APAC market panel: facing stormy seas with positive momentum
21 February 2023
Panellists evaluate the performance of Asia’s securities lending markets during 2022, new market opportunities in the APAC region and where the drivers of growth will be found during the year ahead
Image: stock.adobe.com/ Travel mania
Panellists
Phil Garrett
Head of securities finance, Asia Pacific
Northern Trust
Jansen Chua
Senior vice president, head of securities finance, Asia Pacific
State Street
Natalie Floate
Asia Pacific head of market and financing services, securities services
BNP Paribas
David Lai
Product Manager, agency securities lending, Asia Pacific
J.P. Morgan
Phian Cheung
Asia Pacific desk manager, director of securities finance
BNY Mellon
How do you assess the performance of APAC securities lending markets during 2022?
Jansen Chua: 2022 was a difficult year for the markets, including securities lending activity. Despite a slew of macro headwinds, APAC’s equity lending portfolios modestly beat expectations. A strong contribution from Australia and Taiwan specials lending offset softer Korea and Hong Kong markets. Fixed income lending activity also benefited from a widening of cross currency basis between the US and Australian dollar against the Japanese yen, driven by divergent central bank interest rate policies.
Natalie Floate: Globally, everyone looks at Asia Pacific for high fee levels, new market developments and new lending supply. 2022 did not disappoint in that regard, but it was not as strong as previous years in all areas. We saw increasing activity on the revenue side, with trade opportunities in the usual corporate activity with specials in Hong Kong, but we also saw increased use of Asian-issued government debt as collateral.
On the supply side, we identified new lenders entering the market and a renewed interest — post-COVID ‘pauses’ — to assess and enter the market, or to understand the barriers to entry and potential revenues. The focus on collateral needs has been a key trend — with securities lending being used to source liquidity or collateral, or to generate additional revenue for those long of HQLA.
Phil Garrett: It has been a challenging year across APAC in many respects. But there were also pockets of strong performance during 2022. The macroeconomic headwinds felt globally were compounded regionally by prolonged COVID-19 restrictions and regulatory tightening. The traditionally strong revenue markets of Japan and Hong Kong suffered from a dearth of event activity, including mergers and acquisitions, rights issues, placements and convertible bonds issuance, which are typical drivers of high fee trading strategies. Falling stock market valuations also adversely impacted revenue generation, with most indices tracking down in the 15-20 per cent range over the year. In addition, we saw a de-grossing of hedge fund exposures across the region.
On the positive side, some markets performed strongly — including Australia, boosted by the BHP Group listing consolidation, where revenues were up more than 50 per cent year-on-year. Taiwan revenues increased by approximately 20 per cent relative to 2021, driven by strong demand generated through short exposures to its tech-heavy index. The performance of these two markets and the fact that there was a full year of short selling activity in Korea — in contrast to 2021, where the short-sell ban was only partially lifted in May of that year — meant that overall APAC performance was relatively flat year-on-year.
David Lai: Throughout 2022, the APAC region saw a normalisation of lending activities across most markets and asset classes, with Australia, in particular, providing a plethora of opportunities for outperformance across both equities and fixed income lending.
This was driven by increased corporate event activity and strong directional flows within the equities space, alongside the Australian Government’s Quantitative easing (QE) monetary bond buying programme within the fixed income sphere. The Australian QE programme led to a reduction of fixed income assets in the repo markets — with assets that remained available to trade being highly sought-after — which provided support for funding activity at optimal levels.
Elsewhere in the region, the South Korean and Taiwanese markets continued to excel, offering high spread lending opportunities consistently throughout the year, inspite of the implementation of differing short sell measures by the respective regulators.
A high-volume, low-spread environment was sustained by the Japanese equities lending market in 2022, continuing the theme seen in preceding years — although intermittently interrupted by directional flows within specific sectors. Japanese fixed income lending also afforded additional opportunities for market participants to enhance their lending performance.
The Hong Kong market reacted negatively to ongoing pandemic restrictions during 2022, with pessimistic investor sentiments presenting challenges and impacting lending flows. Performance improved in Q4, with Hong Kong lending participants witnessing a recovery as the year concluded, setting the stage for a positive start to 2023.
Phian Cheung: APAC securities lending markets had a good 2022. Revenue numbers were some of the highest in recent years, although not as high as in 2018 when borrowing demand and volatility surged on the big dive after the longest bull run in history. Hong Kong, Japan and Taiwan were the top three markets in terms of revenue generation. Hong Kong, which has 50 per cent of the top 10 names in the region, enjoyed the highest average spread in five years at 1.27 per cent. Top specials included developers, healthcare, technology and restaurant chains, driven by China’s regulatory crackdown and COVID-zero policy over the year. The top Hong Kong borrow was Tianneng power, which has generated fund interest since 2020.
The top Asia special in 2022 was BHP in Australia, which unified its corporate structure at the beginning of the year. The name was also one of the top 10 specials in 2021, following the launch of its ‘unification’ or listing structure proposal. Revenues in 2022 for APAC were fairly consistent on a quarterly basis. Hong Kong dominated more in Q3 (contributing to 30 per cent of APAC’s number) due to the China property crisis and the slide in China technology and growth stocks. Japan contributed an estimated 21-25 per cent, Taiwan delivered 19-24 per cent, South Korea 13-17 per cent and Australia 11-12 per cent, across quarters.
One clear observation over the years has been that individual specials have contributed less to the overall revenue number and revenue sources have become more diversified. The percentage share of the top 25 and five ‘specials’ contribution to yearly revenue has come down from 35.83 per cent and 13.88 per cent respectively in 2019 to 19.48 per cent and 5.34 per cent in 2022. While a big special in the past (for example, Celltrion in 2018) might have contributed US$85 million on one single name, the sum of revenue brought by the top 10 specials together in 2022 was near to US$86 million. Shown another way, top specials generated between US$6-26 million each in 2021-22 versus US$10-85 million each in 2018-19.
With the Federal Reserve hiking interest rates aggressively and creating volatility around markets, there was also an uptick in demand, spread and revenue from Australia government bonds and EM Asian government bonds. Demand for Australia government bonds, in particular, picked up in Q2 and Q3 owing to bond market volatility and market dislocation driven by the Reserve Bank of Australia’s (RBA’s) prior yield-control strategy. UST versus JGB remained the biggest bond transformation trade globally, with strong demand from APAC.
In which APAC markets do you identify new opportunities for growth of your lending business during 2023?
Chua: We believe Taiwan remains an attractive market for SBL activity, given the current low active foreign beneficial owner participation. The regulators took action in 2022 to limit short selling activity, but this did not have a significant impact on market opportunities and, as such, we see a significant upside for owners to expand their activity in this space.
Korea is another market that we are tracking closely. Recent announcements to replace or remove the current IRC construct by the second half of 2023 could translate into significant operational efficiencies for lending activity and end-investors alike — in turn, driving higher performance and returns.
