“I am more interested in the future than in the past because the future is where I intend to live.” In assessing what could be the key drivers throughout the coming year, many in securities financing would heed Albert Einstein’s quote. Yet with the past year being so unprecedented, it’s helpful to take a glance at where global markets have come from to support any forecasting. That said, what makes 2021 such an important year for assessing what lays ahead?
For many commentators, 2021 saw a significant shift in perspective as global markets began to contemplate the possibility of a post-COVID environment. The roll out of an effective vaccination program provided much needed relief and the markets reacted accordingly. Both corporate and consumer confidence began to rebound and, as the global economy tentatively started to reopen, investors refocused on fundamentals.
The emerging global economic recovery increasingly dominated central banks’ thoughts, as policymakers quickly started to grapple with the prospect of inflationary pressures while at the same time seeking to support fragile growth. In addition, idiosyncratic events such as the rise of retail investors, spurred on by social media, and almost at the same time the default of a highly leveraged family office resurfacing old concerns related to leverage and systemic impact added to overall uncertainty.
The upshot of this topsy-turvy year was a relatively strong finish with global equities trending to record highs as investors focused on economic resilience and highly accommodative monetary policy. The prospects of faster and heftier interest rate rises, especially in the U.S., came into clear focus and despite the emergence of a new variant there was a sense of cautious optimism as markets largely looked past the impact of COVID and focused on longer term opportunities. Although many are still greatly impacted by the virus, there is hope of light at the end of the tunnel.
The prospect of rising interest rates in the U.S. will likely result in increased volatility for risk assets and provide opportunities for stock pickers. The European Central Bank and the Bank of England may follow suit later in 2022 and we expect investors to actively adjust allocation and positioning accordingly. In short, we expect investors will become more active and increasingly hedged as correlation and dispersion begin to widen. The technology sector is likely to remain under pressure on concerns that it is showing signs of being overvalued and as investors pivot allocation on the prospect of rising interest rates.
We expect that the electric vehicle sector will be in focus, given increasing competition and rising lithium prices for batteries and supply chain shortages. COVID-impacted industries such as hotels and travel, may come in focus again if variants do not come under control. We also expect continued demand for consumer discretionary sectors as the pandemic impact continues to weigh heavy and keeps many shoppers out of malls and brick and mortar shops. Supply challenges experienced in 2021 will likely continue, but there are signs that pressure is starting to ease in some sectors. If this happens, the beneficiaries of higher prices and margins in 2020/21 may come into focus – i.e., shipping and semiconductor manufacturers. Separately, demand for financial stocks remains strong as the equity markets start 2022 with some volatility, signaling a potentially rocky year.
In China, the regulatory overhang is likely to continue with education, tech, e-commerce, property/real estate, electric vehicles, and consumption sectors all remaining under pressure and providing continued lending opportunities. Hong Kong IPO activity is likely to improve in 2022 compared to the second half of 2021 following the revision of listing rules and potential increased listings away from the U.S. Japan’s economy is showing signs of resilience as it emerges from the pandemic – corporate earnings and balance sheets are expected to be strong, potentially leading to increased M&A / buyback activity.
Volatile equity markets kicked off 2022, signaling what could be challenging market conditions in Q1 with investors seeking to refocus on fundamentals. President Biden enters his second year in office with ongoing tensions with Russia, unresolved trade disputes with China, and delays to passing the infrastructure bill, remaining at the forefront.
Finally, 2021 was a remarkable year for M&A activity and the expectation is that this will not abate, and in fact momentum will continue forward. Corporate action activity continues to be vibrant with capital raising via rights issues being a focus. We expect M&A activity to pick up throughout this year as corporates look to consolidate or expand taking advantage of cash surpluses and the prevailing low interest environment.
A Pressing Regulatory Agenda
It is also noteworthy that the regulatory agenda continues to have a direct influence and no more pressing is the arrival of the EU’s Central Securities Depository Regulation (CSDR) penalty regime which comes into effect in February 2022. While there has been much debate and many column inches written about the new settlement discipline regime, it will be interesting to keep a watch on how it could influence demand and market liquidity. Early signs suggest that market participants have made significant efforts to prepare and will likely absorb the new regulation, and avail of its benefits, but it could well lead to increased demand as counterparties bolster inventory to mitigate the risk of fails.
In addition, the U.S. Securities and Exchange Commission (SEC) recently published a proposal seeking public comment on a rule intended to increase transparency in the securities lending market. While much debate will likely ensue, the industry will be keenly focused on investor impact and potential influence on supply and demand dynamics.
The Bottom Line
Though it’s early days, we anticipate that demand in 2022 will continue to echo the previous year with COVID-impacted sectors still in focus but perhaps with less conviction as the reopening trade begins in earnest. However, with investors increasingly looking past the pandemic, and focusing their attention on the impact of monetary and fiscal policy, we expect to see a shift in focus where risk assets begin to trade more on fundamentals and less on accommodative stimulus. This more fundamental focus, less correlated, and potentially volatile markets, will likely lead to increased opportunity for securities lending as investors look to adjust and hedge allocations.
That said, as this post pandemic pivot is in a relatively nascent form, coupled with a backdrop of lingering anxieties of future variants and raising geopolitical tensions, it will likely take time to evolve to a more sure-footed “risk on” environment. From a securities lending perspective, the upshot of this pivot may mean a relatively muted start to the year, especially in the ‘hard to borrows’ until exogenous risks are better understood.
We expect demand to accelerate and broaden trading strategies become increasingly convicted. It is also worth mentioning that the idiosyncratic impact of ‘meme stock’ continues to have a chilling impact on demand and the prospect of an exposed short still weights heavy on investors. We will likely see increased focus and demand for ETFs as investors look for broader exposure to support investment strategies.
On an encouraging note, corporate confidence remains buoyant, and boardrooms continue to push forward with strategic transformation. M&A activity will continue to provide securities lending opportunities; and capital restructuring, or reorganization, will likely dominate as companies refocus on long term investment and growth strategies.
Moving Forward: Recalibrating For the Long Term
Overall, it is shaping up to be a very different year where pandemic concerns abate, and the long-term focus comes back into sight. From a securities lending perspective, the table is set for a fascinating year where governments, markets, companies, and investors all look to navigate the post COVID environment. This recalibration will likely act as a catalyst for more robust securities lending demand and opportunities, especially in the long run.
Brown Brothers Harriman & Co. (“BBH”)
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