Supply constraints, anaemic growth, and persistent concerns of a recession continue to weigh on investor sentiment as policymakers focus on controlling inflationary pressures.
From the hawkish central bank policies witnessed at the beginning of the year to the banking crisis in February, the increased anxiety of what was coming next kept many investors on the side-lines.
Looking ahead, policymakers will likely have to hold their nerve a little longer on interest rate policy until they feel target inflation rates has been achieved.
As we enter H2, there is a glimmer of hope, particularly in the U.S., where consumer purchases figures suggest the battle is beginning to turn. However, many commentators continue to warn that any predictions of aggressive interest rates cuts are premature.
Overall, the markets are reflecting much of this shifting complexity. The emergence of mega trends in AI spurred on by the release of ChatGPT, strained trade negotiations between U.S. and China, and the ongoing Russia/Ukraine war all helped to generate increased market volatility and greater divergence in the capital markets.
This divergence and market volatility has created significant opportunities in securities lending. Hard to borrow securities, however, remained increasingly concentrated throughout the first half of the year in key sectors such as AI/digital disruptors, real estate, and technology with U.S. and Asian equities mostly in focus.
The global securities lending market performed strongly versus a backdrop of increasing complexity with equities and fixed income all generating record returns. We expect this volatility will likely prevail for the foreseeable future and the securities lending revenues will be granular and targeted to a concentrated set of opportunities.
Let’s look at these opportunities across each region.
Securities lending revenue and volumes have hit record highs this year, building off 2022’s strong performance with names such as AMC Entertainment, Beyond Meat and Lucid leading the charge.
Overall, demand to borrow U.S. equities was strong and spread over diverse asset classes. Electric vehicle (EV) companies, technology firms that focus on AI programming, and financials were sectors that drove strong directional demand. AMC is currently amid one of the most lucrative deals from a securities lending perspective in over 10 years, as it proposes to convert a preferred line into common A shares on a 1:1 basis.
ETFs remain a popular choice for investors to gain exposure to a targeted sector or region. There are some cases when a specific ETF holds certain asset classes, such as long-term debt instruments, whereby it is more efficient to short the ETF than the actual corporate bonds themselves due to liquidity.
In mid-2022 and into 2023, the preferred share class of stocks also saw demand increase; particularly in the financial sector, and more specifically regional banks, as we saw the Federal Deposit Insurance Corporation being appointed as receiver for the insolvent Silicon Valley Bank prior to its takeover by JP Morgan. Subsequently, the robustness of many other regional banks is being increasingly scrutinized by regulators.
The increased interest rate environment resulted in broad directional interest in several European sectors. Industrials such as Oesterreichische Post, SAS, SGL Carbon, and Varta were in strong demand. In the consumer services/discretionary sector ASOS, Basic Fit, and Cineworld also generated strong returns. Continued strong lending demand in several firms such as Aroundtown, Immofinanz, and Samhallsbyggandsbolaget resulted from high operating costs in the real estate sector.
Corporate deal activity in the first half of 2023 has been especially strong with capital raising via rights issues in focus and a few notable convertible bond issuances such as Meyer Burger, Swiss Prime Site, and Voestalpine. We have also seen a strong pick up in M&A activity dominated by cash/share tender offers and share buybacks.
Regulatory changes in Austria resulted in reduced liquidity across the market which provided opportunities for lenders to generate higher spreads if they were able to navigate some of the challenges around changes related to eligibility of dividend entitlements.
Investment grade corporates in Europe remain discounted compared to historical norms of the past decade. Corporate margins and leverage have recovered post the pandemic and cash flows should remain adequate to protect bond holder pay-outs. As a result of this, we have seen utilization levels in European corporates slightly lower compared to 2022. Key issuances in demand have been in the financial sector and automotives.
Regional securities lending demand was robust with strong levels of activity seen across several markets. Equities rallied in the Nikkei-225 and Topix indices, partly spurred on by strong foreign investor inflows, which in turn contributed to an increase in directional trading activity. High profile share sales by Japan Post Bank and Rakuten Group as well as continued directional demand in the shipping sector helped drive strong lending returns.
In Hong Kong, the euphoria in the markets that began in late 2022 after the re-opening of China’s borders fizzled out from late January sending the local index into bear market territory. As a result, we have seen active securities lending interest in the autos/EV manufacturing and technology sectors as well as Chinese property and real estate firms, with the latter due to renewed concerns over sluggish demand and developers’ ability to meet debt repayments.
In South Korea, we witnessed an increase in tender offers, which helped spur strong lending returns in securities such as Meritz Securities and SM Entertainment. A robust retail-investor driven rally in South Korean EV battery manufacturers, due to attractive growth prospects and favorable subsidies in the U.S., resulted in increased directional interest in several manufacturers as some investors believe valuations had been over-stretched.
With geopolitical tensions increasing across the Taiwan Strait as well as slowing demand for chip equipment PCs and notebooks, we continue to see broad lending demand in the Taiwanese semiconductor and technology sectors. Airlines and shippers such as China Airlines, Eva Airways, Evergreen Marine, and Yang Ming Marine also remain in focus on concerns over inflation and reduced shipping rates.
We expect lending demand to be strong in consumer services, discretionary as well as the real estate sectors as they are likely to continue to face challenges due to higher operating costs because of higher energy prices and tighter financial conditions.
We also expect geopolitical tensions in the Greater China region to continue to negatively weigh on sentiment. The mainland Chinese economy is likely to remain soft for the foreseeable future, which should continue to drive securities lending demand across several sectors such as consumer discretionary, property and technology. We expect corporate deal activity to remain steady in Japan and South Korea and in Australia, it is likely that demand will continue in the lithium mining sector as producers grapple with softer prices.
The quick rise and distribution of AI over the last 12 months will be highly scrutinized across certain industries in the coming months. Jobs/industries which rely heavily on coding, development, data entry, research, and customer services will likely be affected the most, and the economic impact of AI adoption will have inevitable downstream ripples for demand in the securities lending market.
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