Asia under the microscope
The industry turned its focus to South Korea as participants came together in Seoul for the PASLA/RMA Conference on Asian Securities Lending
The flight to Seoul from Heathrow is just shy of 11 hours if you’re lucky enough to fly direct, with a nine-hour time difference to boot once you land—14 hours if you’re coming from New York.
This inevitably creates a lag in correspondence with headquarters, with Asia-based folks often getting updates a day after their western counterparts.
And at this year’s conference, it was made plain that what is true for news also stands for regulation and other market trends.
Each time the industry is hosted by the Pan Asian Securities Lending Association (PASLA) and the Risk Management Association (RMA) for their annual event (now in its 14th year), the Asian markets reliably boast new levels of maturity, but they are still susceptible to the whims of larger markets in Europe and North America.
This year’s gathering opened by addressing the macro-geopolitical topics of the day that are the bombastic President Donald Trump and the potential for widespread disruption of EU regulatory initiatives caused by the surge in nationalism across the continent—with Brexit Britain at the epicentre—and a rapid series of elections due in France and Germany threatening to double down on the union’s problems.
South Korea leads the way
Closer to home for those in Asia, the spotlight was turned on South Korea and its neighbouring markets’ developments in lending activity and regulatory frameworks.
Asia offers a diverse range of securities lending markets, in a variety of stages of development.
This year’s conference, however, focused largely on its host country and the recent controversial rule changes that several in attendance accused of being more politically motivated than economically responsible.
Panellists throughout the three-day event protested that short sellers are being used as a political football, with participants facing burdensome regulatory requirements across the region.
Seoul-based market representatives voiced concerns that the recent hardening of short selling rules in South Korea would negatively affect their business.
This view was reinforced by an audience poll, which saw more than half of those in attendance citing the amendments to short selling as the “most influential rule change in the South Korean market”.
A subsequent poll addressed the problem directly by questioning audience members on what the most reasonable response to complaints over short selling from the wider market should be.
Just over half of respondents opted for improving market accessibility of individual investors for short selling.
A further 23.3 percent voted for strengthening public disclosure requirements for short selling.
This drew further criticism from panellists as public disclosure was highlighted as one of the features of the new ruleset that simply pandered to public opinion and had very little actual merit in terms of financial security.
As part of the package of rule changes, financial penalties for failing to comply with public disclosure and reporting requirements were installed, where previously there was no punishment for failing to comply.
“If South Korea’s Financial Services Commission (FSC) isn’t the one making the decision on these rules then sometimes cooler heads might not prevail,” one panellist commented.
Among other changes, the Korean Exchange will be handed new powers to withdraw “overheated” stocks that receive “extraordinary increases in short selling and sharp falls in prices” during a single day for a 24-hour cooling-off period, as outlined in a statement by South Korea’s FSC in November 2016.
The political nature of the rule changes have caused industry participants to question the thought process behind some of the terms, such as a 60-day limit on term lending.
The limit was handed down without explanation and has since been described as an arbitrary limit with no clarity on whether strategic lending and borrowing is allowed to work around it in order to maintain a short position.
“The short selling rules aren’t a big problem but the concern is if this rule is just the start of a wider initiative,” a panellist who is based in South Korea commented.
It was noted in a later panel discussion that South Korea has been one of the most lucrative Asian markets for securities lending for the past two years, but these new requirements may dampen revenue in the future.
The balance of securities available for lending in the country has risen steadily over the past seven years, with local investors increasingly taking on a larger command of the market. Local investors only accounted for 20 percent back in 2011, but that percentage now hovers around 35 percent on average.
Beset on all sides
Short sellers are also under the kosh elsewhere in Asia. In Hong Kong, the Securities and Futures Commission (SFC) has instigated plans to bring in reporting requirements for short positions from 15 March, in a move that has been described as “disproportionate”.
The Hong Kong office of law firm Deacons responded to the SFC’s November proposals to enhance asset management regulation and point-of-sale transparency at the end of February.
Under the proposals, which were put forward to ensure Hong Kong’s regulatory framework meets international standards, including those formulated as part of the Financial Stability Board’s investigation into and reform of shadow banking, fund managers would be required to report securities lending and repo transactions to investors on an annual basis or upon request.
