Magazine issues » Autumn 2012

SECURITIES LENDING: Closed for business

Bag lockEmerging giants China and India are gradually developing their securities lending markets, but are far from fully embracing the concept. Stefanie Eschenbacher finds expanding into Asia is not easy.

Few Asian countries are similar when it comes to securities lending. Its markets are at various different stages of development, with China and India still not easily accessible for foreign players.

Although both have started securities lending programmes, they are far from fully embracing the concept.

Last year, the China Securities and Regulatory Commission launched a pilot programme, allowing 25 brokers to borrow and lend shares in 90 quoted companies. These companies can only lend what they own and all lending activity is executed through a state council-authorised securities finance company. Foreign investors are still restricted by China’s quota system, the qualified foreign institutional investor (QFII) scheme. They can lend and borrow Hong Kong-listed Chinese equities, or H-shares, but not the A-shares listed in Shanghai or Shenzhen.

Last year, though, the programme for domestic players was extended to 278 shares and seven exchange-traded funds.

Paul York, director at the Pan Asia Securities Lending Association, says the development of securities lending is driven by local regulators and tax authorities.

If a market is easily accessible, investors will generally look

to expand their lendable markets. York says the quota system that exists for offshore investors would impact any model proposed.

“[Investors] are being correctly prudent,” York says, adding that it is difficult for them to enter markets unless regulations are formulated and shared with them.

“Investors need to see a comprehensive framework structure that is both workable and scalable,” he says. “If such a model does not encompass these traits, there will always be reluctance to engage in that underlying market.”

Despite ongoing reforms of the offshore market, the Chinese regulator has not released details of the timing or model that will be applicable to the offshore market.

“One would hope that through the natural progression cycle we will see securities borrowing and lending reforms occurring in the not too distant future,” York says.

Andrew Cheng, head of client sales management, Asia excluding Japan, at JP Morgan Worldwide Securities Services, says he is hoping foreign players will be able to participate under QFII in the future. He estimates this could happen as soon as within the next twelve months, but more realistically in three years.

“Everything is happening at a steady, but measured pace,” Cheng says. “The Chinese regulator has had to pause during the financial crisis because there were factors to think about beyond securities lending.”

He says last year’s broadening of the programme suggests the Chinese government is serious about developing securities lending.

Stephen Howard, managing director at RBS Markets & International Banking, says he expects the pilot to be broadened out to QFII within the next 18 months.

“[Securities lending] will help to facilitate other types of trading activity as it becomes  easier to execute hedging solutions. This will also add more liquidity to the market,” he says.“When they are fully collateralised, securities lending are low risk trading actions. This is more about getting the right infrastructure in place.”

India launched a securities lending scheme in 2007 and operates a centralised depository approach. With 224 stocks, it has authorised even fewer stocks than China.

“India is a big market with many investment opportunities, but the securities lending model is more created for domestic lenders,” Cheng says.

There appears to be less enthusiasm about the prospects of India broadening its securities lending market.

“Often, to change an existing system is more difficult than creating a new one,” York says. “Expansion and removal of the numerous barriers to entry that offshore investors experience in India has and will be a slow process.”

Howard says the market in India is less active owing to the broad and deep single stock futures markets. “When it launched its securities lending trial scheme, it was expected to become a tremendous success, but it was not,” he adds. While he deems it a success for domestic investors, Howard says it is not a market that offshore lenders participate in to a large extent.

Elsewhere in Asia, Indonesia, Malaysia and Vietnam are markets to watch.

One of the challenges for those involved in securities lending in Asia is that markets are at different stages of their development and governed by different regulation.

“Asia is a combination of many different markets, each of which has be dealt with differently,” adds Cheng.

Hong Kong ranks among the most profitable markets for securities lending. Cheng says equities were giving between 20 and 22 basis points over the first quarter of this year. In 2010, he adds, the revenues generated from Hong Kong securities were bigger than those from Japanese equities for the first time.

Cheng says lending Hong Kong, Taiwanese and Korean securities has given lenders “a healthy return”. These compare favourably with most European countries, with the exception of Germany.

Brian Lamb, chief executive officer at EquiLend, says securities lending would make these markets more efficient and liquid. EquiLend recently saw the highest trading levels since it was first established eleven years ago.

Since the first quarter of this year, transaction volumes have consistently hit 23,000, with the highest on 17 May, at 250,000 transactions.

“In Asia, we have been seeing demand for Asian equities picking up early,” Cheng says. “On the supply side, more and more lenders are returning to the programme.”

As market returns slumped, many were looking for additional revenue generation or event or to pay expenses, such as custody fees.

Others have started lending for the first time, having gained a better understanding of securities lending as a revenue generator.

Meanwhile, Australia and Japan have both disappointed.

Howard says RBS has made “a conscious decision to scale back in Australia”, which it no longer considers a key market.

Because of evolving regulatory requirements, it is estimated that by 2013 or 2014 there will be a $3 trillion requirement for US fixed income to be pledged as collateral. “That is good news for securities lending,” Cheng says, adding that this is likely to result in a shortage of collateral. “Borrowing will get more expensive. People want good quality collateral that is liquid, easy to access and easy to dispose off.” Collateral has become more important and both securities lending counterparties have started accepting a broader range of it.

Asia is expected to open up to securities lending, despite ongoing regulatory changes.

©2012 funds global

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