.

Strömberg: In the Nordics I would say that we are more conservative. People don’t want to lend their assets if there is a chance that the market price will drop. However, the index funds are more willing to lend their assets in order to help track their benchmark. I think more and more see that this is necessary: with the management fee decreasing all the time they need to get revenue from somewhere. Those few extra basis points might be the difference between tracking the benchmark and not tracking it.

Chair: What factors might accelerate beneficial owners’ engagement?

Strömberg: Utilisation is increasing all the time, as Paul has said, and is being helped forward by the increase in collateral requirements. If we’re sitting here a year from now and H&M, which is 5% of the OMX, is showing a high utilisation and a high fee, maybe investors will start asking of their fund managers ‘why weren’t you in a lending program because you have underperformed the index’. As I said, we’re seeing collateral requirements increase all the time: in particular we’ve seen fixed income transactions growing. And we’ve seen that there is less collateral out there since people need to reserve more equities on their books, so there are fewer and fewer financing transactions in the market. The pressure around collateral will grow, too: since not all the banks in Sweden are yet signed up to the bilateral initial margin rules – the deadline is next year. We are a little behind Europe and the US in this matter. With those drivers we see a big potential for beneficial owners.

Bromiley-Carmen: We are starting to see cash release being discussed again by clients – not yet from the Nordics yet but elsewhere within Europe. While it’s still early days for those conversations here, clients are now looking at their liquidity and their future commitments. We are going out and educating clients in advance of the deadlines, explaining that we are not just offering solutions in securities finance but that we have a range of other liquidity management  tools and services that we can offer to clients. In terms of clients’ responsiveness to these conversations it’s important to realise that firms have other priorities and also that everyone is at a different stage. When they are ready, we have experienced firms acting quickly. We had a recent example where, after discussing this question for a long time, a board suddenly decided that they had to do something about it as soon as possible.

Clare Bromiley-Carmen, BNY Mellon

Chair: How far is the Nordic region engaging with the various pledge initiatives?

Bromiley-Carmen: As an explanation of pledge, this is a change in how borrowers want to give their non cash collateral. Instead of a title transfer, the collateral is provided by way of a pledge (security interest) over a borrowers collateral account. ISLA have released their draft legal agreements and guidelines on how the pledge model will work. At BNY Mellon we are already operating under a pledge model with some of our clients. We were out in the Nordics in the middle of the year with a road trip explaining how it works. There is definitely demand for the borrower side but it is important that lenders can capture any extra revenue generated.

In addition, at the moment there is discussion around whether UCITS funds might take pledge as a form of collateral. I imagine they may err on the side of caution. So you may have the two different models: pledge and title transfer will always co-exist. In addition, lenders may consider the question of indemnification. You will still want any existing provisions to remain under a pledge model and that is something our pledge model accommodates. I think the general concern with all this, is that our clients will lose revenue opportunities as more and more broker dealers sign up to the pledge model. So you need to make sure as the agent lender that you can capture some of that revenue for them either through the utilisation or through the return. In short, there has to be something in it for the beneficial owner, for this to work.

Wilson: It is worth remembering that anyone who is lending securities on a global basis is already receiving collateral under a pledge in the US. The main difference is the legal structure: this is very clear in the US, whilst outside of the US (say in Europe) it needs to be understood, clarified and documented. Regarding the adoption of securities lending more generally, I’d make the following point about the speed of change, which has applied in the past to opportunities such as corporate action trades, emerging markets and term trades. Many institutional investors have a priority list of, say, ten things and securities lending is typically number 11. Beneficial owners typically take a long time to move or make changes – it can take an incredibly long time to start doing something or get the necessary approvals. If borrowers really want this to be adopted – and the balance and capital saves on this seem relatively material– then the industry needs to put some attractive revenue numbers in front of the beneficial owners. Then they can really see whether this is worth the time and effort.

