Moves by Deutsche Bank and JP Morgan to extend securities lending in Asia underline a push to make a service previously reserved for hedge funds available more broadly to asset owners seeking to boost returns in a low-yield world.
As of last year, the market value of securities available for lending globally was estimated at $10 trillion, and demand for securities on loan across equity and fixed income around $1.5 trillion.
Yet Asia’s share of the global sec-lending pot remains low. From a supply point of view, shortable securities account for less than 10% of the region’s market cap, compared with 30-40% for the US or Europe.
Nevertheless, Deutsche Bank says its decision last month to add agency sec-lending to its principal lending programme in Hong Kong was driven by demand from long-only clients. Similarly, JP Morgan has extended its regional agency sec-lending business to cover Malaysian securities, bringing the number of Asia-Pac markets it covers to nine.
The typical clients of lending agents such as custodian banks are central banks, pension funds, insurance companies, asset managers and other investors who hold fixed income and equity securities.
Principal sec-lending is when banks lend securities exclusively to a borrower. This guarantees revenue to clients and returns can be factored in. Such a service is used in particular by large asset managers, which will lend equity and fixed-income assets for up to a year to exert control over supply and secure better pricing.
Agency sec-lending, on the other hand, is when banks source borrowers in the market on a best-effort basis, with returns to lenders not guaranteed.
“Agency sec-lending complements the principal business," says Fredrik Carstens, Deutsche’s co-head of Emea and Asia agency sec-lending based in London. "Our securities service division focuses mostly on traditional long-only clients such as central banks, and asset managers with large fixed-income and equity portfolios of these securities.”
Principal lending under prime finance at Deutsche largely fulfils the equity financing needs of hedge fund clients’ long/short portfolios. It includes sec-lending for financing repurchase transactions under the bank’s markets division.
By offering sec-lending under both agency and principal structures under two separate divisions, Carstens believes that clients will better be able to distinguish the type of programme they want.
Such tie-ups represent the bank’s response to moves by Asian long-only investors to unbundle their choice of custodian away from sec-lending providers, says Carstens.
Before the Hong Kong desk was opened, Deutsche had been serving clients that borrow and lend Asian securities out of Frankfurt, New York and London. Globally, Carstens leads a team of 40, two of whom are now based in Hong Kong.
Meanwhile, Francesco Squillacioti, Asia-Pacific regional director of securities finance for State Street, tells AsianInvestor that risk management and performance are among the factors clients consider when choosing to go via either a principal or an agency model for securities lending.
To make such a choice, clients are demanding greater transparency, he says. They need more visibility regarding the underlying portfolio that is being lent or borrowed using securities they own.
“A lot of clients want to understand and monitor counterparty exposure, and align interests with a securities lender,” says Squillacioti. “They are looking for strong risk management capabilities, so that the lending programme can be run to meet a clients’ risk appetite.”
Unlike investment banks, custodians such as State Street often do not run their own prime broking division. Still, Squillacioti says by offering both custody and agency sec-lending, the model has the advantage of enhancing operating flow as all aspects of the asset safe-keeping and securities lending are happening within one organisation.
Squillacioti says sec-lending has been used increasingly in recent years as a way to generate incremental return amid the current low-yield environment.