Garrett: We expect to see growth resulting from continued regulatory pressures on balance sheets, the hunt for alpha and the need to optimise long holdings through funding trades. For APAC, this will provide opportunities for lenders that are able to accept expanded collateral types such as Korean treasury bonds, Korean equities and Stock Connect equities.
Development of APAC’s securities lending markets will continue with measured progress, whether it is the enhancement of the China and India models or the implementation of offshore platforms in the Philippines, Indonesia and Vietnam. However, we do not expect developments in these markets to present material opportunities in 2023.
Lai: The implementation of the framework to support securities lending by offshore participants in the China, Philippines and Indonesian markets is always front of mind for us as we refine and develop our APAC strategy. Financial regulators have introduced a range of positive developments in these markets. We remain optimistic that the ongoing industry engagement and regulatory changes will yield positive results in future years.
General themes — with respect to collateral optimisation, digitalisation and the ability to provide bespoke solutions to our clients — drive the investment and strategy of our wider trading services business. Our teams of multi-asset traders, our unique ASF financing solutions team and our triparty business, ensure that we are always at the forefront of introducing new products to the market, thereby increasing our APAC footprint strategically to monetise growth opportunities as and when it is appropriate.
Which regulatory initiatives in APAC markets will consume most attention for your agency lending and collateral management teams over the coming 12 months? What programmes are ongoing within PASLA, and at industry-level more broadly, to support this change agenda?
Garrett: Taiwan and Korea will be prominent in our regulatory focus. Taiwan reduced its short-sell quota from 30 per cent of 30-day average daily volume to 20 per cent, and then 10 per cent in October. While this did not have an immediate impact on lending performance, a prolonged period of reduced quota may be detrimental through 2023.
In Korea, disappointingly, we did not see the anticipated lifting of the remaining short-sell ban in 2023. As it stands, short selling can still only occur for KOSPI200 and KOSDAQ15 constituents, providing limited opportunity for market participants. The enhanced regulatory reporting, oversight and enforcement regime, while well intended, creates an additional burden and risk for borrowers which is likely to play a critical part in any decision pertaining to participating in the Korean market. This does not bode well for demand for Korea heading into 2023 and we expect revenue opportunities from this market to remain suppressed.
Northern Trust is an active member of the PASLA board and within its working groups. The working groups cover all the APAC markets, engaging with regulators and regional stock exchanges to promote the development and enhancement of securities lending across the region.
Chua: We are expecting to work closely with PASLA and ASIFMA over the next 12 months on the further liberalisation of the Chinese markets. Adoption of proposed recommendations and structural changes could help ignite SBL activity within the HK-Stock Connect framework, which would further provide benefits in terms of improved market resilience and financial stability.
The proposed change to T+1 for US equity markets, while not strictly related to APAC, will have an impact on agent lenders and APAC beneficial owners, particularly those with US equity lending programmes. Changes to investment management operating models (such as trade capture timings, instruction routing and information dissemination) and SBL processing (such as trade inputs, recall processing) are likely to be necessary in order to ensure compliance.
Finally, we also expect to be engaged with PASLA regarding Indonesia and the Philippines, following up with the relevant authorities on the positive strides made by both jurisdictions in 2022 to open up securities financing markets.
Cheung: Balance sheet management has never been more important to the securities lending industry, including for agency lenders as balance sheets of major prime broker borrowers have been greatly strained in past years. The cost of indemnification and other Comprehensive Capital Analysis and Review (CCAR) issues from agency lenders are resulting in the need for detailed and proactive capital planning.
The increase in high-quality capital to risk-weighted assets (RWA) of financial companies — a priority since the inception of CCAR in 2009 — has been growing over the years. This has created incredible funding trade opportunities for lenders. The focus of RWA has also driven borrowers to shift balances to lenders that can offer decent amounts of inventory via low RWA funds.
This trend has continued in 2022. In response, banks have been working on creating innovative solutions for RWA buckets, automating consistent CCAR processes and frameworks, as well as building seamless risk-model architecture. They will require more resources and talent to improve in 2023 and beyond. The ability to navigate CCAR challenges and apply capital efficiently will, to a greater extent, differentiate the winners and losers across the industry.
From a lender’s perspective, competitive margins and greater investments in technology and infrastructure changes regionally resulted in flows channelled to a reduced number of prime broker borrowers. For brokers, the landscape has evolved in the last couple of years — each concentrating on its own niche, be it ASEAN markets, Taiwan-specific execution or funding. On the lender side, if fewer brokers borrow securities, certain conservative restrictions on loan concentration leads to undesired ratios such as the single counterparty credit limit (SCCL), which in turn can impact daily business.
The cost of capital has also driven some agents to move up their GC rates to optimise return on capital. With all the challenges banks are facing on RWA and SCCL constraints, solutions have emerged such as agency prime brokerage, which connects buy-side lenders to buy-side borrowers through prime brokers, or peer-to-peer lending, which similarly connects buy-side participants directly via technology.
Agency SWAPs — SWAP access for prime brokers or borrowers hedged via buy-side inventory positions — managed by an agent lender, has also become more important. The industry anticipates further developments. To stay relevant in the new normal, intermediaries will continue to come up with creative solutions.
What investments and adaptations to technology and working practices have you made during 2022 to sustain and grow your securities lending activity in the Asia-Pacific region?
Lai: At J.P. Morgan, we believe our firm-wide technology budget is unrivalled in the industry, with more than US$14 billion allocated across our technology programme in 2022. While our underlying clients are direct beneficiaries of shared investment funds across the firm, for our securities services lines of business, technology investment has increased 40 per cent since 2016.
This investment has enabled the integration of our securities finance, collateral management and triparty services, allowing us to offer new collateral mobilisation and optimisation tools to our clients, helping to minimise the impact of increased margin requirements on financing revenue.
Investments have been made in support of growing demand for non-custody lending, as more beneficial owners take a ‘best of breed’ approach to agent selection, to providing a flexible approach to indemnification and facilitating direct financing transactions.
Empowering our clients to ‘self-serve’ has been a continuing theme. While there has been a focus on modernisation and security — for example, greater use of our portal as opposed to emails — we have also concentrated on other important aspects such as data integration — leveraging across our multiple product offerings to bring more product related information together — and interoperability — streamlining across various applications.
Floate: We have been working on our global model for all developments. However, ensuring that functionalities, feeds and reporting work consistently from the US to Australia and New Zealand time-zones has been a key consideration for us. One example of this has been our trading overlay, which allows our traders, located at a desk anywhere in the world, to lend a local asset regardless of where the beneficial owner of that asset, or the account it resides in, is located.
We have also been focusing on settlement efficiency. It may sound a little boring, but we are in an environment where settlement cycles continue to contract. Consequently, it is essential to continue to improve operational efficiency to minimise the prospects of settlement fails or late matching.
