JUMPING THROUGH HOOPS
By Kathryn Tully
In the hunt for demand and revenue, securities lending in emerging markets sounds perfect, but big obstacles still curtail liquidity.
Faced with falling demand and tighter regulation in North America and Europe, securities lenders and agent banks, you might think, would all be looking to emerging markets to boost revenues. Yet even in crucial BRIC economies, which boast both the demand and regulatory framework to enable offshore securities lending, there are still significant barriers to entry.
John Arnesen, global head of securities lending at BNP Paribas Securities Services, says that although Brazil and India are of interest to securities lenders because of the size of their economies, liquidity is limited and there is little offshore activity. “India, for example, has loosened restrictions and now allows loans of three months instead of one month, yet if you look at conventional transactions from an off-shore agent lender to a borrower, the volume is tiny.” One obstacle to faster offshore development is that both countries operate central clearing counterparty models, where collateral received for lent securities is held by the national exchange, not by the agent. “Because this isn’t a familiar model, clients are less interested in those markets and agent lenders have less impetus to operate there. Markets that use central counterparty clearing houses will continue to suffer from lower liquidity, unless the fees are so lucrative that agent lenders address some of these barriers to entry.”
By contrast, markets such as Poland, South Africa and Turkey, with established over-the-counter securities lending structures, will continue to attract liquidity, according to Arneson: “In Poland and South Africa, more lucrative yield-enhancing structures are possible, and in all three there is borrower demand derived from directional shorting and capital-raising.”
Yet Turkey and Poland, along with many Asian emerging markets, also impose rather draconian penalties if trades fail. “Whether via a fine, mandatory buy-in, or in the worst case, the loss of a trading license, penalties can be financially severe and cause reputational damage too,” says Paul Solway, regional head of equity finance for Asia-Pacific at BNY Mellon.
Solway says that securities lenders who want to succeed in Asian markets need to be flexible about the collateral they receive. “The good news is that most Asian markets now accommodate for both lender and borrower to negotiate the required collateral—usually any combination of cash, bonds or equity.”
Given the demand for securities across Asia, Solway thinks that Malaysia, Indonesia and Thailand could all offer promising growth for international securities lending in 2013. “Malaysia’s legislation now allows onshore and offshore institutions to participate in the Bursa’s securities lending platform. Thailand and Indonesia are watching very closely the progress and growth of Malaysia as they assess the right model to develop their own exchange offerings.” Since the country lifted its stock short-selling ban in November 2011, he notes, demand in Korea continues to grow — particularly in the shipping, chemical, energy and tech-heavy sectors.
What about China, the granddaddy of emerging markets? After all, Hong Kong, with its well-established, well-regulated and liquid market, is already the darling of Asia’s securities lending industry. Arnesen thinks that mainland China will become an important market if non-Chinese institutions are able to participate one day, but that it is not there yet. In his view, the other BRIC economies have got some way to go, as well.