Strömberg:  The important thing, I agree, is to see how far the benefits of pledge and the capital cost savings are going to be shared or divided. It's really important to have that discussion with the client.

Chair: How much scrutiny are clients currently giving to fees?

Bjorklund: We have a lot of clients lending their assets who want a bigger part of the cake. They want us to justify our spreads, in terms of the credit exposure and transaction costs that we bear, which are features that they are familiar with and which they could be prepared to carry out themselves. The question is different for smaller lenders. They might have questions about how much of the cake we are taking, but they have no interest at all in having the credit exposure towards their counterparties. In both cases, I think it's a case of education, education and education.  Clients might pinpoint the spreads on occasions and question whether we are taking too large a share of the cake. But we need to be able to explain what our costs are related to the specific trades in question.

Strömberg: I agree that, especially in the Nordic area, there is a number of funds that are quite small who I don’t think will ever engage in a peer-to-peer lending with a hedge fund because of the credit risk. They prefer to have a relationship with a single bank, which does all their securities lending as well as a lot of other activities. These smaller funds simply do not have the set-up internally to lend the assets on their own. In this respect I think they appreciate that the fees charged by lending desks go towards the costs associated with the transactions.

Per Strömberg, Handelsbanken

Chair: How far are ETFs featuring in securities lending in the region?

Wilson: For ETFs in the Nordics, the issue is with the borrowing volumes and not with supply from the lenders. Over the last two years, there has been a large increase in the number of ETF securities that Nordic investors have made available. But year to date the revenue generated has been less than $20k. It seems to me, the lending of ETF’s is a bit like lending equities generally, there is no interest to borrow many ETF names, interest is focused on specific ETF’s where there is a special demand or interest (sector, market, asset type, corporate bonds).

Bromiley-Carmen: Is that also because of the collateral parameters? A lot of the US ETFs want to pledge dollar as collateral. We've had some European clients that are non-cash collateral only and it's been quite hard, unless it's trading special, to get it out

Wilson: According to our data there is somewhere in the region of $63 billion of ETFs being borrowed globally (approx. 11% utilisation). We estimate approximately 70% of these are being borrowed against cash. Interestingly at IHS Markit, we pioneered the concept of the ETF collateral list, which selects ETFs against a set of criteria of acceptability such as size, liquidity, turnover, type of asset and so forth and every day we publish the schedule of ETFs that meet the criteria. This is then commonly used by the market to define the ETF’s that are acceptable as collateral, because the appropriate screening has been undertaken.

Strömberg: That list is very good: it’s the first time someone has published an index with ETFs that are accepted by the market. Since that list came out it's been more and more acceptable for client to take ETFs as collateral, as they’ve understood that these are as good as the underlying shares – more or less. Here in the Nordic region, the list has helped this shift from ETFs being like a taboo - that you’re not allowed to take as collateral – to a place where clients are increasingly convinced of the validity of accepting ETFs.

Chair: What impact do you foresee from SFTR reporting requirements?

Bromiley-Carmen: The simple answer is that we need to work with the providers, to ensure that data captures all the requirements. There have been lots of discussions in the industry to make sure that we understand these requirements and if there needs to be any enrichment to the existing securities lending data. Then the key will be working with these providers so that we meet those requirements.

Wilson: Our approach is to provide a modular solution to SFTR. This includes the ability to capture the transactions, through industry utilities like Pirum or other sources. Then, when the data is in our warehouse we'll enrich it, add missing pieces, LEIs, allocate UTI transactions if they're not already done and so forth.  And lastly submit transactions to the chosen trade repository. We recognise that all market participants are very different. For example, we recognise that an agent lender is not the principal to the transaction, so therefore we need to provide them different tools that enable them and their underlying clients to fulfill their responsibilities. I think learning from the implementation of EMIR, the more commonality there is between trade repositories and the more commonality you can get through the vendor choice, then the more likely it is that downstream issue can be eliminated or avoided.

Chair: What can the industry to facilitate the wider adoption of securities lending in the region?    