Cheung: Automation of manual processes — for example, via Pirum and auto-borrow trading — remains a fundamental focus of most banks and market participants. Tighter lending settlement practices are here to stay as squeezes around efficiencies, regulation and fears of penalties bite. Taiwan is already a no-fail market. Korean authorities have upped the ante when it comes to short-sell penalties for any rule-breakers. If, or when, China opens its SBL market to offshore participants, a same-day settlement market awaits. Therefore, we are investing proactively in scaled solutions.
At BNY Mellon, we are focused on connecting the dots across our businesses to ensure that clients can take advantage of our services across liquidity, IM segregation, collateral optimisation, treasury services and FX. We are also committed to our people. Giving staff flexibility around work location has been key to our resiliency throughout the past three years. It has also been a game-changer in terms of both talent retention and attraction. A happy staff ultimately feeds through to happy clients and a culture of trust and resiliency.
Garrett: Our clients are facing growing demands on their assets as they seek to cover increasingly complex margin requirements, while remaining compliant with global regulatory challenges. At the same time, they are looking to minimise the impact of these challenges on overall performance. Northern Trust is working on a solution to help clients manage this complexity and drive efficiencies. Alongside Northern Trust’s existing capabilities, we are pursuing the development of an integrated inventory management platform solution that would serve as the single point of interface across collateral management, financing and liquidity, as well as securities lending and borrowing.
Chua: We continue to invest in a multi-year re-platforming exercise for our proprietary securities financing platform and this effort has started to deliver efficiencies in 2022. We anticipate further opportunities to improve our offering in 2023 as roll-outs of new functions gather pace.
State Street also launched Venturi in 2022. Venturi is a peer-to-peer financing platform designed to connect buy-side firms with new sources of liquidity in the global repo space. Built through our partnership with FinOptSys, Venturi supports trade negotiation and enhances trade settlement and collateral management. In helping to centralise liquidity and enhance transparency, we believe Venturi will help clients to open up new trading opportunities, lower transaction costs and improve returns.
How have monetary conditions shaped post-pandemic securities lending opportunities in the Japanese market?
How are you positioning yourself to maximise opportunities for lenders and borrowers in this environment?
Lai: Japan is of strategic importance for the wider J.P. Morgan Securities Services franchise. We opened our agency securities finance trading desk in Tokyo in December 2021 and now clients can access the full suite of our trading services through our Japan team. Our ongoing investment in people and across our onshore platform allows us to bring our market-leading global product offerings and services, overlaid and refined by local expertise, to borrowers and lenders in the Japanese market. This local experience ensures that we are well-positioned to navigate market conditions more efficiently and provides a framework to deliver local market solutions that better support the nuances and needs of the Japanese market.
Garrett: Loose monetary policy in Japan, as well as rising interest rates set by the US Federal Open Market Committee, led to a further widening of the cross-currency basis spread between the US dollar and Japanese yen in 2022. Clients that were able to lend US treasuries against JGB collateral were able to benefit from the arbitrage opportunity. This strategy was given a jolt in December 2022 when the Bank of Japan announced a surprising increase to its 10-year bond yield cap to 0.5 per cent, which initially saw the basis narrow for several days before widening again. The ability to balance exposures between overnight and term trades is key to optimising returns in the face of potential future surprises from central banks.
Cheung: Central banks, including the Bank of Japan, are facing the difficult challenge of scaling back bond-purchase programmes without creating market turmoil. Inflationary pressures in the developed world, created by the liquidity from expanded balance sheets, were further intensified by supply chain disruptions, labour market shortages and the energy crisis. Japan’s core inflation recently exceeded the BoJ’s 2 per cent target and hit a 41-year high. The BoJ surprised markets in December by raising the upper limit of its tolerance band on 10-year government bonds to 0.5 per cent from 0.25 per cent, though it kept its ultra-low benchmark interest rates unchanged.
The magnitude of QE in Japan, relative to the overall economy, has been much larger compared to other developed countries. Moreover, the range of assets purchased — including corporate bonds, ETFs and equities — has been much broader. All of this suggests that market volatility is likely to follow once the BoJ starts to reduce its balance sheet and, consequently, liquidity in the financial system declines. However, increased market volatility will create opportunities for the lending business.
The recent selloff in global bond markets has pushed the 10-year JGB yield to the upper limit of the BoJ’s range, forcing the BoJ to execute more bond purchases into the end of last year to defend its cap. The indirect impact on the SBL market would be the reduction of JGB supply in the market. Market functioning and liquidity have deteriorated with the BoJ’s increasing presence in the bond market and its massive JGB purchases; this made it slightly more expensive to source JGBs for different types of funding trades.
Lenders and borrowers will need to manage inventory well to tackle potential volatility in JGBs. Maximising opportunities in pricing and trading JGBs correctly is one thing, but increasing collateral diversity away from JGBs when borrowing and lending UST or HQLA may be necessary. Ultimately, sourcing JGB collateral might not be as swift and as easy in future with the BoJ’s proactive action.
Chua: Post-pandemic global inflation and interest rate divergence has driven a widening of the cross currency basis spread (in particular US$ and AU$ versus JPY). This has provided a strong revenue opportunity through 2022 for fixed income portfolios. We believe this will continue into 2023. The likelihood of higher interest rates in Japan should also present more opportunities for equity borrowing and fixed income lending. Expanding State Street’s longstanding market-leading capabilities in yen cash collateral will be a focus for 2023, as well as further developing JGB trading to position for future opportunities.
In December 2020, Chinese regulatory authorities expanded the scope of products available to those who had a Qualified Foreign Institutional Investor (QFII) licence to include securities lending and short selling, among other amendments.
How do you assess potential for growth of securities lending activity in the Chinese market?
Garrett: The potential for growth in the Chinese market through physical securities lending remains extremely compelling. However, the current operating models offered through Stock Connect or QFII still present idiosyncratic challenges. The most obvious hurdle for the offshore lending community is the lack of inclusion of agent lenders in the regulatory frameworks. Without the infrastructure and expertise provided by an agent lender, it would be extremely challenging for beneficial owners to access those platforms.
For the QFII model in particular, many challenges persist for both agent lenders (fixed fees and tenors on the main board, collateral retained at the CCP, untested default process) and for borrowers (uptick rules, onerous margin requirements, short settlement cycles). To address these issues, industry engagement with regulators through associations like PASLA and ASIFMA is of paramount importance. In 2023, the post-pandemic easing of travel into mainland China will be beneficial to this goal.
Lai: We would note other positive related announcements — for example, notices regarding insurance funds participating in securities lending markets. From a J.P. Morgan perspective, this has facilitated more dialogue internally and externally and we are excited about this workstream. The potential for growth of securities lending activity in the Chinese market is unprecedented. China simply cannot be overlooked.
