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US equity special balances decline sharply from peak
Nikola Motors most revenue generating security of the month,
$106m
German equity specials deliver
Global securities lending returns increased 1.4% YoY in July.
During the first half of 2020 securities finance trends emerged and
receded rapidly; July presented a similar reversal of recently
prevailing trends. Surging US equity special revenue was a defining
characteristic of Q2, with on-loan balances increasing sharply as
the broad market rally had an outsized impact on less liquid
equities; That trend reversed in July as hard to borrow (HTB)
shares underperformed and some arbitrage trades closed out.
Similarly, total returns for fixed income lenders soared in Q2 as
the result of Federal Reserve rate cuts along with increased borrow
demand, which both widened fee spreads and increased reinvestment
returns; Fee spreads and loan balances declined in July and
reinvestment returns remained on downward trend from March peak. In
this note we'll examine some drivers for securities finance borrow
demand and lending revenue for July along with implications for the
remaining five months of 2020.
July was the first month of 2020 to see a YoY increase in
European equity lending revenue. There were a few drivers of the
$141m in July revenue, a 21% YoY increase. To some degree the
relative outperformance YoY in July could have been anticipated,
based on dividends which were delayed into the month which
otherwise would have fallen in Q2. In addition to the shift in
seasonal demand, a handful of equity specials did emerge which also
contributed to YoY revenue growth. German equity revenues continue
to be robust despite Wirecard no longer appearing on the top
revenue generating securities; Deutsche Lufthansa Ag and Varta Ag
were among the top 20 most revenue generating securities in July
and combined for 48% of German equity lending revenue. For all of
Europe equity lending revenues are down 29% YTD through the end of
July.
Americas equity revenues came in at $436m for June, a 13% YoY
increase; The $2.3bn YTD total reflects an increase of 25% YoY. US
equity revenues exploded higher in June, led by a handful of
specials, however the broad short squeeze in hard-to-borrow shares
had the knock-on impact of increasing special balances broadly. The
increased special balances persisted into July; however daily
revenue declined steadily during the month. US equity revenue for
July came in at $396m, a 22% YoY increase, however it's worth
noting that the last week of the month had the lowest revenue for
any week since the last week of April.
SPAC arbitrage continues to be a driver for US equity special
balances; Nikola Motors delivered $106m in July revenues on the
back of eye-popping fees in late-June and early-July ahead of the
increased liquidity provided by warrant conversion, the most for
any security globally. While the SPACs have certainly garnered
their share of headlines, other corporate actions which drive
borrow demand such as M&A and convertible issuance continue to
bolster lending returns as the market continues to rally. Match
Group Inc was a particularly remunerative example, generating $41m
in June revenue in front of the completion of the spin-off from
former parent company IAC on July 1st; The conclusion of the trade,
which had $3.6bn in average balances for June, was a contributor to
the July decline in US equity special balances.
Canadian equity lending had $39m in July revenues, a 33% YoY
decline (or a 15% MoM decline compared with June). Declining
revenue from lending HTB shares was the primary culprit for revenue
decline, with July average fees declining 31% YoY, while on-loan
balances only declined by 4%.
Asia equity lending revenues remain subdued, with July revenues
of $118m reflecting a 23% YoY decline. The largest market, Japan
equities, delivered $44m in July revenues, broadly in line with the
Q2 average monthly return; YTD revenues of $347m reflect a 25% YoY
decline compared with the same period in 2019. Hong Kong equity
lending revenues have been steady at just over $30m per month since
May, with July revenues of $31.2m reflecting a 31% YoY increase.
The upswing in HK returns which started in May has been broad based
with a handful of HTB equities leading in roughly equal measure,
while overall balances and fees have grown YoY. The YTD returns for
HK equities are still down 14%, owing to substantial shortfall over
the first four months of the year. Australia equity returns for
July declined by 16%, entirely the result of lower on-loan
balances, while average fees have shown a YoY increase for each
month since April. The short sale ban in South Korea has limited
lending revenue, with $14.9m in July revenue being the lowest for
any month of 2020 and reflecting a 54% YoY decline.
Global ETF revenues were $31.8m for July, a 27% YoY increase,
however it is also the lowest monthly revenue for the asset class
since February. The lower returns relative to Q2 are the result of
declining on-loan balances, however both metrics remain elevated
compared with pre-COVID levels. The top five most revenue
generating funds are illustrative of overall demand, with iShares
Russell 2000 fund first (IWM) and the SPDR S&P 500 fifth (SPY),
with three China focused funds in the between them. Global ETF
utilization in July extended the trend lower from the March peak,
as borrow demand failed to keep pace with the growth in lendable
assets.
Corporate bond lending revenues continue to fall short of 2019
comparison, mostly as the result of fees declining 24% YoY, however
balances have also declined by 8.6% YoY. Corporate lending returns
came in at $35.3m for May, a 33% decline YoY. Central bank support
for global credit has dampened borrow demand, however the market is
bifurcated. In the high-yield space credit events are piling up,
and bonds from some distressed issuers are generating elevated
lending returns, however broad returns for the asset class were
stellar in July, which may have kept a lid on broad borrow demand.
The utilization of corporate bonds in lending programs continues to
decline from the late-March peak; Lendable assets were 8% higher in
July than March, while on-loan balances declined by 10% during that
time.
Fee-based revenue for US government bond lending came in at $68m
for July, a 5.5% YoY increase resulting from larger loan balances.
From the peak revenue in April, the downtrend in spread returns for
UST lenders has been steady, with July delivering the lowest
monthly return since February. For beneficial owners, returns from
lending US Treasury securities in 2020 have been substantially
bolstered by reinvestment of cash collateral, however reinvestment
returns have steadily trended lower since late March as well.
Returns from lending European sovereigns were $38m for June, a 1.9%
YoY increase as the result of slightly higher balances and fees.
Global government bond fee-based revenues are up 10% YoY through
July 2020.
Conclusion:
A substantial portion of the demand for the most revenue
generating securities was driven by arbitrage trades of various
types. While the durations of these trades vary, the increased
corporate action related borrow demand appears likely to remain in
place for the latter portion of 2020 as firms seek to optimize
their operations for a rapidly changing corporate landscape.
After a challenging period for many equity short sellers from
April to June, high-fee US equities underperformed relatively easy
to borrow shares in July, generally a boon to long-short equity
strategies. With that said it's worth bearing in mind for
conversations about "short sellers", that convertible or SPAC
warrant arbitrageurs will generally benefit most from an increase
in share prices.
Global securities finance revenues increased 1.4% YoY in July
however the trend is to the downside, with utilization steadily
falling since March, reinvestment returns declining and US equity
special balances heading back toward baseline trend after Q2 surge.
Some of the key H1 drivers of lending revenues may be fading in Q3,
however the reversals of trend have been rapid in 2020.
Our 2020 mid-year review is available
here, as always stay tuned for monthly updates from IHS
Markit.
Posted 07 August 2020 by Sam Pierson, Director of Securities Finance, S&P Global Market Intelligence
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