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With the global economic havoc caused by COVID-19, securities
lending revenues declined 18% YoY for the month of March, despite
an increase in borrow demand for some asset classes, most notably
exchange traded funds. Total Q1 revenues decreased by 5.5% YoY,
however that belies the evolving mix of demand drivers and spread
incomes. After reaching an all-time low in mid-January, equity
utilization increased by a third to end March at 5.6%.
Driving the increase in utilization, global equity lendable
assets declined at a more rapid pace than loan balances, causing
the largest one 30-day increase in utilization since May 2011. The
peak in utilization was on March 23rd, reversing the last twelve
months during which lendable asset growth dramatically outpaced
borrow demand.
Global equity borrow demand increased globally over the first
two weeks of March, resulting in loan balances only declining by
3%; most equity indices declined by at least three times that
amount. There are a few factors at play, likely including borrow
demand for new shorts, both single name and borrows for creation of
ETFs. Another potential factor is dealers shifting sources of
borrow, from internal to external, for existing short
positions.
North American equity revenues came in at $884m for Q1, a
decline of 9% QoQ compared with Q4 2019. The major event in March
from a revenue perspective was the McKesson exchange offer for
shares of Change Healthcare on March 9th, which generated just over
$33m in reported revenue.
Some context for US equity borrow demand is provided by the
bi-monthly reporting of US broker-dealer short positions via
exchanges. Year to date, through the most recent March 13th short
interest reporting, the value of short positions declined by $181bn
or 21%; the value of US equity borrows reported to IHS Markit only
fell by $42bn YTD, or 8%. The ratio of value of borrowed shares to
value of reported short positions reached 72% on February 13th, up
from 61% as of the end of December. The implication is that the
combination of borrows for create-to-lend ETFs and replacement of
previously dealer internalized borrows caused loan balances to
decline by less than short interest values.
Asia equity revenues totalled $427m in Q1, a 22% decline YoY and
a 2% decline QoQ compared with Q4. That makes Q1 the least revenue
generating quarter for lending Asia equities since Q2 2017. The
general trend in the region of more GC demand and fewer specials
remains in place. Asia equity lendable assets reached $2T for the
first time in late December 2019 and set a new all-time high of
$2.1T in early January.
European equity revenues totalled $282m in Q1, -22% YoY. The Q1
revenues were the lowest for any quarter since Q3 2014. Compared
with Q1 2019, loan balances and fees are down, depressing revenues,
while lendable assets have increased, pushing down on utilization.
The utilization down trend did reverse course in March, which may
set the table for increase returns to lendable assets in Q2.
Borrow demand for ETFs surged in late February and early March.
Revenues from lending ETFs also increased, with $97m in Q1 revenue,
the most since Q4 2018 record of $107m. The uptick in demand was
broad and the top 10 most revenue generating funds paint a portrait
of what was on the minds of investors in Q1; high-yield credit,
EM/China focus and US equities across the market capitalization
spectrum. The revenue from lending fixed income funds came in at
$24m in Q1, more than doubling the returns in Q4, and delivering
28% of all ETF lending revenues. Part of the uptick in borrow
demand for ETFs in was likely driven by short term unwinding
create-to-lend trades, which is reflected in increased borrow
demand for ETF shares (beyond changes in short interest), with
similar dollar amount outflows from the funds. Those flows may have
reversed over the last two weeks of March, with substantial inflows
to ETFs, increases in GC single name borrowing and a decrease in
borrow demand for ETF shares.
Given the stress in credit markets, it's interesting to note
that there's been relatively little pickup in lending revenues or
spreads for corporate bonds, despite global CDS indices reaching
post-GFC wides in March. There was some pickup in borrow demand
during the first week of March, pushing global corporate bond loan
balances to a post-GFC peak of $213bn on March 9th; the uptick in
demand was short-lived and failed to produce a substantial increase
in revenue. The failure of increasing demand to push up on revenues
was partly due to the concentration in demand for investment grade
credits. After the brief increase in demand high-yield revenues
declined over the last two weeks of March, doubly put upon by
falling valuations and an active reduction in face value on
loan.
Borrow demand for sovereign debt has been relatively flat, with
fees being the more dynamic aspect for the asset class. Over the
course of Q1 sovereign loan balances increased by 4%, while loan
balances with negative spreads fell by 9%.
Conclusion:
As noted in our February update, securities finance revenues
often pick up in times of market stress, which is most often true
in terms of returns on lendable assets, but also sometimes true in
absolute revenue terms, for example US equity and credit for
late-2015/early-2016, EM equity for middle of 2018, EU equities in
2012 and ETFs in Q4 2018. Exchange traded funds and GC equities
have been the primary beneficiary of increased borrow demand and
revenues during the virus related 2020 economic slowdown. Equity
balances have proven resilient, leading to an increase in
utilization, however lower fee spreads have slowed the increase of
return on lendable assets (also worth noting the increase in
utilization is coming off the all-time low). There has been a
dearth of emergent equity specials during the sell-off, however
given the speed of the decline it makes sense that demand for
liquid hedges have led borrow demand. Going forward the lack of
IPOs with lockup expiries will be felt in YoY comparisons, however
not all demand drivers for 2019 have dried up, with the Cannabis
sector still seeing outsized fees and revenues. The relative
stability in government debt lending revenues, and the ongoing
stress in credit markets, may drive increased fixed income revenues
going forward (provided the asset classes aren't purchased wholly
by central banks). As the global economy reacts to the stoppage of
activity resulting from the pandemic, the uncertainty of future
investment returns is elevated and the need to both hedge exposures
and generate excess returns is paramount, which ought to be a
constructive environment for securities lending market
participation.
Posted 03 April 2020 by Sam Pierson, Director of Securities Finance, S&P Global Market Intelligence
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