Head of capital markets for the Asia Pacific
Asia Pacific head of agent lending
Head of Asian securities lending trading
Brown Brothers Harriman
Head of securities finance Asia Pacific
Head of equity finance for Asia
Global head of equity and fixed income finance
Many of Asia’s market regulators are pushing ahead with ambitious regulatory initiatives at the moment. Which market has made the most progress in the past 12 months?
Stewart Cowan: We have seen a number of regulatory changes to assist liquidity, specifically Malaysia’s reforms to the uptick rule, Taiwan’s consideration of a reduction to the securities transaction tax (STT) rate and the expansion of Stock Connect to include Shenzhen. These changes are all designed to improve liquidity and, in turn, pricing transparency.
While some regulators have indicated their desire to review short selling and lending regulations, market volatility may have been a factor that delayed further regulatory reforms. However, the industry remains encouraged by the consultative approach taken by Asian regional regulators.
Industry interactions have been particularly thoughtful and deliberate and we see this as the best practice when approaching market reforms.
It should also be noted that we continue to monitor European and US regulatory changes and their impact on the Asia Pacific. Specifically, we are watching the EU Securities Financing Transactions Regulation (SFTR), which is expected to impose greater disclosure of lending activity, including offshore branches.
Dane Fannin: Hong Kong made positive moves for securities borrowing and lending with its much-anticipated launch of the Shenzhen-Hong Kong Connect scheme in late 2016.
This complements the existing Shanghai-Hong Kong Connect initiative and importantly gives international investors access to China’s two main bourses.
This marked an important milestone towards achieving an approved and feasible solution for lenders and borrowers of Chinese A-shares. This achievement could also potentially serve as a catalyst for China to be included in major indices, which would help to drive the liquidity pool of lendable assets ahead of any securities borrowing and lending structure being approved.
Francois Maury: If we take a wider look, we are seeing a general evolution towards greater homogeneity in the market regulations across Asia. The third driver has probably been the various new regulations coming from the US and Europe, such as the Dodd–Frank Act (especially the Volcker Rule) along with the various leverage ratios, triggering an ever increasing focus on resources management (liquidity, balance sheet, leverage) and changing market practices (more total return swaps, more asset versus asset deals).
What other markets have attracted your interest?
Fannin: South Korea has remained in focus over the past 24 months and we have observed robust growth in demand and revenue. We cite three key drivers for this: firstly, various regulatory measures introduced in other jurisdictions in the region have made it increasingly challenging for investors to execute their strategies effectively, highlighting the potential of South Korea as an alternative destination.
Secondly, South Korean authorities have introduced positive regulatory changes over the years in an effort to help promote increased liquidity and trading volume, which have attracted increased foreign flows of investment.
Thirdly, South Korea’s economic construct has been exposed to major economic themes including a slowdown in China, falling oil prices, and others that have led to increased investment opportunities and increased trading in specials.
Malaysia also continues attract focus. Here, while market demand remains highly sporadic, which fundamentals such as currency and commodity price fluctuation largely driving activity, it is a market where supply continues to grow. We expect this to drive further liquidity and spur a greater allocation of capital from investors.
Zubair Nizami: South Korea was by far one of the standout markets in Asia last year and, certainly from our perspective, it generated significantly higher returns than Hong Kong, which in itself had a record year in 2015.
Lending demand was largely driven by the slowdown in the South Korean economy, partly due to sluggish growth in China, but also related to longstanding structural issues in key sectors such as heavy industries, shipping and shipbuilding. Although spreads have compressed in Malaysia and Taiwan, they still both offer attractive returns.
One of the biggest challenges for agent lenders is to engage the right type of client with the appropriate assets to engage in these markets, as they can require an increased level of involvement on their part in order to navigate through myriad legal, regulatory and operational hurdles.
Cowan: Naturally, we also continue to closely monitor the Chinese market for plans to expand Stock Connect, along with short selling and stock loan rules for further signs that China plans open it doors. While we have conducted initial due diligence on a number of Asian markets and have several markets on close watch, at this point we don’t see any new markets nearing a point where they would be viable from an securities borrowing and lending perspective.We continue to work to realise the maximum value from our existing markets. For example, Malaysia continues to garner a significant amount of interest and our existing business in South Korea and Taiwan is flourishing.
Jansen Chua: We recently added Malaysian lending to our agency lending capabilities. We continue to watch the emerging market space: Indonesia, India and the Philippines all raise interest regionally.
Maury: PASLA has made an interesting choice with Seoul, as South Korea has been high on our list in 2016. Our firm has made significant inroads in equity derivatives on South Korea in 2016. We are now increasing our market presence in equity finance.
Rob Chiuch: Japan and South Korea continue to be sources of significant securities financing activity and earnings. In South Korea, a volatile market and high levels of corporate activity are driving opportunities for hard-to-borrow securities/specials (for example, pharmaceutical and shipping sectors).