While the benefits of Chinese shares being included in various global indices have been previously discussed, the Chinese market stands poised to benefit from the expected increased liquidity that will flow to the region this year. Without revisiting previous articles and material, I expect the industry to remain focused in this space, with the initial priority once again to look at the role that an agent lender can play in this process.
What expectations do your APAC clients have from you as a service provider in supporting their commitment to sustainable lending and borrowing?
Chua: ESG-compliant solutions for securities lending activity remains a topic of interest among clients, but no clear agreement has emerged around implementation or compliance. Current ideas revolve around proxy voting, collateral eligibility and cash reinvestment guidelines.
Floate: This topic has mainly been relevant for our buy-side lending clients that have mature ESG principles implemented across their core investment portfolios. They view securities lending as an ancillary activity and look to us, acting as their agent, for two things.
Firstly, to ensure that we meet their core objectives — for example, not accepting a security that does not meet the ESG criteria of their main investment portfolio as collateral. Secondly, to provide them with elements of ESG adherence that only we can implement as their agent. For instance, ensuring a proper recall mechanism is in place to enable them to exercise proper governance and vote at key general meetings.
Lai: J.P. Morgan Agency Securities Finance remains fully committed to serving our global clients in all aspects of their securities lending programme. In terms of sustainability, our approach centres on the provision and use of various tools to define individual requirements and outline a tailored programme. For instance, in the concept of proxy voting, our platform offers clients the ability to set requirements based on criteria such as meeting type, market and asset type.
In terms of non-cash collateral, clients are provided with multiple levels of eligibility restrictions. Our continuing investments in our technology platform helps us to support our client’s ESG requirements. It would be presumptive on our part to believe that recent market conditions and geopolitical stresses have not had some impact on the demand for ESG-compliant lending solutions. The material in the public domain is a testament to this. The offerings we provide at J.P. Morgan reflects the diverse nature of our global client base.
How do you assess the outlook for APAC securities lending markets for 2023?
Cheung: We see a great opportunity for Hong Kong in 2023 in an improved macro environment, after its links with the mainland were re-established on the border reopening on 8 January this year. We think the Hong Kong IPO market will perform strongly in 2023, with positive momentum from the beginning of the year and signs that the technology crackdown is coming to an end. A revival in IPOs and placements in Hong Kong will be helpful to the growth of the lending business this year.
China’s reopening would also help export-driven North Asia, especially technology names that have China exposure. South Korea and Taiwan, for example, have a reputation as “early-cycle” leaders in a demand recovery. Some of the semiconductor names are already up 10 per cent year-to-date. Volatility around capacitors and semis will remain and SBL activity will still be active in Taiwan, like in 2022. Another Taiwan sector likely to remain in focus is shipping. Normalisation in global trade could bring inflated revenue for the sector back to normal. Geopolitical risk related to Taiwan would surely add instability to the market.
Given the current pace of Fed rate hikes, the strong US dollar and the massive capital outflow in 2022, it might take some time for emerging markets to stabilise. Consequently, EM regulators might not lift their short-sell bans and restrictions completely in the first half of the year. However, we do see a chance of that happening in the second half of the year when markets stabilise. Brokers perceive South Korean stocks to be the top “rebound candidate”, given their low valuations. Given the bumpy road ahead, we believe market flows in the securities finance space will be active.
With brokers shifting their borrowing needs to synthetic business with lower balance sheet constraints, and with the internalisation of prime brokers’ own books, markets like Japan and Australia have not been as active in the physical borrowing space. While seasonal names still generated volatility and borrow activities across Japan, specials activity in Japan has become less and less. None of the top-10 ranked APAC specials included a Japanese name in 2022 and 2021, whereas Japan occupied 30-40 per cent of the top names in previous years.
The lack of specials borrowing in the physical markets is also illustrated by a reduction in the average fee for Japanese loans to around 47-52bps for the past few years, compared with more than 80bps in 2019. APAC markets are unlikely to see a meaningful revenue uptick in 2023 unless there is another big deal or corporate action event trade like BHP in Australia. As always, it is all about those specials!
Lai: APAC securities lending markets will almost certainly experience some headwinds in 2023. We are not immune to the slowing pace of growth globally and are likely to be impacted if markets appear to be heading into a recession. However, we do expect some to be outliers to this trend. China’s reopening will help to boost market sentiments across the APAC region. We expect corporate earnings to increase in Hong Kong as the outlook for the economy improves. We also expect to see a resumption of IPOs and corporate activity, supporting a return to previous market performance as the city continues along its path to recovery.
There is speculation within Japan that the BOJ will shift its monetary policy in Q2 to counter inflation, while the declining USD and JPY exchange rate will continue to create opportunities across fixed income and equities. More generally, balance sheet optimisation will remain our focus in 2023, along with the development of more sophisticated solutions to support evolving client requirements in this space regionally and globally.
Chua: We are optimistic for growth in APAC SBL markets this year, driven by the reopening story in China and Hong Kong. The outlook for the Japanese economy and related equity finance activity will be heavily impacted by how the Bank of Japan adjusts monetary policy in 2023. We believe that cross-currency basis transactions will remain popular, although spreads will compress as interest rate divergence eases.
The Korea regulator has added resourcing and increased oversight cadence into SBL and short selling activity conducted by foreign banks and broker dealers. This greater intensity seems to demonstrate regulatory and political support for short selling, albeit with enhanced penalties and stronger safeguards. Any moves to loosen current short selling restrictions (currently limited to 350 issuers, imposed in 2020) is likely to strengthen demand and improve market returns in 2023.
As the opportunity cost for deploying cash increases with interest rates, we also expect the trend for non-cash collateral usage to continue. Lenders, on the other hand, will continue to demand high-quality collateral such as Australia government bonds, on top of the traditional cash, USTs and JGBS.
Garrett: Looking ahead, there are good reasons to be optimistic. We expect to see a marked increase in trading opportunities within APAC as the drag on the performance, seen through 2022, eases. China’s easing of its Zero-COVID policy — and recent constructive political interaction signalling potential for de-escalation of the US-China trade war — could be positive for APAC stock markets which have already been buoyed by these developments. Counterintuitively, strong performing markets will allow for increased exposures on the short side, as well as the long side, as stock prices decorrelate.
The start of 2023 has seen several companies raising capital through secondary offerings, and this could bode well for event-driven lending activity in the region.
Floate: We identify a positive outlook for 2023! We are uniquely positioned in Asia Pacific, as we are in a region which still has a broad mix of developed and developing markets. We were recently reviewing a table of Asia Pacific market specificities for the upcoming training session of the PASLA conference (first day). We found that even those who have worked in the region for many years were struck by the market-to-market nuances and differences between regulations, reporting requirements, pre-trade requirements and exchange requirements.
With these differences, we have a broad mix of activities daily — for example, Hong Kong or Japanese equity trading that we know well, while also working to help open some of the lesser developed markets to securities lending. This latter element brings variety as we work with exchanges, regulators and tax offices and then with our internal product and functional teams to bring something new to the market. In my view, nothing beats doing a new type of trade for the first time in finance.
