As the EU attempts to deal with the crisis in Ukraine, attention has inexorably turned towards how economic sanctions against Russia and its retaliatory measures could affect European economies. Poland has already asked the European Commission to lodge a formal complaint with the World Trade Organization over a Russian ban on EU food products that has hit the country hard. Poland’s total food exports to Russia were reportedly worth approximately $1.5 billion in 2013.
Poland is one European country that did not suffer as poorly as others following the fall of Lehman Brothers and the resulting financial chaos in Europe. Southern eurozone states Italy, Spain and Portugal, each with different economies but a shared currency, needed help dealing with their debts.
With another crisis looming, what are securities borrowing and lending markets saying about how well the trio has recovered?
Securities borrowing and lending figures indicate a negative outlook, according to SunGard’s Astec Analytics data. Borrowing levels in fixed income assets across Italy, Spain and Portugal reduced between January 2007 and June 2014, with only Portugal remaining above half of the volume on loan compared with January 2007 (56 percent), while Italy and Spain have collapsed to 45 and 35 percent, respectively.
Portugal showed the most dramatic changes between January 2007 and June 2014 with volumes on loan rising between four and five fold during 2007, before beginning a steady decline through 2008 and 2009. But Astec Analytics analysts say that it is important to note that the Portuguese bond market is less than 10 percent of the Spanish and only 6 percent of the Italian market (as at January 2007).
The Italian and Spanish markets grew in volume in 2008 but Spain declined rapidly entering the second half of the year, coinciding with the run up to the default of Lehman Brothers and its aftermath. Italy managed to maintain balances through 2009 but issues with falling credit ratings and the coining of the PIGS acronym (Portugal, Italy, Greece and Spain) weighed heavily on the countries bonds, according to Astec Analytics analysts. All three countries were well below January 2007 levels by the start of 2010 and largely remained there, falling to the lows being seen in 2014.
Falling interest in borrowing bonds is reflective of deeper underlying problems in the economy and the credit worthiness of their issuers, government and corporate alike, add the Astec Analytics analysts.
John Arnesen, global head of agency lending at BNP Paribas Securities Services, agrees, saying that fixed income demand is driven by Basel III’s liquidity coverage ratio and the need to borrow high quality liquid assets.
“The difference between Italy, and its neighbours France, Germany, Austria and the Netherlands, is perhaps that borrowers don’t tend to have the same demand to borrow it and then repo it out on the other side, this isn’t as liquid as doing it with those other countries. We don’t see as much demand for that, even though those instruments would be eligible to be borrowed for those purposes. Italian banks would give you a different story, because obviously a lot of Italian fixed income is very much traded domestically.”
Barbara Ferri, head of stock lending at Banca IMI, the investment bank of Intesa Sanpaolo, says that bond volume, at least, bounced back following the crash. She says: “After the financial crisis, the securities lending business on Italian assets has seen a recovery in volumes mainly in bond rather than in stock lending.”
Given the spreads available in Europe, the lack of interest in non-core fixed income assets isn’t a surprise to Arnesen. “The European governed debt market has limited spread to it. That will change soon and it will widen out.”
“But at the moment, with interest rates very low and spreads thin, it’s really driven by pure short covering. I thought we would see more demand for Spanish and Italian debt for posting as collateral upgrades. If someone was long in Spain or Italy, we would absolutely expect to see that.”
“What would be interesting to see are Italian or Spanish equities being posted as collateral. We see some demand for that and it could be very strategically driven. Those trades tend to be quite bespoke. So if we’re structuring something and that’s something they want to post, we certainly have no problem with doing it.”
Statistics in equity borrowing in Italy, Spain and Portugal between January 2007 and June 2014 tell a different story about volumes, according to Astec Analytics analysts. Portugal is a fraction of the size of Spain or Italy, totalling less than 9 and 7 percent by volume of its European cousins (as at January 2007).
Balances in Portuguese equities being borrowed has grown dramatically since 2007—almost 45 times, although this was from a very low base, say Astec Analytics analysts.
By June of this year, the growth in Portuguese equity borrowing made it a staggering 85 percent larger than its neighbour Spain, which had itself grown 75 percent over the period, while Portugal remained less than 60 percent of the size of the Italian market, which had grown around 375 percent.
Italy’s securities lending recovery was mainly due to capital increases or specific corporate action deals, but it did not reach pre-crisis levels, says Ferri.
“The reasons for this partial recovery lie in the fact that Italy is not a relevant trading market for investment banks anymore and that there is an excess supply of Italian assets.”
“Furthermore, many international players are restricted taking double risk exposure. This has an impact on all Italian players in securities lending market whose inventories are mainly Italian assets.”
Arnesen adds: “The thing with Italy though is that a lot of companies haven’t been paying dividends in the last year. If that drives demand, it sort of takes away the value. The flipside of that is whether we are seeing Italian equities being posted as collateral or a desire for them to be posted as collateral? And that actually is increasing.”
“For those that can take it, and there’s no reason why you couldn’t, depending on your risk profile, we’re seeing more demand for Italy, and Spain, to be posted as collateral.”
Astec Analytics analysts see all three countries’ decision to instigate short selling bans over the past four to five years as an indicator of negative interest.
“[They] in fact created volatility in the markets rather than calm them, with Spain and Italy suffering the most due to their inconsistent strategies. Italy varied their short selling rules with little or no notice whilst Spain applied the rules, then suspended them and applied them again a number of times.”
Arnesen adds: “Portugal is interesting for two reasons. It’s a much smaller market in general. I think the supply available in the market is very modest indeed, more akin to Eastern European markets. And yet if you look at some of the strategies in Portugal, it has much higher utilisation than the other two.”
“It’s also fairly reflective of the wider situation in Europe. There are some short selling bans on certain Portuguese banks, which are either temporary or they tend to repeat themselves, but again the drivers there are mainly aligned to financial stocks, which I see purely as directional short selling.”
Astec Analytics analysts add that with credit ratings and the broader economic outlook looking poor for all three countries, the shares issued in Italy, Spain and Portugal are not acceptable as collateral, and dividend arbitrage opportunities are less common than they were before. as a result, borrowing is seen as mainly for short selling.
“Rising balances in short positions portray a negative sentiment across the market and an expectation that price levels will not be sustained over the long term. They were not alone in this—other countries both in and out of the eurozone suffered in a similar fashion.”
With Italy, Spain and Portugal still looking to bounce back, what are local beneficial owners saying about the business they are willing to do?
Of Italy, Ferri says: “Pension and hedge funds in Italy are still far to be an active players in the securities lending market due to the limited development of this category of funds.”
“In addition, historically Italian players were diffident in entering the securities lending business.”
Pension funds are notoriously cautious and slow to come to market, says Arnesen. “I think if there is anywhere left in Europe that still struggles with the concept, it’s going to be the pension funds in Spain and Italy.”
“Having said that, the asset management sector in both of those countries is very much engaged in securities lending, and increasingly so. We are seeing much more interest coming out of Italy. This makes sense because everyone is suffering from low returns across the board.”
“Securities lending is gaining attraction for asset managers, but I think we’re still going to have more work to do as an industry with pension funds in both of those markets.”