In response, Deacons said: “While we appreciate the concern of regulators globally to be kept informed regarding repos and similar transactions in light of concerns over the potential impact of the ‘shadow banking system’ on financial stability, we believe that the disclosure and reporting requirements proposed in paragraphs 32 and 33 [of the SFC’s consultation paper] are disproportionate.”
The Hong Kong Exchange also tightened its criteria for securities eligible for short selling in mid-2016 to bring them in line with the state’s equity market.
At the same time, Taiwan’s stock exchange is now monitoring short selling volumes on its platform more closely for indicators of when securities become ‘attention stocks’, which are then liable for pricing limits, as of June 2016.
Strong the west wind blows
According to PASLA/RMA panellists, Asian market participants have more than just homegrown regulatory challenges to face.
Fresh regulatory requirements that are currently germinating in Europe are expected to spill over into Asian markets in the near future. One example offered by panellists was that beneficial owners across Asia must come to terms with stay protocols in the near future if they want to do business in foreign markets.
A stay protocol is a standard form that promises a globally systemically important bank (G-SIB) will, in the event of a default, freeze all relevant assets for a short time in order to avoid exacerbating market stress through a rush to reclaim collateral. The protocol is signed on a voluntary basis by participants in a few jurisdictions, but any entities wishing to access those markets for securities finance are also required to sign up.
One legal expert at the conference explained that the issue for lenders that are expected to adhere to these rules is that, in the case of a default of a major investment bank, the counterparty is forced to hold on to collateral whose value might be crashing.
The potential for lenders to take on losses as a result of a stay protocol has led some legal teams that are new to the requirement to attempt to negotiate the terms, or even to advise against signing.
The relative lack of G-SIBS in Asia means that local securities finance participants have so far operated without the use of stay protocols, but that time is nearly over, according panellists.
Currently, only the UK, Switzerland, Germany and Japan have finalised their stay protocol regulations, but the US is expected to catch up in the first half of this year. The EU passed rules requiring member states to publish legislation as of 1 January 2016, but progress still varies from state to state.
The fact that the stay is voluntary puts the onus for education about these rules on the industry, which is expected to outline the requirements to their counterparties in jurisdictions that may not have equivalent rules, but that are expected to agree to them to access to markets that do. Conference panellists advised attendees to seek legal advice on how to approach incorporating stay protocols in order to remain open for trading in these markets.
A Trump shaped spanner
While Asia and the EU double down on their efforts to manage the financial stability of their capital markets, the new US president appears to have missed the memo.
Delegates heard in the opening panel of the conference that the future of Basel IV has been thrown into question in the wake of a new wave of anti-regulation sentiment emanating from the US.
A panel of regulatory experts concluded that Trump’s attempts to reopen the debate on the need for post-financial crisis banking regulation has put a significant roadblock in the way of future initiatives.
“There is some nervousness in the Basel Committee on Banking Supervision because of the uncertainty,” one panellist explained.
Another panellist agreed and added that he is confident a further iteration of the Basel regulatory framework will be formed, but that it will likely be “so watered down that people will get some flexibility”.
“It’s better to have something agreed than nothing,” the panellist said.
Basel IV will likely focus on aligning the many requirements of existing regulations around the world, including Basel III, which will finish being rolled out in 2018.
Trump laid the groundwork for an extensive review of US financial regulation in the opening weeks of his administration by signing an executive order giving the Treasury broad powers to scrap rules that do not comply with his administration’s loosely defined ‘core principles’.
Another panellist argued against ending preparations for upcoming regulatory deadlines on the assumption that they may be postponed, given the lack of appetite for significant rollbacks globally.
Nice to CCP you
No conference would be complete without a panel on central counterparties (CCPs). The tone of the CCP panel was set in a poll from the previous technology-focused panel that revealed that, in terms of allocation, only 8 percent of audience members saw central clearing as their biggest spend.
EU-based CCPs in Asia essentially find themselves back at square one in most Asian countries, although some, including South Korea, offer a CCP facility for securities lending trading.
As it stands, however, no non-state affiliated CCPs are operating in Asia.
Despite some optimism in the conference hall, the problem, at least in the short term, is that the widespread disparity on regulatory standards across Asia makes standardising for a multi-cross-border product highly complex.
This feature of the European lending market, it seems, is still in transit.