Ahead of our Finadium Investors in Securities Lending (FISL) conference taking place in May 8-9 in New York, we talk to our panelist experts to get a broad overview of the major changes shaking up what and how the market’s trading.
Looking back at 2023, the market saw the highest generating year for securities lending in 15 years, but not everybody felt the benefits because returns were heavily concentrated in certain stocks and sectors. The picture emerging in 2024 in the first quarter meanwhile shows a considerable drop off in revenues, said Matt Chessum, director for the Securities Lending unit at S&P Global Market Intelligence, who will be speaking on the “Navigating a new landscape” panel.
“It’s all about RoI,” Chessum noted. “Given high inflation , there has been a rise across the board in both servicing and regulatory and reporting costs …Margins for agent lenders are being squeezed.” In the backdrop, equity market valuations have been increasing, which have been supportive of revenues as this increases the value of the stock-on-loan, however, in terms of conviction borrows – pure directional trades – there’s been relatively little action so far this year, he noted.
Revenue themes
The bottom line is that the market is much dampened compared to Q1 2023 amid a lack of volatility, despite looming anticipated geopolitical shocks related to elections and global conflicts. Europe, Middle East and North Africa (EMEA) equities for example, are at the lowest levels since 2014: “There’s just no significant demand across EMEA equities (and) I don’t think that’s going to change until we see some sort of movement in interest rates,” he said, which can be expected in Q2 and Q3, although it’s highly contested when central banks might take any action.
“Markets are riding high off of this AI (artificial intelligence) exuberance and the positive sentiment created by investors believing that funding is going to become cheaper. Equity markets are currently at an all-time high as a result, but I think that could turn on a dime,” Chessum said. “Market participants need to take advantage of the current situation, because I believe that the rest of the year is going to be quite choppy.”
Most of the activity remains in the US, largely due to the outsized market, while in Asia there is a lot of divergence – with southeast Asia markets depending on China economic activity struggling, according to S&P Global Market Intelligence data.
At the same time, Chessum stressed that not all securities lending transactions are motivated by short selling, and he expects T+1 to be a big driver for demand when the regulation goes live at the end of May. Moreover, technological advances in data analytics and use of AI are going to bring more reliability and predictability to a market where transparency is still relatively new.
“We are going to be able to generate more revenues, have more liquidity, we are going to have better risk management, we are going to have better client conversations and they are all going to be because of the quality of the data and the amount of data that is being fed through thanks to the advent of artificial intelligence,” he said.
Markets and routes
On the flip side of the promise of technology and market electronification are the risks, which have been brought into sharp focus as a result of cyber incidents heavily impacting firms’ operations and regulatory obligations. The reality is that this can happen to any firm and venue in this day and age of cyber and it’s incumbent on the market as a whole to coalesce around one another in times of stress, said Matt Cohen, chief executive officer of Provable Markets, who will be speaking on the “Routes to market” panel.
While redundancy considerations are a natural step, the focus should not be about single points of failure, rather how to improve market structure as a whole, he added. Provable built its venue with an eye on US equity market structure, in which there are dozens of exchanges and alternative trading systems (ATSs), all of which are interoperable in the truest sense of being connected to route to each other, ultimately paving the way for best execution, he explained. In other words, connecting to Provable means connecting to every other provider.
“What we want to promote is a healthier market structure and ecosystem where redundancy is automatic between the providers and the customers because of connectivity,” he said. “We are happy to route (to another venue) if they have better pricing (and) that should be vice versa…and then, if somebody wants to have a better mousetrap for specials trading, or GC or term, it’s incumbent on whatever other platforms are out there to have a good product that people want to send their flow to.”
Supporting progress is one of the ways that beneficial owners and borrowers protect their interests as they mull options, and a healthy market structure is going to allow the chips to fall where they may, and maybe should, as well as provide tangible options if, for example, a beneficial owner wants to take control of their program and trade directly. And this should not be viewed as a threat to the important roles that all participants play in concert with one another in fostering an efficient and mutually beneficial ecosystem, he added.
Centralized interoperability
When considering how securities lending market structure is evolving, clearing has traditionally been a critical part of that story for over 30 years, said Obie Knapp, head of Securities Lending at the Options Clearing Corporation (OCC), who joins Cohen on the “Routes to market” panel.
Of the 85 current clearing members, over a dozen are specific to securities lending, with average daily transactions at some $169 billion in Q1 2024, making OCC the largest U.S. equities lending counterparty in the industry, he noted: “Central clearing is often talked about in the industry as if it’s a new or aspirational idea, but it’s proven (and) is about much more than capital savings…The role of CCPs is one of providing financial and operational resiliency (and) reducing risks, even in times of stress.”
OCC clears for 20 markets, a growing number, across listed option exchanges, futures exchanges and a securities lending platform, and he noted that the multi-exchange model is common in public markets and the securities lending industry should not be “scared” of developments in this direction.
“Exchanges are growing, not shrinking,” he said. “CCPs bring explicit interoperability into the markets they serve, which reduces complexity and interconnectedness among counterparties, exchanges and other key stakeholders…Concepts like transparency and resiliency, and risk management are extremely valuable for all market participants, particularly when you can count on it most in times of stress, which is what CCPs are built for.”
Chessum, Cohen and Knapp will be joining colleagues from BNY Mellon, EquiLend, Fidelity Agency Lending, GLMX, Goldman Sachs, J.P. Morgan, Northern Trust and State Street at FISL, which takes place in New York from May 8 to May 9. It is our 8th annual conference bringing together a broad cross-section of the industry to share expert insights on the latest and most important developments in securities lending. Registration is free for qualified buy-side firms including asset owners, asset managers, insurance firms and hedge funds.