Bromiley-Carmen: I think we need to start educating our clients a lot more. Securities lending has been something that people shy away from discussing. But actually we should be proud about what we do. We have started doing more ‘market update’ type Webex's for our clients; so they can dial in, understand what major trends we're seeing in the market, get more comfortable with the issues. Hopefully they can then go on to have those conversations about adoption internally. It’s a case of expelling the myths and reinforcing the truths.

Strömberg: I agree.  We need to educate the clients – getting them to see the benefits and in this way getting more acceptance from the market. As we’ve said, a lot of beneficial owners within the Nordic region don’t want to lend because they don’t want to be participating in their own assets being shorted. We need to change the perception, by getting them to see the benefits of the practice to the market – in terms of improved liquidity, for example ­– and also to themselves  – in terms how much they can earn from it. We want the beneficial owners to see not only that it's important but that it might be necessary to be part of some kind of loan progamme in order to track the benchmark. With the lower management fees – now even some funds with zero management fee –the pressure to keep up and to chase revenue is very high, so this should make them receptive to this argument.

Bjorklund: The most important thing is to be flexible I would say. This applies not only to the adoption of securities lending itself, but also around futures trading or on derivatives trading or – as we have discussed – cash collateral or transfer. You need to be open-minded to find solutions that fit that specific client's need: not everyone can trade in the same way.

Wilson: I think the easy win, if you're a passive manager is the scrip trade as they are obliged to elect for cash on cash stock option dividends. Typically, the stock dividend is offered at a discount thus creating a securities lending revenue opportunity for the difference. This the easiest money, especially for an index tracker fund, which has no choice around whether or not to take cash.

Chair: How much will improvements in infrastructure help this?

Bjorklund: I agree that we need to do whatever we can in terms of providing a bespoke solution and – in terms of market infrastructure – streamlining the process for beneficial owners.  A lot of local fund managers don’t like the process of fails in the market. Hence initiatives such as T2S are very valuable in providing a continuous cycle of settlement, instead of daily cut-offs imposing constraints on how and when you receive or deliver your shares. The initiatives that are required to make the market infrastructure more robust are not things that we participants in our specific area of securities lending can do ourselves. But we can lobby for them and therefore help them come about. In the future, this work will make it easier for our current and future clients to see the benefits of joining lending pools.

Tobias Bjorklund, Danske Bank

Wilson: The ironic thing is that with no lending, there would be less liquidity and therefore more failed settlements. There is a good amount of data that can help here, too. For example at IHS Markit we calculate a liquidity score against every single security that is being lent and borrowed so you can see if a security is becoming illiquid, and then use this information to determine whether or not it should be recalled.

Bjorklund: Absolutely. Every such data point that we can provide like this will make it easier for beneficial owners to manage their portfolio.

Bromiley-Carmen:  How many meetings do go to where you want to talk about something strategic and all that your client wants to talk about is a failed trade. You can have the best product in the world but the client will remember what impacts them specifically. If their fund manager has been upset because they haven’t been able to trade after being told that securities lending is seamless, that is what they will remember. So, when the market infrastructure improves, this will happen less and that will help take away some of the noise.

Wilson: I would also say that beneficial owners should undertake a regular review of their lending programmes. There are new opportunities emerging all the time, and they should be evaluating them. Similarly, there may be changes in their underlying portfolios and therefore it is important that securities lending programs and activities are complimentary to the underlying portfolio and investment strategy.

Bjorklund: At least from a local perspective, there is a fair amount of backseat driving when it comes to running the stock loans of a particular fund and also, therefore, with respect to evaluating the lending programme. It's very hard to get a portfolio manager interested in this type of business - it's the back and mid-office that are managing the stock loan part of the trade. And they might not put it up very high on their priority list to evaluate whether other providers can offer a better service than the one they are receiving, such as by providing a different type of collateral, As Paul said, securities lending is number 11 on the 10-item priority list of the fund.

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