According to leading data providers, the supply of Australian assets accounts for approximately a fifth of Asia’s inventory. Although declining dramatically during the global financial crisis, supply has now returned and eclipsed pre-2008 levels. However, this trend does not hold true for demand, which remains comparatively lower to pre-crisis levels by a factor of three.
This dynamic is no different those within the broader industry, although is perhaps more pronounced in Australia. It has been largely driven by a decline in index arbitrage strategies, which previously accounted for significant loan volumes before disappearing as a function of increased balance sheet costs and regulation.
A unique aspect of the Australian market is its domestic orientation and relatively intimate investment community, which makes a local presence valuable for relationships and information flows. In this respect, Northern Trust’s trading presence in Sydney and capability to provide local expertise from there has proved valuable to clients.
In addition, as the superfund sector has continued to consolidate and grow, this dynamic has encouraged a healthy level of dialogue and benchmarking amongst asset owners, helping promote best practices and drive innovation in Australia. It has also been the backdrop for a growing change in perception towards securities lending within the beneficial owner community, which is increasingly reshaping the lens through which investors assess the value proposition for the product.
Re-engagement and renewed interest
For those participants who opted out of securities lending following the crisis, onshore appetite for local lenders to re-engage their programmes has generally been weaker relative to other jurisdictions.
Since then, the industry has been able to demonstrate how securities lending has evolved into a more robust, transparent and flexible offering, with new tools available for customising parameters and managing risk. We are now seeing increased interest in the product, including from asset owners who have not entertained the idea of participating in securities lending programmes before. As funds have struggled to fight the headwinds and impacts of the low interest-rate environment, the need to reduce costs and enhance performance has come to the fore, particularly for products that can deliver revenue streams at relatively low levels of risk.
While some asset owners are working closely with their boards to obtain approval to engage in securities lending, there are lenders on another side of the spectrum who are advancing the way in which it can be used as a vehicle to drive the needs across other functions of the business.
One interesting theme being explored is the extent to which securities lending can help the needs of the treasury function, in respect of cash management and liquidity, through advanced concepts such as agency repo and peer-to-peer lending.
Helping to drive the decision making process on securities lending is the landscape for demand trends. Most Australian funds have a unique home-bias in asset allocation and therefore the opportunity to utilise Australian assets is of particular focus for lenders.
We see sporadic demand across the main equity index largely driven by directional strategies pertaining to the commodity sector, and expect this theme to persist, given the exposure Australia has to evolving global demand—particularly that of China.
As is the case in many markets, the really attractive inventory for borrowers lies beyond blue chip shares and in the mid- to small-cap arena, driven by a growth in quantitative-type investor strategies that typically trade within this bracket.
Fixed income opportunities
In the fixed income space, we have observed a notable trend in rising demand to borrow high quality liquid assets (HQLA) on a termed basis, driven partly by how Basel III requires borrowers to meet certain liquidity and funding ratios, such as the liquidity coverage ratio and the net stable funding ratio. Reforms to move over-the-counter derivatives to central clearing, requiring the posting of HQLA as collateral, have also been a catalyst.
Borrowers have also sought to raise HQLA by pledging lower-rated or less liquid securities, which, if otherwise not utilised, act as a drag on balance sheets. This increasingly common occurrence in the term lending of HQLA has given rise to new revenue opportunities. Foremost of these are owners of Australian government bonds who are willing to provide greater flexibility in collateral, and have the appetite for extended loan durations.
We feel that securities lending is in a strong place in Australia and expect continued efforts by beneficial owners to open up their programmes against a backdrop of robust global demand.
These trends should see a growing pool of domestic wealth driving divestment beyond the borders of Australia, increasing the importance of global service providers. We remain absolutely committed to helping our clients develop solutions locally that can help them achieve their long-term goals.