Stock borrowing and lending (SBL) activity in Asia Pacific has surged to multi-year highs in the recent past with every major market seeing an increase in demand. 

The prospects for the region appear bright with the key driver of opportunity unlikely to diminish – volatile Chinese markets. They have offered ample opportunities to short shares directly exposed to the country’s economic headwinds, as well as shares that have come under pressure from the related slowing demand for commodities. 

The Asian securities lending industry generated $672m from lending out stocks in 2015 – an increase of 20% – and the highest level ever recorded according to data provider Markit, which described it as a “banner year” for lending in the region. 

Within this, Hong Kong accounted for 40% of regional revenues, up from 38% in 2014. This growth in revenue has also been driven by an increase in the value on loan. Markit has the average daily value of shares on loan at $115bn, up 15% on the previous year and at the highest level since the global financial crisis. 

DataLend, which has on loan balances even higher at $147.01bn, figures reveal that utilisation rates remain lower in Asia, at 10.98% compared to 13.14% in EMEA and 12.9% in North America. It is specials (shares trading at more than 150bps) that continue to be the key revenue driver, generating more than 80% of the region’s revenues despite only making up 21% of on loan balances on any given day. 

Indeed, the average cost of borrowing securities in Asia is much higher than in other regions – two or three times as large depending the dataset used. DataLend has the average fee at 97.06bps compared to 32.91 in EMEA and 38.4 in North America in the year to 1 February. Astec Analytics data shows a similar gap, with Asia at 1.12% compared to Europe at 0.63% and North America 0.40% for 2015. 

“We see more specials lending in Asia than we do in Europe,” confirms Stuart Cornock from Clearstream’s global securities financing sales and relationship management Asia Pacific team. “While collateral swaps make up part of our book, we concentrate more time on lending smaller, special bonds that generate more revenue.” 

National nuances 

Market participants also need to understand operating models and risks within each individual country to be successful. “Asian securities markets are highly diversified and agent lenders need to set up for lending in each individual country and comply with each country’s regulators to have a successful pan-Asian offering,” says Finadium managing principal Josh Galper. 

The pace of reform within Asia’s markets can be a double-edged sword, suggests Andrew McCardle, head of Hong Kong-based EquiLend Asia, the automated securities finance trading platform. While presenting a challenge to stay up-to-date with each country’s regulatory constraints, he says “having that understanding gives participants the opportunity to seize the initiative and perhaps be among the first to offer trading in a particular region”. 

Because regulation is key to maintaining properly functioning markets, it is critical that the right balance is achieved. “This provides users with the confidence that is necessary for markets to develop,” adds McCardle. 

For example, Taiwan has very strict rules around securities lending for offshore participants in terms of using local brokers, reporting requirements, meeting local tax obligations and prenotifications with strict punishments for those not adhering to them, observes Madalin Prout, head of relationship management APAC , securities finance and processing at SunGard. 

But perhaps a more fundamental difference with the rest of the world, however, is the dominance of retail investors. In China, Hong Kong, Japan and Singapore, affluent retail investors have access to margin lending accounts to leverage their investments and are also able to take short positions to bet against a stock. 

This creates security-rich local brokerages, which are now looking to securities lending as a means of generating extra returns on their holdings as well as rehypothecating the securities into cash to fund their margin lending activity. 

“This creates a new type of lender for the region but also adds systemic risk,” says Prout. “In turbulent markets, retail investors are less predictable in terms of holding their positions, which could present challenges for the institutional lenders and borrowers relying on this inventory.” 

Beneficial positions 

Being able to lend across a range of markets is a key advantage, but given the nuances and regulatory complexities in markets such as Malaysia and Taiwan (see profiles on pages 48 and 56 respectively), particularly around settlement fails, ensuring the right balance between risk and revenue maximisation is critical for beneficial owners. 

According to Ariel Winiger, head of securities finance services, Asia Pacific at Societe Generale, the key characteristics of successful securities lending programmes in Asia are good clients, efficient technology and an appreciation of regulations that impact the business.

“The emerging markets are particularly complicated to deal with – quite a few have not yet implemented a functioning securities lending market,” he says. “Rules and practices have changed over the years but this is not a rapid process.” 

A recent report from the World Federation of Exchanges (WFE) underlined this seismic shift in activity, highlighting that the value of share trading in the Asia Pacific region rose 127% from the levels seen in 2014. Yet, despite this astounding growth, a fully scalable, offshore securities lending model has yet to emerge. 

While the longterm prospects look promising, recent market volatility and a shift in regulatory priorities away from further liberalisation are likely to delay the emergence of a viable offshore securities lending model in the near term. 

The other important change in Asia has been the development of the offshore securities market for China, notably the Shanghai-Hong Kong Stock Connect scheme, says Dane Fannin, head of securities lending Asia-Pacific at Northern Trust. 

The assets that are available for loan in many Asian markets are proportionately low because foreigners invest in the region to a lesser extent and Asian institutions have not been major asset gatherers for as long as some other regions, observes Roy Zimmerhansl, global head of securities lending at HSBC Securities Services. 

