Regulatory complexities mask securities lending opportunities
As the securities lending space moves towards integration in Europe and North America in step with ongoing global financial reforms, the Asian market is implementing the new rules at a slower pace and remains characterised by a confusing patchwork of country-specific controls. But regulatory intricacies aside, the industry in Asia has fared better through the economic troubles of recent years and offers a source of new business at a time of limited opportunities in developed markets.
Martin Corrall, Asia-Pacific director of securities finance at Citi Securities & Fund Services and chairman of the Pan Asian Securities Lending Association (PASLA), says: “We are seeing renewed interest from new lenders in Asia amid challenges for portfolio managers. The region offers more opportunities in terms of untapped funds, both public pension funds and in the private sector.”
As a prominent industry advocate with an established footprint in emerging economies, Citi has started to eye opportunities outside the region’s traditional markets. “We have five traders in the Asia-Pacific region - four in Hong Kong and one in Sydney. And we are working to bring India and Malaysia on-stream as new lending markets.”
Still, these two countries pose a unique set of challenges. India has eschewed the typical bilateral approach for a more rigid central counterparty (CCP) model with rules requiring approved intermediaries, local legal agreements on collateral and fixed-term contracts, Corrall says. “The level of control makes market entry more difficult for lenders. We are seeing interest from domestic hedge funds and mutual funds rather than offshore investors.”
Malaysia has a regulatory framework in place and recently relaxed controls to allow participants to sell securities that are on loan without the need to recall them. “The market is less restricted than India and allows collateral to be taken offshore, making it much more palatable from the lenders perspective. But demand is relatively low and is focused on a limited number of securities.”
“China is further down the curve than India and is also considering a CCP-type model. Currently the market is only open to local brokers margin trading.”
The industry’s development in China was knocked back in 2008, and while the regulatory environment is expected to open up in due time, exactly how it will develop is a “guessing gaming”, according to Corrall.
Meanwhile securities lending enjoyed a good year in more established Asian markets in 2011 amid difficulties elsewhere, despite some tightening on the regulatory front, which Corrall largely puts down to political pressures.
Volatility in the KOSPI led Korea to introduce a temporary three-month ban on short selling, while Taiwan brought in restrictions on shorts that remain in place and limit transactions to a certain percentage of the previous day’s trading volume. And Hong Kong, which was one of the few markets to make it through the 2008 crisis without any major changes, now looks set to institute more onerous reporting requirements. But such controls are unlikely to have a significant effect on pricing, Corrall notes.
The downstream impact of ongoing global financial reform and a stricter regulatory environment following the 2008 crisis - and more recently the sovereign debt problems - can be read a positive development from the perspective of lenders, says Tim Douglas, a Managing Director at Citi.
Counterparty risk and quality of collateral have come under increased scrutiny, potentially increasing yields on lending and making it a more viable option for participants such as pension funds. While brokers face greater regulatory pressure from new capital guidelines, borrowers are being encouraged to devise more creative solutions for collateral, which is another plus for lenders and may also help to widen market access, says Douglas.
Citi has introduced its OpenLend programme in response to the changing environment. The platform incorporates an “open-architecture” approach to increase the transparency and flexibility of the lending process, and is aimed at providing tailored solutions to clients in areas such as collateral concerns.
Meanwhile, the global regulatory reform process is far from over and the industry faces “a barrage of rules, regulations and guidance from every angle”, Paget Bryan, partner at Clifford Chance, and Gregory Lyons, partner at Debevoise & Plimpton LLP, said in March.
The effects of new international standards such as Basel III however will take time to filter through to Asian markets. While Europe and North America are pressing ahead with implementation of the latest accord, execution of Basel II in Asia remains patchy - the rules are in place in Hong Kong and Singapore, while implementation is still underway in China among others.
Asian banks are for the most part expected to manage higher capital requirements under the new framework. “[The] most rated Asia-Pacific banks are unlikely to face significant difficulty in complying with Basel III [but] some banks with weak capital quality or a high dependence on wholesale funding will find it tougher to adapt,” Standard & Poor’s said in a report in October.
While Bryan and Lyons believe the SIFI surcharge is unlikely to apply in Asia, liquidity rules were singled out as a major concern on account of increased costs, inadequate sovereign-debt-eligible high-quality assets in local currencies, and product-specific impacts.
If thoroughly implemented, financial transactions taxes could also be very damaging for securities lending, says Douglas. But questions remain over how such levies would be applied to the string of transactions associated with the lending process, while the low margins involved make it difficult to justify the move, he adds.
How global regulatory reform will pan out and its downstream impact on securities lending in Asia remain a case of watch and wait. In the meantime, the evolution of national regulatory frameworks in the region is paving the way for an increasing range of fresh growth opportunities when new business is scant in established markets.