Year on year, securities on loan globally have fallen somewhat, from $1.9 trillion in mid-2011 to $1.8 trillion today, while over $12 trillion worth of securities remain available for lending.
That masks a less visible but positive trend in Asia, where sec-lending markets are developing in places such as India, Malaysia and Taiwan, where none previously existed. The lending base is also becoming more diverse, as some sovereign wealth funds experiment with lending assets.
That bodes well for the industry’s long-term development, but current market conditions are dampening interest among asset owners to on-lend their stock.
This is expressed specifically in reduced demand among lenders to demand cash collateral. Asset owners are cash rich, and with super-low interest rates it’s difficult to use cash to generate a return, says Andrew Cheng, who runs JP Morgan’s Asia ex-Japan sec-lending sales. He says five years ago, 80% of the industry’s collateral pool was cash, but that’s now only 60%.
The US federal funds rate is 0-25 basis points, and the European Central Bank’s policy rate was recently cut to 75bp, both historical lows. Lenders fear not being able to generate a return that would cover the rebate they had agreed to pass back to borrowers for posting cash collateral.
As a result, lenders are more focused today on the spread they can generate from the intrinsic value of the securities. As borrowers today prefer lenders that are more flexible regarding the range and quality of non-cash collateral, lenders are more likely to accommodate such collateral flexibility, if justified by attractive spreads.
Simultaneously, Asian lenders are warming to the idea of being more flexible in their collateral guidelines, and accepting cross-currency sovereign collateral, says Sean Greaves, head of Bank of New York Mellon’s global securities lending in Hong Kong.
Money-market funds, the traditional destination for collateral, have since tightened standards and are now safer, but returns are very low. So lenders are now investing cash collateral into reversed repos.
The lender typically buys government securities from another bank, with that third counterparty agreeing to repurchase the debt at a certain time and at a rate that should compensate the lender.
Banks are hungry to borrow paper of up to 30 days’ maturity to meet new liquidity requirements under Basel III. Their varying needs make it possible for lenders (or their agents) to customise tenors or other features of reverse repos.
For lenders looking to keep returns robust, this effectively means adding counterparty risk. Complexity is the price paid for better returns in a low-yield world.
A fuller version of this story appears in the September edition of AsianInvestor magazine.