Meanwhile, Japan is the most liquid market in Asia Pacific and is outperforming in the region mainly due to significant directional trading activity.
While the Asian markets are developing their securities lending infrastructure, the future of overall regional growth depends on China. Considering the progress that’s been made, how much longer do you see that being the case?
Chiuch: There is more progress to be made. For example, if China A-shares were included in MSCI, they would constitute approximately 55 percent of the total A-share market cap representing more than 1,400 A-share issuers—this would help expand the market.
Another review is expected to happen in June this year. Another potential growth factor is offshore participation in the Chinese securities lending market. Currently, only domestic institutions are permitted to borrow and lend securities in China, but if regulations change to allow offshore participants, that could generate strong additional growth. If or when this will happen is anyone’s guess.
Other markets with potential are Indonesia, the Philippines and Vietnam. A well-functioning securities finance model can complement broader expansion into these markets.
Chua: China continues to be a story for tomorrow rather than today. We believe one of the main growth stories in 2017 will be the continued development of institutional investors in China, driving the shift from a predominantly retail market to one that is more institutional.
Fannin: While China undoubtedly offers compelling long-term revenue propositions, there are a number of additional opportunities with potential to grow Asia’s revenue profile significantly.
For example, India and Indonesia are two of the region’s largest economies, and are progressing regulatory investment into securities lending.
Given the depth in liquidity and expected growth profiles of these markets, we expect them to be key securities lending destinations, as and when they become viable for offshore participation.
Cowan: It’s hard to ignore China’s ever increasing role and influence within the region. The potential for China to continue to drive the regional outlook for the foreseeable seems inevitable.
Maury: China is indeed the key country. We are hoping for legal progress on the subject of transfer of securities to lead to the development of a real onshore stock lending market.
In our recent conversations with regulators we have been under the impression that it would take some time.
The Hong Kong-Shenzhen Stock Connect and its Shanghai counterpart have so far failed to inspire the securities finance market the way many hoped. What’s your prognosis on the problem and is it being addressed?
Nizami: While a lending model for offshore holders of Shanghai listed A-Shares does exist via the Stock Connect scheme, its use remains limited due to various restrictions in place that curb both lending supply and end-user demand.
Regulatory momentum behind the further development of a viable offshore model has stalled somewhat given the turbulence that we witnessed in the Chinese equity markets during the summer of 2015.
Our view is that the Chinese Regulatory Securities Commission (CSRC) will continue to remain focused on overall market stability as opposed to further liberalisation of the securities finance market in the near term, particularly in light of China’s ambition to be added to the MSCI Emerging Markets Index.
Longer term, we are optimistic that the CSRC will look to introduce gradual reforms to the offshore securities finance market.
That said, in terms of timeframes, we are probably quite some time away. We expect that a more scalable model is unlikely to evolve within the next two to three years.
Cowan: We have seen a lukewarm response by markets to Stock Connect, perhaps due to some of the intricacies of the model, however, the direction is a strong indication of the desire to expand and open Chinese exchanges to the broader international markets.
PASLA and other industry organisations and market participants continue to engage with regulators, however, since there is a substantive regulatory agenda we do not expect to see any significant changes to the current framework in the short term.
Chua: The much-anticipated advent of securities lending and borrowing via Stock Connect has not been activated as quickly as the market anticipated. This has muted demand for A-Shares via the platform, as directional positions have not met volume expectations.
Given concerns over issues like margin trading, regulators will likely require more time to become comfortable with the platform and the nuances it introduces.
Chiuch: Let’s put things into perspective. The Shanghai Stock Connect was first launched in 2014. The Shenzhen Stock Connect was only announced mid-2016. While challenges exist, it’s probably a little early for final conclusions.
One challenge is that only domestic participants are able to engage in securities lending and borrowing in China, so this limits the development of a more globally active securities finance market.
Additionally and in regard to China’s same-day settlement period you don’t have time to recall loaned securities to cover trades.Share suspensions in Hong Kong and/or China also remain a hot topic especially for exchange-traded funds (ETF) issuers in that space. ETFs are, furthermore, reportedly being considered as potential eligible securities in the Stock Connect.
Maury: I do not believe the Stock Connect was supposed to boost stock finance. It was simply an important step into the opening of Chinese equity markets.
Unfortunately, that positive step came somehow at a wrong timing, at the beginning of a deep market consolidation phase following the massive rally of 2015.
Therefore, volume of inward investment was somehow disappointing. Besides the regulatory environment needed for active stock lending and repo using the Stock Connect is not ready yet, which limits active trading on the short side.
Global securities lending participants saw strong revenue in 2016 due to turmoil in the Asian markets caused by China. Which markets are you expecting to follow this trend, or buck it?
