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Special Report

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Lessons from the US

The US has been at the forefront in securities lending. What can be learned from its industry developments, asks Linda Kearney.

In order to assess if the securities lending market in the rest of the world will follow the trends set by the US, let us consider the conditions that have lead to the US's growth in this industry. We have seen certain trends and developments in the US over the last five years which certainly lead us to believe that the rest of the world is moving in the same direction.

There has been a significant increase in the number of securities lending participants in the US. It is more the norm for plan sponsors to participate in a lending programme because of the low risks associated with the business, and the incremental income which the business provides. Trustees have an obligation to provide best value for its plan members, which makes securities lending a value added service that goes hand in hand with custody. We are beginning to see this trend in Europe as financial institutions and pension funds become more cost conscious and look for ways to reduce their expenses.

As the number of participants have increased in the US, more depth has been added to the liquidity of the market, which has in turn driven fee and rebate rates down. As a result, the securities lending market in the US has become a very finely tuned specials and general collateral market. There are more specials today then in previous years, as more arbitrage opportunities arise with the increase issuance in corporate debt. Again, this is a trend that we should see in Europe, especially with the potential opportunities which are expected to arise as a result of the European Monetary Union (EMU).

It is anticipated that a single European market will lead to greater competition, promoting corporate re-structuring, a much larger government bond market, and an acceleration towards direct financing, therefore increased corporate debt is-suance.

We mentioned above that EMU will lead to greater competition and promote corporate restructuring. This is a trend that we have already seen in the US over the last three years, especially in the banking industry which has had a definite affect on the securities lending market, as we see the number of custodian bank lenders decrease,primarily through the takeover and mergers of regional banks, and the mega mergers of larger US and global banks.

The growth of the hedge fund activity in the last five years, has also led to greater demand for securities lending, and this is definitely a trend we should see in Europe, again with the expected merger and acquisition activity expected with EMU. More restructuring of corporate debt and equity issuance will lead to many more trading opportunities for hedge funds, and therefore securities lending.

In the US, the increased use in technology for trading has also helped grow the US equity lending market, where auto-borrowing has seen some very strong demand. Auto returns, auto marking and contract compare are becoming facilities that the market expects as part of the service in order to retain and win business.

It has often been thought that this service would be difficult to transfer to Europe, as individual markets have different settlement requirements and different systems. However, with the expected introduction of central clearing facilities for member countries of EMU, perhaps this hurdle may not be an unrealistic one to overcome, and again, the market will be able to follow the path of the US.

As a product, the legal documentation is becoming more standardised across the globe. However, clients are becoming more sophisticated and demanding. In the US, we have seen sophisticated clients demand customised collateral funds, and expanding collateral options to take into account the more global nature of the business. As securities lending be-comes a more mature industry outside the US, we can also expect to see this trend continue. In fact with certain respect, Europe has probably led the way in terms of the diversification of non cash forms of collateral, but can learn some lessons from the US in terms of cash collateral reinvestment, ie the range and sophistication of products used, and some of the pitfalls that can occur as a result of poor cash management.

The evolution of EMU will definitely have a large impact on the direction of the securities lending market in Europe. This evolution will shift the European market from a currency culture to a credit culture, a bank culture to an equity culture, and restructuring will trigger merger and acquisition activity, corporate debt and equity financing, which all go towards moving the European debt and corporate markets to look more and more like the US. This only leads us to believe that we will be looking at a European securities lending market, which looks very similar to the US securities lending market today.

Linda Kearney is vice president with Northern Trust in London

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  • QN-2546

    Asset class: Real Estate Equity Fund (non listed).
    Asset region: Europe.
    Size: Total CHF 600m, approx. CHF 100-300m per fund investment.
    Closing date: 2019-06-28.

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