How has the German securities finance market evolved in the past two years and how do the main trends in Germany compare to the rest of Europe and beyond?
There has been an overall change in the market, not just in Germany but globally. The market is much more focused on regulatory and balance sheet topics. Limits are focused on balance sheet or the consumption of the liquidity coverage ratio (LCR), rather than maximum holding in specific shares. So today, discussions are focused much more on collateral sets, collateral optimisation and terms, than a few years ago.
From the ‘outside’, the German market can appear contrarian, but in fact it is extremely simple and straightforward. The nature of clients and their approach to investments is much more conservative. There is no mature hedge fund industry, and historically not much appetite for synthetic prime brokerage. In addition, with Eurex based in Frankfurt, clients are much more familiar with trading listed derivatives instead of swaps. One of the key differences between business here and business in other European countries is the market for synthetic financing. Germany is underdeveloped and behind other markets in this area.
The rise of evergreen trades is something that’s been seen in several securities lending markets around the world. Is this also the case in Germany?
Yes, this is also the case for Germany and this is driven by LCR needs for banks and yield pressure in a low yield environment for beneficial owners.
German investors can be conservative. How does this affect the wider market? Are they missing out on revenue opportunities?
Yes and no. Germany is probably the most competitive market in Europe, so it is difficult to say that investors ‘miss’ revenue opportunities, at least not within the transactions they are actively doing. However, synthetic financing is an important instrument for many banks, and it implies a good pickup compared to classic finance trades. This is something which is recognised and understood by most German investors. Unfortunately, the desk setups are not really there yet.
How do German investors’ aversion to synthetic trades affect the country’s scrip market? How active is it?
Scrips and corporate actions are a heterogeneous topic. Some investors are very active and professional in terms of setup. Synthetic trades play a less important role for Germany as the market is rather long in assets. As a result, a synthetic trade is not necessarily favourable in terms of the pricing.
There are several regulatory frameworks being implemented in the EU at the moment. What impact are they having on the German market and the behaviour of the buy and sell sides?
That’s a key question. It brings a lot of uncertainty. A good example is the new tax law on German dividends. The rationale behind those changes is clear, but the market is still not clear on what the 45-day rule means, whether it is really only 45 days, or 45 days before and/or 45 days after the dividend date. The effect has been somewhat dramatic. Some beneficial owners have stopped all securities lending in German underlying.
This is tragic enough for market liquidity in German equities, but it also affects pricing in all kinds of market structures. If you have a net zero position in a share and you want to hedge a long call that, for example, an insurance company is selling to you in order to reduce an overweight position, how do you delta hedge the call if you do not want to use other derivatives?
Another example is index arbitrage. If the underlying securities lending market is not liquid anymore, it affects liquidity in the indexarb as well.
Unlike most other European markets, Germany’s financial hubs are not focused in its capital. How does this affect the way Germans do business, both domestically and internationally?
I would say there is no correlation between the location of the financial hubs within or outside the capital city. So for me, the way business is done is similar to other countries. As stated earlier, Germany is a super competitive market. All of the major banks are active here.
Similar to France, for example, it is of course an advantage to have a local presence and to be a native speaker. It is also down to the culture—hence a conservative approach and a proper organisational setup are probably more important than in other countries.