Chiuch: Given its size and breadth and the current macro environment, Japan will probably continue to generate strong securities lending revenue. Hong Kong’s liquidity and healthy average trading volumes are also favourable for securities lending activity.
Overall, markets where regulatory change encourages liquidity are good candidates for stronger securities financing revenue flows. Some Asia Pacific markets can be challenging for securities financing because of their size and the apparently reactionary way regulation responds to market trends. Depending on market sentiment, regulatory oversight in some markets could change. This can affect market liquidity, which in turn can hamper securities lending revenue.
Fannin: The scale of the Chinese economy means it affects most economies either directly or indirectly, and we expect its ongoing transition from a manufacturing to service consumption economy to continue providing opportunities for investors across Asia. This should bode well for future securities lending demand.
This theme will be more obviously applicable to some jurisdictions than others. One of these is, of course, Hong Kong, given the access and exposure to China that it provides to international investors via H-shares.
The Hong Kong market boasts an impressive revenue stream for the industry, and given its growing depth of liquidity we expect this to continue.
Other markets including Australia, Japan, South Korea and Taiwan all account for demand relating to China exposure, whether that is a function of export demand or exchange rate sensitivity.
These all represent long-term themes that should continue to be important catalysts of demand for the foreseeable future.
Nizami: With a number of market valuations looking somewhat inflated and increasing sentiment around potential downside volatility, we could witness an increased focus on hedging as investor concerns surrounding a potential sell-off in the Asian markets grow.
We believe market neutral long/short equity strategies could see a bump in demand, which would ultimately drive demand for borrowed securities.
In addition, the impact of geopolitical events on capital markets and rising interest rates in the US may also contribute to increased volatility, which in turn could create greater distortions in pricing and thus generate securities lending opportunities.
However, the potential dampener on this outcome is if the political rhetoric becomes so distracting that a risk-off environment is created and activity levels become muted until investors gain a better understanding of where the markets may be headed.
Against this backdrop we are optimistic from a demand perspective and expect that Hong Kong, Japan and South Korea will continue to drive a significant portion of our revenue in Asia again this year.
Although China witnessed stable GDP growth of around 6.5 percent to 7 percent last year, which compares favourably to growth of 1.6 percent in the US and 1.7 percent in the eurozone area, there are still some investor concerns.
These include the state of its economy, particularly in relation to its gradually depreciating currency, as well as increasing capital outflows and high debt levels, especially in the property sector.
We believe these themes will provide securities lending opportunities for market participants in 2017.
Cowan: 2017 has started relatively quietly. First, as a result of the spillover from end of year rebalancing by borrowers and; second, hedge funds appear to be taking a wait-and-see approach in the face of the current political changes.
One material change, which is driving demand, is the move away from stock specific shorts to the broader quant trading.
This has resulted in broader, more consistent demand albeit at lower spreads. That being said, we believe that overall the trading and revenue generation should remain consistent and continue its upward momentum.
Japan and China are obviously significant economic drivers across the region (and globally) and events specific to these markets, combined with the political shifts, could provide volatility, which in turn may generate additional trading opportunities.
Chua: Japan and Hong Kong have shown considerable strength at the start of the year and are likely to be key markets in 2017.
Australia, South Korea and Taiwan all have potential for revenue generation, but the latter two may experience more volatility in earnings as regulations tighten.
India was pinpointed as the next lucrative market in 2016. Is that still the case, and why?
Nizami: That certainly was a rather optimistic prediction for 2016. From an offshore securities lending standpoint, it is quite a long way from being of any interest to us and our clients.
There are still restrictive parameters around loan tenures, collateral types, and other operational areas which certainly won’t encourage much participation from the offshore market.
It could have significant potential in the long term, especially given the size and scale of the Indian economy.
However, until there are some wholesale changes to some of these aspects of the existing securities lending model, I don’t think this is a market that would garner a lot of attention in the next few years.
Cowan: A limited number of international firms have been able to facilitate trades within India stemming from the current centralised clearing model which makes it difficult for many lenders to participate.
Since participation also requires a considerable amount of due diligence, legal and investment dollars, we anticipate international participation and overall volumes will continue to be quite low.
Chua: India continues to be a market of interest and one to watch regionally. Depth of supply continues to be a challenge for most lenders due to specific requirements around collateral and trade duration.
This has caused most lenders to wait until further developments bring the market in line with their existing programmes.
Maury: The Indian market has been in an extended bull run since the Lehman shock, with the NIFTY tripling over the period.
There was a volatility episode at the end of 2016 when Prime Minister Narendra Modi surprisingly launched a very ambitious demonetisation plan with the explicit purpose to crush the large shadow economy.
The immediate negative impact on growth of the reform has now been discounted by the market, with a nice start of 2017.
On the fiscal side also, some uncertainty was created by the reform of the tax convention with Mauritius. In general, we expect the Indian market to remain very interesting in 2017, albeit more volatile.