Phil Garrett
Head of securities finance, Asia Pacific
Northern Trust
Jansen Chua
Senior vice president, head of securities finance, Asia Pacific
State Street
Natalie Floate
Asia Pacific head of market and financing services, securities services
BNP Paribas
David Lai
Product Manager, agency securities lending, Asia Pacific
J.P. Morgan
Phian Cheung
Asia Pacific desk manager, director of securities finance
BNY Mellon
How do you assess the performance of APAC securities lending markets during 2022?
Jansen Chua: 2022 was a difficult year for the markets, including securities lending activity. Despite a slew of macro headwinds, APAC’s equity lending portfolios modestly beat expectations. A strong contribution from Australia and Taiwan specials lending offset softer Korea and Hong Kong markets. Fixed income lending activity also benefited from a widening of cross currency basis between the US and Australian dollar against the Japanese yen, driven by divergent central bank interest rate policies.
Natalie Floate: Globally, everyone looks at Asia Pacific for high fee levels, new market developments and new lending supply. 2022 did not disappoint in that regard, but it was not as strong as previous years in all areas. We saw increasing activity on the revenue side, with trade opportunities in the usual corporate activity with specials in Hong Kong, but we also saw increased use of Asian-issued government debt as collateral.
On the supply side, we identified new lenders entering the market and a renewed interest — post-COVID ‘pauses’ — to assess and enter the market, or to understand the barriers to entry and potential revenues. The focus on collateral needs has been a key trend — with securities lending being used to source liquidity or collateral, or to generate additional revenue for those long of HQLA.
Phil Garrett: It has been a challenging year across APAC in many respects. But there were also pockets of strong performance during 2022. The macroeconomic headwinds felt globally were compounded regionally by prolonged COVID-19 restrictions and regulatory tightening. The traditionally strong revenue markets of Japan and Hong Kong suffered from a dearth of event activity, including mergers and acquisitions, rights issues, placements and convertible bonds issuance, which are typical drivers of high fee trading strategies. Falling stock market valuations also adversely impacted revenue generation, with most indices tracking down in the 15-20 per cent range over the year. In addition, we saw a de-grossing of hedge fund exposures across the region.
On the positive side, some markets performed strongly — including Australia, boosted by the BHP Group listing consolidation, where revenues were up more than 50 per cent year-on-year. Taiwan revenues increased by approximately 20 per cent relative to 2021, driven by strong demand generated through short exposures to its tech-heavy index. The performance of these two markets and the fact that there was a full year of short selling activity in Korea — in contrast to 2021, where the short-sell ban was only partially lifted in May of that year — meant that overall APAC performance was relatively flat year-on-year.
David Lai: Throughout 2022, the APAC region saw a normalisation of lending activities across most markets and asset classes, with Australia, in particular, providing a plethora of opportunities for outperformance across both equities and fixed income lending.
This was driven by increased corporate event activity and strong directional flows within the equities space, alongside the Australian Government’s Quantitative easing (QE) monetary bond buying programme within the fixed income sphere. The Australian QE programme led to a reduction of fixed income assets in the repo markets — with assets that remained available to trade being highly sought-after — which provided support for funding activity at optimal levels.
Elsewhere in the region, the South Korean and Taiwanese markets continued to excel, offering high spread lending opportunities consistently throughout the year, inspite of the implementation of differing short sell measures by the respective regulators.
A high-volume, low-spread environment was sustained by the Japanese equities lending market in 2022, continuing the theme seen in preceding years — although intermittently interrupted by directional flows within specific sectors. Japanese fixed income lending also afforded additional opportunities for market participants to enhance their lending performance.
The Hong Kong market reacted negatively to ongoing pandemic restrictions during 2022, with pessimistic investor sentiments presenting challenges and impacting lending flows. Performance improved in Q4, with Hong Kong lending participants witnessing a recovery as the year concluded, setting the stage for a positive start to 2023.
Phian Cheung: APAC securities lending markets had a good 2022. Revenue numbers were some of the highest in recent years, although not as high as in 2018 when borrowing demand and volatility surged on the big dive after the longest bull run in history. Hong Kong, Japan and Taiwan were the top three markets in terms of revenue generation. Hong Kong, which has 50 per cent of the top 10 names in the region, enjoyed the highest average spread in five years at 1.27 per cent. Top specials included developers, healthcare, technology and restaurant chains, driven by China’s regulatory crackdown and COVID-zero policy over the year. The top Hong Kong borrow was Tianneng power, which has generated fund interest since 2020.
The top Asia special in 2022 was BHP in Australia, which unified its corporate structure at the beginning of the year. The name was also one of the top 10 specials in 2021, following the launch of its ‘unification’ or listing structure proposal. Revenues in 2022 for APAC were fairly consistent on a quarterly basis. Hong Kong dominated more in Q3 (contributing to 30 per cent of APAC’s number) due to the China property crisis and the slide in China technology and growth stocks. Japan contributed an estimated 21-25 per cent, Taiwan delivered 19-24 per cent, South Korea 13-17 per cent and Australia 11-12 per cent, across quarters.
One clear observation over the years has been that individual specials have contributed less to the overall revenue number and revenue sources have become more diversified. The percentage share of the top 25 and five ‘specials’ contribution to yearly revenue has come down from 35.83 per cent and 13.88 per cent respectively in 2019 to 19.48 per cent and 5.34 per cent in 2022. While a big special in the past (for example, Celltrion in 2018) might have contributed US$85 million on one single name, the sum of revenue brought by the top 10 specials together in 2022 was near to US$86 million. Shown another way, top specials generated between US$6-26 million each in 2021-22 versus US$10-85 million each in 2018-19.
With the Federal Reserve hiking interest rates aggressively and creating volatility around markets, there was also an uptick in demand, spread and revenue from Australia government bonds and EM Asian government bonds. Demand for Australia government bonds, in particular, picked up in Q2 and Q3 owing to bond market volatility and market dislocation driven by the Reserve Bank of Australia’s (RBA’s) prior yield-control strategy. UST versus JGB remained the biggest bond transformation trade globally, with strong demand from APAC.
In which APAC markets do you identify new opportunities for growth of your lending business during 2023?
Chua: We believe Taiwan remains an attractive market for SBL activity, given the current low active foreign beneficial owner participation. The regulators took action in 2022 to limit short selling activity, but this did not have a significant impact on market opportunities and, as such, we see a significant upside for owners to expand their activity in this space.
Korea is another market that we are tracking closely. Recent announcements to replace or remove the current IRC construct by the second half of 2023 could translate into significant operational efficiencies for lending activity and end-investors alike — in turn, driving higher performance and returns.
