Approaching 2020 Year End
As we approach year end, our thoughts naturally move towards the future and this year it seems particularly important. Unprecedented, resilient, and exhausting have all been words that have characterised this challenging year. But as we near the turn, there is a sense that we are perhaps over the worst of it. The recent and promising announcement of effective and available vaccines has provided a much-needed boost. While the long lasting effects of the pandemic on the global economy has yet to be determined, there is a feeling that we are moving into the next phase of the crisis with investors increasingly refocusing on the fundamentals of their investment decisions.
Throughout 2020, securities lending demand has been relatively muted and has been defined by several key drivers including low to negative global interest rates, temporary short sale bans, as well as soaring equity valuations. All these factors have naturally supported a long bias tilt and reduced the need to hedge and consequently borrow securities. As year-end approaches, the focus among industry participants remains on the sustainability of the recent market rally and whether in the coming months, we will witness a less correlated and more bi-directional market rooted in fundamentals. If this pivot transpires, it should increase demand for hedging and may improve conditions for stock pickers. Separately, corporate confidence, which had been severely weakened during the crisis, appears to be returning and with it there has been an uptick in capital restructuring, IPOs, and M&A activity as pent up demand comes to market.
As we run down the final days of the year, the emergence of a global recovery, the impact of further stimulus — both fiscal and monetary — as well as the return of corporate and consumer confidence, are increasingly weighing on investor sentiment. On the geopolitical front, Brexit is in the final act, and although negotiations will be complex and fraught, there is hope that a definitive outcome will be welcome relief for investors. In addition, implications of the ongoing trade war between the U.S. and China continues to rumble on and thoughts have focused on whether there will be a change of tone under a new political landscape in the U.S. Finally, we would be remiss not to acknowledge the increased momentum of ESG investing and how sustainability principles will impact investor demand as well as the broadening implications for investment decisions in the coming year.
Looking Back and Ahead
Although our outlook is positive and optimistic in the main, it is important to acknowledge the ongoing social impact of the pandemic. While we feel that a recovery is underway, we recognise that it remains fragile and the risks and uncertainties that could derail optimism are still very much present.
The dual announcement of a COVID vaccine and Joe Biden’s victory sent the broader U.S. stock market surging. This created securities lending demand, specifically in the pharma, real estate, and electric vehicle sectors. Inovio Pharmaceuticals (INO) and Sorrento Therapeutics (SRNE) drove pharma demand as investors placed bets on the successful distribution of COVID vaccines and treatments. Brookfield Property (BPYU) and The Macerich Company (MAC) led demand in the REIT space as retail shopping areas and urban real estate continue to suffer. Workhorse (WKHS), Nikola Corp (NKLA), and Blink Charging (BLNK) led the way in the electric vehicle space as competition emerged in one of the few markets to grow during the pandemic. Finally, one last event in 2020 that bears attention is the addition of Tesla to the S&P 500. The electric car maker will be added to the index on Dec. 21st, which could result in an uptick in demand to facilitate extraordinary trading volumes, albeit likely for short period.
Additionally, 2020 has seen upward of 300 IPOs priced in the U.S., valued at a record $130 billion according to Bloomberg as of Dec 2020, plus the advent of Special Purpose Acquisition Companies (SPACs), both of which inherently attract interest in the securities lending market. The interest is due to multiple factors, including investor settlement needs and negative sentiment with regards to aggressive IPO pricing. This new demand has added to that for Chinese ADRs which already existed pre-pandemic.
Looking ahead to 2021, President-elect Biden has asked the former chair of the Federal Reserve, Janet Yellen, to be his nominee for Treasury Secretary. It is widely expected that the Fed and the new Treasury Secretary will be on the same page fiscally and a low interest rate environment will persist for the bulk of Biden’s first term. A persistent low interest rate environment naturally promotes healthy deal conditions as buybacks and acquisitions become cheaper and potentially more appealing. We expect to see a healthy schedule of deal activity which has a historically generated and sustained demand in the lending market. These ideal borrowing conditions in the deal space as well as continued interest in the US-China trade war, all point to an expectation of a busy demand environment for the U.S. lending market in 2021.
Canadian equity lending revenues slid in the fourth quarter 2020, as investors unwound cannabis short positions amid reduced sector volatility. Short interest may rebound in the near-term, if Republicans gain control of the U.S. Senate, which could slow legalization at the federal level and consequently have an impact on the demand for Canadian cannabis products. In addition, market sentiment continues to favor U.S. multi-state operators (MSOs) over Canadian producers that will continue to focus on balance sheet repair in 2021. Cannabis and commodities all witnessed significant corporate restructuring in 2020 that should carry into the new year and the divergence in equity prices could continue to pose opportunities for potential increases in M&A activity.
