In this Q&A, Donato D’Eramo, president at the Canadian Securities Lending Association (CASLA) and managing director and global head, securities finance at RBC Investor & Treasury Services, Royal Bank of Canada, provides an update on the association’s activities and the latest trends in the Canadian securities lending market.

What notable highlights and hurdles did the Canadian securities lending industry experience in 2018?

Although 2018 was the most outstanding year for the global securities lending industry post financial crisis, this did not necessarily translate in North America, and especially here in Canada where specials were somewhat subdued. Canadian cannabis stocks carried much of Canadian equities throughout the year and Canadian government bonds remain highly sought after. With the increasing focus to fulfil liquidity requirements, financial institutions continue to seek out sizeable balances for high-quality liquid assets (HQLA) and especially on longer duration trades.

The Canadian securities lending industry continues to face several challenges from a regulatory readiness perspective, in line with global peers. Not necessarily hurdles per se, but with the onset of Securities Financing  Transactions Regulation (SFTR), Central Securities Depositories Regulation (CSDR), and pledge structures, all imminent in the next 12 to 28 months, much work has been done across all players to ensure solutions are in place.

As we approach a year since Canada voted to legalise recreational cannabis, can you outline how you have seen demand for cannabis stocks evolve and impact the securities lending market?

Despite the challenges surrounding specials in the Canadian market, we saw a great deal of activity within the Cannabis sector in 2018. The market followed the evolution of the legalization scheme here in Canada quite closely over the past 12 to 18 months, and it remained a hot topic and an area of interest amongst beneficial owners throughout the year. In addition to the general directional demand names across this sector, M&A activity also presented additional revenue opportunities to beneficial owners open to lending. As certain US states continue to move towards similar legalization, further consolidation within the sector is to be expected, which should ultimately drive demand for securities lending.

Cannabis names continue to dominate the warm and hot space, albeit at lower levels than last year, and more volatile in demand and levels. Additionally, as companies in the sector continue to evolve and become mature, we begin to see an emergence into the large capitalization indices, which may or may not impact demand.

January 2019 saw Canada implement new rules allowing retail investors to access alternative investment strategies through alternative mutual funds. What does the new regime mean for securities lending and borrowing?

Liquid alternatives was quite the buzzword in 2018 as the industry geared up for its January 2019 implementation. Its introduction is significant as it now allows a broader investor base access to this investment structure. However, it may still be early in the life cycle as the adoption by retail investors may take some time. As more asset managers develop and launch various alternative strategies, it is expected that the impact to both borrowers and underlying beneficial owners will continue to grow through increased flows and activity for Canadian securities lending.

Have you seen beneficial owners’ approaches and attitudes towards securities lending change over the last few years? If so, what do you believe is driving this?

Generally, since the financial crisis of 2008, we have continued to see an increasing number of beneficial owners re-enter into securities lending arrangements. In the current environment, beneficial owners are more attuned with the intricacies of securities lending than ever before as they are increasingly open to new revenue generating strategies and are moving towards a more flexible collateral profile. Asset managers specifically are increasingly looking to securities lending as an alpha generating tool and a mechanism to help offset lower fixed income yields. In the public fund space, some managers now see securities lending revenue as a necessity in an effort to reduce fees in an increasing competitive market.

What steps are being taken to enhance efficiencies in Canada’s securities lending industry?

Overall, Canadian firms have been working diligently on enhancing efficiencies in the market and lately there has been a particular focus towards borrow/return automation with the goal of the desk focusing more on value added opportunities. Additionally, the efforts to streamline collateral through tri-party agents and enable contract compare functionality has enhanced efficiencies, not only within the front office, but also with middle and back offices.

We continue to see the industry apply emerging technologies towards providing beneficial owners with an enhanced view of how programs are being optimized, which capture incremental returns on assets as well as present client information in different mediums to be ingested. Future opportunities revolve around deploying machine learning in some elements of day-to-day decision making to further optimize returns, but also resolve post-trade activities to reduce operational risk. Distributed technology is another space that has the potential to be a significant game-changer. This is because it could radically alter the industry operating environment where the interaction between agents and counterparts is a single view that is real time and always matched. 

What are the key regulatory issues facing market participants in 2019?

SFTR remains the key regulatory focus facing market participants today. Although not expected to take effect until April 2020, firms are investing efforts to ensure the optimal solution is deployed. This in itself warrants a strategic view, however simple details are critical for firms to grasp as it would likely result in how firms want to approach their SFTR solutions. There is no one-size-fits-all solution and market participants should remain conscious of not making assumptions on their European Market Infrastructure Regulation (EMIR) experience. SFTR aside, various tax administration changes continue to create uncertainty around permissible securities financing transactions. This has presented market participants with its own set of challenges as such changes remain short on guidance.

Additionally, recent Canadian federal government tax changes announced on March 19 2019 impact the treatment of compensation payments for non-Canadian beneficial owners lending Canadian equities and non-Canadian equities to Canadian borrowers versus equity.

CASLA’s objectives include increasing public understanding of securities lending and advocating on behalf of the industry. Can you share examples of how the association works to achieve these aims and your main priorities in these areas for the year ahead?

One of CASLA’s fundamental aims is to enhance the public’s understanding of securities lending and the role it plays in Canada. As such, CASLA will be focussed on developing and promoting the importance, subtleties and breadth of the securities lending industry, particularly geared towards beneficial owners and stakeholders, while remaining engaged with other global industry associations where international regulations may impact Canadian beneficial owners.   

Also, an ongoing focus of CASLA in 2019 will be the advocacy work being done to permit National Instrument 81-102 mutual funds to accept equity securities as eligible collateral in securities lending transactions. CASLA continues to engage with regulators, and although these discussions are still in their early days, it is a key priority here in the Canadian market – similar to that in the US for equivalent 40 Act funds.