Garrett: We expect to see growth resulting from continued regulatory pressures on balance sheets, the hunt for alpha and the need to optimise long holdings through funding trades. For APAC, this will provide opportunities for lenders that are able to accept expanded collateral types such as Korean treasury bonds, Korean equities and Stock Connect equities.
Development of APAC’s securities lending markets will continue with measured progress, whether it is the enhancement of the China and India models or the implementation of offshore platforms in the Philippines, Indonesia and Vietnam. However, we do not expect developments in these markets to present material opportunities in 2023.
Lai: The implementation of the framework to support securities lending by offshore participants in the China, Philippines and Indonesian markets is always front of mind for us as we refine and develop our APAC strategy. Financial regulators have introduced a range of positive developments in these markets. We remain optimistic that the ongoing industry engagement and regulatory changes will yield positive results in future years.
General themes — with respect to collateral optimisation, digitalisation and the ability to provide bespoke solutions to our clients — drive the investment and strategy of our wider trading services business. Our teams of multi-asset traders, our unique ASF financing solutions team and our triparty business, ensure that we are always at the forefront of introducing new products to the market, thereby increasing our APAC footprint strategically to monetise growth opportunities as and when it is appropriate.
Which regulatory initiatives in APAC markets will consume most attention for your agency lending and collateral management teams over the coming 12 months? What programmes are ongoing within PASLA, and at industry-level more broadly, to support this change agenda?
Garrett: Taiwan and Korea will be prominent in our regulatory focus. Taiwan reduced its short-sell quota from 30 per cent of 30-day average daily volume to 20 per cent, and then 10 per cent in October. While this did not have an immediate impact on lending performance, a prolonged period of reduced quota may be detrimental through 2023.
In Korea, disappointingly, we did not see the anticipated lifting of the remaining short-sell ban in 2023. As it stands, short selling can still only occur for KOSPI200 and KOSDAQ15 constituents, providing limited opportunity for market participants. The enhanced regulatory reporting, oversight and enforcement regime, while well intended, creates an additional burden and risk for borrowers which is likely to play a critical part in any decision pertaining to participating in the Korean market. This does not bode well for demand for Korea heading into 2023 and we expect revenue opportunities from this market to remain suppressed.
Northern Trust is an active member of the PASLA board and within its working groups. The working groups cover all the APAC markets, engaging with regulators and regional stock exchanges to promote the development and enhancement of securities lending across the region.
Chua: We are expecting to work closely with PASLA and ASIFMA over the next 12 months on the further liberalisation of the Chinese markets. Adoption of proposed recommendations and structural changes could help ignite SBL activity within the HK-Stock Connect framework, which would further provide benefits in terms of improved market resilience and financial stability.
The proposed change to T+1 for US equity markets, while not strictly related to APAC, will have an impact on agent lenders and APAC beneficial owners, particularly those with US equity lending programmes. Changes to investment management operating models (such as trade capture timings, instruction routing and information dissemination) and SBL processing (such as trade inputs, recall processing) are likely to be necessary in order to ensure compliance.
Finally, we also expect to be engaged with PASLA regarding Indonesia and the Philippines, following up with the relevant authorities on the positive strides made by both jurisdictions in 2022 to open up securities financing markets.
Cheung: Balance sheet management has never been more important to the securities lending industry, including for agency lenders as balance sheets of major prime broker borrowers have been greatly strained in past years. The cost of indemnification and other Comprehensive Capital Analysis and Review (CCAR) issues from agency lenders are resulting in the need for detailed and proactive capital planning.
The increase in high-quality capital to risk-weighted assets (RWA) of financial companies — a priority since the inception of CCAR in 2009 — has been growing over the years. This has created incredible funding trade opportunities for lenders. The focus of RWA has also driven borrowers to shift balances to lenders that can offer decent amounts of inventory via low RWA funds.
This trend has continued in 2022. In response, banks have been working on creating innovative solutions for RWA buckets, automating consistent CCAR processes and frameworks, as well as building seamless risk-model architecture. They will require more resources and talent to improve in 2023 and beyond. The ability to navigate CCAR challenges and apply capital efficiently will, to a greater extent, differentiate the winners and losers across the industry.
From a lender’s perspective, competitive margins and greater investments in technology and infrastructure changes regionally resulted in flows channelled to a reduced number of prime broker borrowers. For brokers, the landscape has evolved in the last couple of years — each concentrating on its own niche, be it ASEAN markets, Taiwan-specific execution or funding. On the lender side, if fewer brokers borrow securities, certain conservative restrictions on loan concentration leads to undesired ratios such as the single counterparty credit limit (SCCL), which in turn can impact daily business.
The cost of capital has also driven some agents to move up their GC rates to optimise return on capital. With all the challenges banks are facing on RWA and SCCL constraints, solutions have emerged such as agency prime brokerage, which connects buy-side lenders to buy-side borrowers through prime brokers, or peer-to-peer lending, which similarly connects buy-side participants directly via technology.
Agency SWAPs — SWAP access for prime brokers or borrowers hedged via buy-side inventory positions — managed by an agent lender, has also become more important. The industry anticipates further developments. To stay relevant in the new normal, intermediaries will continue to come up with creative solutions.
What investments and adaptations to technology and working practices have you made during 2022 to sustain and grow your securities lending activity in the Asia-Pacific region?
Lai: At J.P. Morgan, we believe our firm-wide technology budget is unrivalled in the industry, with more than US$14 billion allocated across our technology programme in 2022. While our underlying clients are direct beneficiaries of shared investment funds across the firm, for our securities services lines of business, technology investment has increased 40 per cent since 2016.
This investment has enabled the integration of our securities finance, collateral management and triparty services, allowing us to offer new collateral mobilisation and optimisation tools to our clients, helping to minimise the impact of increased margin requirements on financing revenue.
Investments have been made in support of growing demand for non-custody lending, as more beneficial owners take a ‘best of breed’ approach to agent selection, to providing a flexible approach to indemnification and facilitating direct financing transactions.
Empowering our clients to ‘self-serve’ has been a continuing theme. While there has been a focus on modernisation and security — for example, greater use of our portal as opposed to emails — we have also concentrated on other important aspects such as data integration — leveraging across our multiple product offerings to bring more product related information together — and interoperability — streamlining across various applications.
Floate: We have been working on our global model for all developments. However, ensuring that functionalities, feeds and reporting work consistently from the US to Australia and New Zealand time-zones has been a key consideration for us. One example of this has been our trading overlay, which allows our traders, located at a desk anywhere in the world, to lend a local asset regardless of where the beneficial owner of that asset, or the account it resides in, is located.
We have also been focusing on settlement efficiency. It may sound a little boring, but we are in an environment where settlement cycles continue to contract. Consequently, it is essential to continue to improve operational efficiency to minimise the prospects of settlement fails or late matching.