European securities lending demand has been driven by two key sectors. First, demand for securities lending in travel and tourism soared in the likes of Air France, Easyjet, Finnair, Deutsche Lufthansa, and TUI where news of decreased revenue, restructuring, and government bailouts made for common reading. Second, several retail focused names emerged including shopping centre operators such as Hammerson and Unibail as continued rent pressure and falling revenues was caused by non-essential shop closures, E-commerce growth, and shoppers staying at home.
Third quarter revenues across the securities lending industry in Europe rose by 10% compared to Q3 the prior year. This was due predominately to increased corporate restructuring activity via capital raising which flourished in the latter half as many cash strapped businesses looked to the markets for a necessary injection of capital. This has continued into year end 2020 with events in companies such as Rolls Royce, TUI Group, BPER Banca, and Fugro driving lending demand in this space.
Although buoyed by vaccine news, the early stages of 2021 are likely to see a continuation of 2020’s themes as the continent waits for mass vaccine approval and rollout. Restrictions on travel and leisure activities are likely to remain in some form well into the new year. This will likely continue to place pressure on the sectors already suffering, most notably travel and tourism, which are unlikely to see pre-COVID levels of revenue for months, if not years. The uptick in event driven demand is expected to continue as companies look to strengthen cash reserves and make the most of the low interest rate environment to fast-track acquisitions and consolidation plans. Finally, as the Brexit deal deadline looms and differences between U.K. and European politicians remain, we may observe the re-emergence of demand driven by trade related news and on businesses set to lose from any changes to the current trade model.
The impact of the pandemic in Asia was particularly severe for travel related firms. As such, we saw increased demand for regional airlines such as All Nippon Airways, Cathay Pacific Airways, and Singapore Airlines. There was also outsized demand for travel management firms Corporate Travel Limited, Flight Centre and Webjet, as they sought funding from governments or through the equity markets in order to mitigate the effects of their depleted balance sheets.
In Hong Kong, we witnessed an increase in demand for locally listed Chinese ETFs, particularly during the market turmoil in March 2020, as investors sought broad exposure in the domestic ‘A’ share market. Despite the dual challenges of the pandemic and increased political tensions, both locally and between the U.S. and China, lending demand remained steady in connection with robust capital raising activity. Most notably, prominent Chinese firms trading in the U.S., such as JD.Com and Netease Inc., raised funds through secondary listings in Hong Kong. Although the listing of Ant Group, which was set to be the world’s largest ever IPO, was scrapped at the eleventh-hour, the IPO pipeline continued to remain strong in the last quarter of 2020.
Securities lending demand in both Japan and South Korea was significantly weaker throughout 2020. In Japan, the combination of deleveraging of long-term hard-to-borrow names and increased lending supply resulted in lower demand, though an increase in capital raising deals in the last quarter somewhat stemmed the tide. The cancellation or reduction of many dividend payments by Japanese companies also adversely impacted lending demand. In South Korea, demand for borrowed securities was negatively impacted by the continuing ban on short selling that was imposed in March 2020, resulting in lower volumes and fees of long-term specials.
Despite the challenges for APAC lending demand in 2020, there is room for optimism next year. The ban on short selling in South Korea is expected to be lifted in March 2021 which is likely to spur lending demand. We expect a continuation in secondary capital raising deals and IPOs in Hong Kong as concerns of potential delisting of Chinese firms in the U.S., given ongoing tensions between the two countries, is unlikely to abate. In Japan, we expect deal activity to increase as consolidation across various sectors ramps up and activist shareholders continue to seek changes to corporate governance practices. Finally, with equity markets at or near record highs, we expect this may present renewed opportunities for fundamental and long/short strategy hedge funds across the region.
Like most asset classes, fixed income has seen a volatile year. In March and April 2020, we witnessed an increase in demand for high quality government debt primarily driven by a flight to quality as the crisis began to take hold. However, once stimulus and stability measures began to kick in, the uptick began to slow as market confidence returned. Separately, it has been a disappointing year in the corporate bond space particularly for securities lending revenues as weakening valuations in both Investment Grade and High Yield debt instruments failed to translate into meaningful demand from investors.
As we look to 2021, and with the US elections behind us, there are some themes we could see play out. The Fed’s bond buying scheme introduced at the start of the crisis is set to expire at the end of 2020, which could attract more interest from funds. Looking at a micro level, we see pockets of value for beneficial holders taking a long view in highly affected COVID industries such as retail and travel. As the pursuit and rolling out of vaccines will no doubt continue into 2021, the idea of any setback or further disruption to these industries could provide ample demand for issues and see a higher return from lending.
We remain optimistic for demand in securities lending to increase in the coming quarters. The expected focus on the emerging fundamentals, increased confidence in the corporate environment, and more bidirectional movement across sectors, markets, and asset classes, all build a base case for additional securities lending opportunities to come to market. The pandemic will of course continue to have an influence and while early optimism around vaccine prevails, the long-term management of the pandemic will likely take longer. All of these factors and more will likely make for an interesting year.
Opinions and forecasts represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2020. All rights reserved. IS-06866-2020-12-10