“Even if you had the same level of investor penetration in Asia as in Europe or the US, the supply side would be smaller in Asia,” he says. “Success comes down to having the right assets in the mature markets. 

Everyone is in Japan, Hong Kong, Australia and New Zealand and to a lesser extent Singapore and Thailand and adding more complex markets such as Taiwan. Securities lending in Korea has expanded rapidly over the last three to four years but that was preceded by a decade of gradual market development.” 

Most institutions participating in securities lending, whether domestic or international, are going to be largely focused on indexes. 

Where strategies diverge is in the mid-cap and small-cap portfolio space, which attracts fewer assets in Asia than in other parts of the world and therefore attracts a premium, adds Zimmerhansl, who suggests that this scarcity of assets means collateral and the capital weighting of the lenders of those assets are relatively less important in Asia. 

“Borrowers typically run their trading books for Asia out of Europe, so the collateral management process is a secondary consideration,” he says. “Getting the ‘right kind’ of collateral is more important now than it was even a year ago generally, but there is less room for negotiation where assets are scarce.” 

According to Zimmerhansl, assessing the returns on offer in the region is problematic since investment diversification by non-Asian participants is wider than elsewhere in the world. Where Asia has more in common with the US and Europe is that most of the money is made from a limited number of names. 

As a result of regulatory restrictions on proprietary trading for banks and leverage for hedge funds, leveraged trading in large cap names has been reduced. Zimmerhansl observes that while some Asian sovereign wealth funds have been lending securities for decades and are among the most sophisticated lenders in the market, other institutions have required more education than might have been expected. 

“Many potential lenders have heard about losses suffered elsewhere and as an industry we are doing more to educate clients about risk,” he says. “Investors are asking more questions after the crisis and they are receiving more information.” 

Increased engagement 

Carlo Minieri, head of investment fund product management and sales Asia at Euroclear states that Asian lenders do not seem to have higher requirements on the type of collateral than their European peers, a view shared by eSecLending managing director Simon Lee. 

“Asset owners in Asia look for cash, government bonds and equities,” says Lee. “The regulatory and interest rate environments are driving an increased amount of non-cash collateral in the system and a similar reduction in cash.” 

One of the big shifts following the global financial crisis was an increased level of engagement from beneficial owners in the management of their securities lending programmes and Asian lenders are no exception in that regard, he adds. “They are better educated, more engaged and have an increased understanding of the mechanics of their securities lending programmes.” 

Asian asset owners remain highly conservative in their requirement for high quality government bonds or cash as collateral, says Galper. “Large beneficial owners have resisted moving to accept corporate bonds and equities as collateral and they will be able to maintain this stance so long as there is high demand for securities in the market.”

Clearstream’s lenders tend to be on the more conservative end of the risk scale, explains Cornock, as central banks, for example, cannot take collateral that is rated lower than the bonds they are allowed to purchase in their investment programmes.

“In this respect we are looking at G7 government bonds and specific supranational bonds,” he says. “The commercial and private banks can go further down the collateral curve, but not many are interested in taking any bonds related below A+.” 

Cash counts 

Asia has historically been a non-cash (and cash pool) market and this has not changed in recent years, with the split between cash and non-cash collateral hovering around 20:80 during 2015, adds Prout. “Cash pool trades account for a significant proportion of the non-cash collateral totals and this is likely to continue as the new local participants increase their securities lending activity, seeking to re-hypothecate securities into cash to fund their margin lending activities.” 

There is a good deal of engagement among clients on the issue of risk, agrees Francesco Squillacioti, regional head of securities lending Asia Pacific at State Street. 

“Asian clients spend time thinking about and understanding lending not only because they want to have a good understanding of risk and how their agents are helping to manage it, but also because lending continues to be an important activity for them and they want to make sure that they are optimising their opportunities.” 

Winiger explains that most banks in Asia take a global view of collateral management, which means the requirements in Asia are often little different to those in the US or Europe. “Local participants sometimes have different collateral requirements and if these incur higher costs we will price this into the transaction.” 

He adds that the average fees on hard to borrow names in Asia tend to be higher – around 1% compared with around 70bps in the US and below 50bps in Europe. “Asia usually generates a higher return in basis points compared to other regions, although it will depend on the actual client portfolio.” 

In a report published last March, Nicholas Borst – an analyst in the country analysis unit within the division of financial institution supervision and credit at Federal Reserve Bank of San Francisco – says Asian sovereign wealth funds (SWFs) are major players in global financial markets, managing enormous investment portfolios and actively investing in both public securities and private equity. 

According to data from Astec Analytics, in Asia SWFs account for a higher proportion of securities available for lending than in any other region. This inventory originates from a combination of the large regional SWFs and also those domiciled elsewhere and lending Asian securities through their global custodians. 

Borst suggests that the prominence of these funds is likely to increase as Asian countries continue to accumulate foreign exchange reserves and allocate more resources to retirement funds. 

Global Investor/ISF contacted a number of sovereign wealth funds in the region to find out more about their attitudes to securities lending – but there remains a widespread reluctance to talk publically about the practice.