Cheung: Automation of manual processes — for example, via Pirum and auto-borrow trading — remains a fundamental focus of most banks and market participants. Tighter lending settlement practices are here to stay as squeezes around efficiencies, regulation and fears of penalties bite. Taiwan is already a no-fail market. Korean authorities have upped the ante when it comes to short-sell penalties for any rule-breakers. If, or when, China opens its SBL market to offshore participants, a same-day settlement market awaits. Therefore, we are investing proactively in scaled solutions.
At BNY Mellon, we are focused on connecting the dots across our businesses to ensure that clients can take advantage of our services across liquidity, IM segregation, collateral optimisation, treasury services and FX. We are also committed to our people. Giving staff flexibility around work location has been key to our resiliency throughout the past three years. It has also been a game-changer in terms of both talent retention and attraction. A happy staff ultimately feeds through to happy clients and a culture of trust and resiliency.
Garrett: Our clients are facing growing demands on their assets as they seek to cover increasingly complex margin requirements, while remaining compliant with global regulatory challenges. At the same time, they are looking to minimise the impact of these challenges on overall performance. Northern Trust is working on a solution to help clients manage this complexity and drive efficiencies. Alongside Northern Trust’s existing capabilities, we are pursuing the development of an integrated inventory management platform solution that would serve as the single point of interface across collateral management, financing and liquidity, as well as securities lending and borrowing.
Chua: We continue to invest in a multi-year re-platforming exercise for our proprietary securities financing platform and this effort has started to deliver efficiencies in 2022. We anticipate further opportunities to improve our offering in 2023 as roll-outs of new functions gather pace.
State Street also launched Venturi in 2022. Venturi is a peer-to-peer financing platform designed to connect buy-side firms with new sources of liquidity in the global repo space. Built through our partnership with FinOptSys, Venturi supports trade negotiation and enhances trade settlement and collateral management. In helping to centralise liquidity and enhance transparency, we believe Venturi will help clients to open up new trading opportunities, lower transaction costs and improve returns.
How have monetary conditions shaped post-pandemic securities lending opportunities in the Japanese market?
How are you positioning yourself to maximise opportunities for lenders and borrowers in this environment?
Lai: Japan is of strategic importance for the wider J.P. Morgan Securities Services franchise. We opened our agency securities finance trading desk in Tokyo in December 2021 and now clients can access the full suite of our trading services through our Japan team. Our ongoing investment in people and across our onshore platform allows us to bring our market-leading global product offerings and services, overlaid and refined by local expertise, to borrowers and lenders in the Japanese market. This local experience ensures that we are well-positioned to navigate market conditions more efficiently and provides a framework to deliver local market solutions that better support the nuances and needs of the Japanese market.
Garrett: Loose monetary policy in Japan, as well as rising interest rates set by the US Federal Open Market Committee, led to a further widening of the cross-currency basis spread between the US dollar and Japanese yen in 2022. Clients that were able to lend US treasuries against JGB collateral were able to benefit from the arbitrage opportunity. This strategy was given a jolt in December 2022 when the Bank of Japan announced a surprising increase to its 10-year bond yield cap to 0.5 per cent, which initially saw the basis narrow for several days before widening again. The ability to balance exposures between overnight and term trades is key to optimising returns in the face of potential future surprises from central banks.
Cheung: Central banks, including the Bank of Japan, are facing the difficult challenge of scaling back bond-purchase programmes without creating market turmoil. Inflationary pressures in the developed world, created by the liquidity from expanded balance sheets, were further intensified by supply chain disruptions, labour market shortages and the energy crisis. Japan’s core inflation recently exceeded the BoJ’s 2 per cent target and hit a 41-year high. The BoJ surprised markets in December by raising the upper limit of its tolerance band on 10-year government bonds to 0.5 per cent from 0.25 per cent, though it kept its ultra-low benchmark interest rates unchanged.
The magnitude of QE in Japan, relative to the overall economy, has been much larger compared to other developed countries. Moreover, the range of assets purchased — including corporate bonds, ETFs and equities — has been much broader. All of this suggests that market volatility is likely to follow once the BoJ starts to reduce its balance sheet and, consequently, liquidity in the financial system declines. However, increased market volatility will create opportunities for the lending business.
The recent selloff in global bond markets has pushed the 10-year JGB yield to the upper limit of the BoJ’s range, forcing the BoJ to execute more bond purchases into the end of last year to defend its cap. The indirect impact on the SBL market would be the reduction of JGB supply in the market. Market functioning and liquidity have deteriorated with the BoJ’s increasing presence in the bond market and its massive JGB purchases; this made it slightly more expensive to source JGBs for different types of funding trades.
Lenders and borrowers will need to manage inventory well to tackle potential volatility in JGBs. Maximising opportunities in pricing and trading JGBs correctly is one thing, but increasing collateral diversity away from JGBs when borrowing and lending UST or HQLA may be necessary. Ultimately, sourcing JGB collateral might not be as swift and as easy in future with the BoJ’s proactive action.
Chua: Post-pandemic global inflation and interest rate divergence has driven a widening of the cross currency basis spread (in particular US$ and AU$ versus JPY). This has provided a strong revenue opportunity through 2022 for fixed income portfolios. We believe this will continue into 2023. The likelihood of higher interest rates in Japan should also present more opportunities for equity borrowing and fixed income lending. Expanding State Street’s longstanding market-leading capabilities in yen cash collateral will be a focus for 2023, as well as further developing JGB trading to position for future opportunities.
In December 2020, Chinese regulatory authorities expanded the scope of products available to those who had a Qualified Foreign Institutional Investor (QFII) licence to include securities lending and short selling, among other amendments.
How do you assess potential for growth of securities lending activity in the Chinese market?
Garrett: The potential for growth in the Chinese market through physical securities lending remains extremely compelling. However, the current operating models offered through Stock Connect or QFII still present idiosyncratic challenges. The most obvious hurdle for the offshore lending community is the lack of inclusion of agent lenders in the regulatory frameworks. Without the infrastructure and expertise provided by an agent lender, it would be extremely challenging for beneficial owners to access those platforms.
For the QFII model in particular, many challenges persist for both agent lenders (fixed fees and tenors on the main board, collateral retained at the CCP, untested default process) and for borrowers (uptick rules, onerous margin requirements, short settlement cycles). To address these issues, industry engagement with regulators through associations like PASLA and ASIFMA is of paramount importance. In 2023, the post-pandemic easing of travel into mainland China will be beneficial to this goal.
Lai: We would note other positive related announcements — for example, notices regarding insurance funds participating in securities lending markets. From a J.P. Morgan perspective, this has facilitated more dialogue internally and externally and we are excited about this workstream. The potential for growth of securities lending activity in the Chinese market is unprecedented. China simply cannot be overlooked.
While the benefits of Chinese shares being included in various global indices have been previously discussed, the Chinese market stands poised to benefit from the expected increased liquidity that will flow to the region this year. Without revisiting previous articles and material, I expect the industry to remain focused in this space, with the initial priority once again to look at the role that an agent lender can play in this process.
What expectations do your APAC clients have from you as a service provider in supporting their commitment to sustainable lending and borrowing?
Chua: ESG-compliant solutions for securities lending activity remains a topic of interest among clients, but no clear agreement has emerged around implementation or compliance. Current ideas revolve around proxy voting, collateral eligibility and cash reinvestment guidelines.
Floate: This topic has mainly been relevant for our buy-side lending clients that have mature ESG principles implemented across their core investment portfolios. They view securities lending as an ancillary activity and look to us, acting as their agent, for two things.
Firstly, to ensure that we meet their core objectives — for example, not accepting a security that does not meet the ESG criteria of their main investment portfolio as collateral. Secondly, to provide them with elements of ESG adherence that only we can implement as their agent. For instance, ensuring a proper recall mechanism is in place to enable them to exercise proper governance and vote at key general meetings.
Lai: J.P. Morgan Agency Securities Finance remains fully committed to serving our global clients in all aspects of their securities lending programme. In terms of sustainability, our approach centres on the provision and use of various tools to define individual requirements and outline a tailored programme. For instance, in the concept of proxy voting, our platform offers clients the ability to set requirements based on criteria such as meeting type, market and asset type.
In terms of non-cash collateral, clients are provided with multiple levels of eligibility restrictions. Our continuing investments in our technology platform helps us to support our client’s ESG requirements. It would be presumptive on our part to believe that recent market conditions and geopolitical stresses have not had some impact on the demand for ESG-compliant lending solutions. The material in the public domain is a testament to this. The offerings we provide at J.P. Morgan reflects the diverse nature of our global client base.
How do you assess the outlook for APAC securities lending markets for 2023?
Cheung: We see a great opportunity for Hong Kong in 2023 in an improved macro environment, after its links with the mainland were re-established on the border reopening on 8 January this year. We think the Hong Kong IPO market will perform strongly in 2023, with positive momentum from the beginning of the year and signs that the technology crackdown is coming to an end. A revival in IPOs and placements in Hong Kong will be helpful to the growth of the lending business this year.
China’s reopening would also help export-driven North Asia, especially technology names that have China exposure. South Korea and Taiwan, for example, have a reputation as “early-cycle” leaders in a demand recovery. Some of the semiconductor names are already up 10 per cent year-to-date. Volatility around capacitors and semis will remain and SBL activity will still be active in Taiwan, like in 2022. Another Taiwan sector likely to remain in focus is shipping. Normalisation in global trade could bring inflated revenue for the sector back to normal. Geopolitical risk related to Taiwan would surely add instability to the market.
Given the current pace of Fed rate hikes, the strong US dollar and the massive capital outflow in 2022, it might take some time for emerging markets to stabilise. Consequently, EM regulators might not lift their short-sell bans and restrictions completely in the first half of the year. However, we do see a chance of that happening in the second half of the year when markets stabilise. Brokers perceive South Korean stocks to be the top “rebound candidate”, given their low valuations. Given the bumpy road ahead, we believe market flows in the securities finance space will be active.
With brokers shifting their borrowing needs to synthetic business with lower balance sheet constraints, and with the internalisation of prime brokers’ own books, markets like Japan and Australia have not been as active in the physical borrowing space. While seasonal names still generated volatility and borrow activities across Japan, specials activity in Japan has become less and less. None of the top-10 ranked APAC specials included a Japanese name in 2022 and 2021, whereas Japan occupied 30-40 per cent of the top names in previous years.
The lack of specials borrowing in the physical markets is also illustrated by a reduction in the average fee for Japanese loans to around 47-52bps for the past few years, compared with more than 80bps in 2019. APAC markets are unlikely to see a meaningful revenue uptick in 2023 unless there is another big deal or corporate action event trade like BHP in Australia. As always, it is all about those specials!
Lai: APAC securities lending markets will almost certainly experience some headwinds in 2023. We are not immune to the slowing pace of growth globally and are likely to be impacted if markets appear to be heading into a recession. However, we do expect some to be outliers to this trend. China’s reopening will help to boost market sentiments across the APAC region. We expect corporate earnings to increase in Hong Kong as the outlook for the economy improves. We also expect to see a resumption of IPOs and corporate activity, supporting a return to previous market performance as the city continues along its path to recovery.
There is speculation within Japan that the BOJ will shift its monetary policy in Q2 to counter inflation, while the declining USD and JPY exchange rate will continue to create opportunities across fixed income and equities. More generally, balance sheet optimisation will remain our focus in 2023, along with the development of more sophisticated solutions to support evolving client requirements in this space regionally and globally.
Chua: We are optimistic for growth in APAC SBL markets this year, driven by the reopening story in China and Hong Kong. The outlook for the Japanese economy and related equity finance activity will be heavily impacted by how the Bank of Japan adjusts monetary policy in 2023. We believe that cross-currency basis transactions will remain popular, although spreads will compress as interest rate divergence eases.
The Korea regulator has added resourcing and increased oversight cadence into SBL and short selling activity conducted by foreign banks and broker dealers. This greater intensity seems to demonstrate regulatory and political support for short selling, albeit with enhanced penalties and stronger safeguards. Any moves to loosen current short selling restrictions (currently limited to 350 issuers, imposed in 2020) is likely to strengthen demand and improve market returns in 2023.
As the opportunity cost for deploying cash increases with interest rates, we also expect the trend for non-cash collateral usage to continue. Lenders, on the other hand, will continue to demand high-quality collateral such as Australia government bonds, on top of the traditional cash, USTs and JGBS.
Garrett: Looking ahead, there are good reasons to be optimistic. We expect to see a marked increase in trading opportunities within APAC as the drag on the performance, seen through 2022, eases. China’s easing of its Zero-COVID policy — and recent constructive political interaction signalling potential for de-escalation of the US-China trade war — could be positive for APAC stock markets which have already been buoyed by these developments. Counterintuitively, strong performing markets will allow for increased exposures on the short side, as well as the long side, as stock prices decorrelate.
The start of 2023 has seen several companies raising capital through secondary offerings, and this could bode well for event-driven lending activity in the region.
Floate: We identify a positive outlook for 2023! We are uniquely positioned in Asia Pacific, as we are in a region which still has a broad mix of developed and developing markets. We were recently reviewing a table of Asia Pacific market specificities for the upcoming training session of the PASLA conference (first day). We found that even those who have worked in the region for many years were struck by the market-to-market nuances and differences between regulations, reporting requirements, pre-trade requirements and exchange requirements.
With these differences, we have a broad mix of activities daily — for example, Hong Kong or Japanese equity trading that we know well, while also working to help open some of the lesser developed markets to securities lending. This latter element brings variety as we work with exchanges, regulators and tax offices and then with our internal product and functional teams to bring something new to the market. In my view, nothing beats doing a new type of trade for the first time in finance.
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