Securities Finance Industry News | Emerging markets: unlocking dead capital and new liquidity
Growing support for new markets in the Middle East, Africa and China is growing in the securities finance sector, alongside ambition to unlock new liquidity. Accessing additional potential and connecting national markets to international players has become essential after the sector continues to operate in a difficult environment.
FrontClear, an organization focused on maturing money market funds (MMFs) and capital markets in developing markets, seeks to unlock access to global and interbank markets by providing advice and improving the regulatory framework to enable the opening of these markets.
Sarah Nicholson, Director of Consolo, speaks at the 29th Annual International Securities Lending Association (ISLA) Collateral Funding and Management Conference as a representative of FrontClear.
Working in the Ugandan market, Nicholson says the focus in these markets is to provide liquidity and stability by opening MMFs. If money market funds do not perform well, the industry could face additional market risk and the markets failing to function properly.
Nicholson adds, “By focusing on capital markets, the FrontClear-run project enables securities lending and repurchase agreements to move capital. Freeing up this otherwise dormant capital and pumping it back into the market through repo transactions and more broadly into money markets will help local businesses manage macro-shocks, provide the medium and long-term financing they need really need and help this market resilience.
In the Ugandan market, a significant portion of government bonds are held by pension funds and institutions under a hold-to-maturity strategy. This blocks market liquidity, discourages people from investing in the market, and prevents capital from moving into the market.
Expanding on the importance of new markets, eSecLending Managing Director of Product Development Ed Oliver says that if a participant becomes an early entrant into new markets, that participant is likely to carve out lion’s share of revenue. Over time, as liquidity increases in the market, the typical dynamics of supply and demand apply and earnings “fall off a bit”.
“We have clients who invest in emerging markets who are acutely aware of this opportunity and are pushing us as a loan officer to ensure that we are doing what we can to operate in these markets in the safest way. possible,” Oliver interjects. “To do that you need the right infrastructure, the right rules and regulations, but once that’s in place, it’s all about trying to get that supply to market.”
Find a way to market
According to Patrick Archenhold, head of securities lending operations at Morgan Stanley, four components are important for any market. These are ease of access, stability of inventory and funding, liquidity of inventory, and cost of operating the market.
He continues: “When we look around the world, the first route to markets for companies is usually a synthetic model, mainly because of ease of access. When looking to grow a market, having a limited universe of counterparties to trade with starts to inhibit growth. If you look at what securities lending brings to the market, going back to the other three points, it can bring stability to stocks and funding for real money long-term investors.
“It can also provide the liquidity and breadth of inventory that we need from people to really look at short ideas. On an ongoing basis, the cost ends up being significantly lower because, in a synthetic-only market, the dealers keep inventory on their books whether they use it or not.The on-demand title lending market gives you more flexibility.
Although the synthetic model is becoming a “first way” option in the market, it brings a certain complexity that not all beneficial owners would be able to resolve or are favorable to resolution. Oliver of eSecLending agreed that the traditional route gives beneficial owners more options.
This complexity represents a constraint for participating in synthetic transactions. Oliver advises participants that if they want to “inject liquidity into a market”, the securities lending route is the preferred option. He explains, “We don’t support the synthetic route, but we have customers who will use the synthetic route and transact with people like Patrick. But for us, it is waiting for the securities lending market to be in place.
As chair of ISLA’s Developing Markets Working Group, Oliver says Turkey is a market that ISLA members have been lending to for several years. One of the issues highlighted by Oliver was the concern of beneficial owners over the “two hits and out” rule. Section 35 explains that if a participant defaults twice within a three-month period, it may have to pre-finance its purchases and sales. This can be handled by a loan officer through different channels.
“We are all familiar with the concept of stamps and, in some cases, pre-sale notification. As soon as you enter into these kind of measures it limits the amount of supply you can bring to the market, some people won’t come into the market at all, some people will, but because you put measures of ‘mitigation around that, it limits how much you can actually advance as supply,’ Oliver comments.
Before considering a deal, Consolo’s Nicholson warns that a “phenomenal” level of due diligence must be achieved. One of the complications is the minute details, which can surprise companies. For example, Nicholson recalls previous situations where accounting practices in a particular market differed from international standards, leading to complications.
With a multitude of opportunities present in markets around the world, industry experts predict the future potential of markets in Asia and the Middle East and North Africa (MENA) region. With so many markets on the radar, it is difficult to determine which region offers the most attractive opportunities, whether it is those already mentioned or the lending opportunities that are currently emerging in Central and Eastern Europe.
“We work in some of these markets and have worked with onshore infrastructure providers for many years. You have to keep all the balls in the air and keep the engagement going and I think that’s key,” eSecLending’s Oliver interjects. “Being able to have this ability to help introduce best practice internationally to onshore providers and hopefully when securities lending moves up the agenda, change happens. This is what we expect. »
Focusing on China, Morgan Stanley’s Archenhold says there is no liquid offshore lending facility left for A-shares. Billed as the world’s second-largest stock exchange, China is currently only partially represented in the MSCI EM indices. “If it becomes more important and an offshore mechanism is established, there will be a good opportunity for growth in China.”
“Other potential opportunities include the MENA region,” says Archenhold. Considering its presence in major emerging indices, adjusted for free flow, you’re looking at half a trillion in investable assets. Looking at four or five key markets, as in the case of China, there is no established mechanism for securities lending. There are multi-billion or multi-trillion dollar companies in these markets that aren’t currently covered by securities finance, and I think that’s exciting.
According to Neil McLeod, Head of Group Treasury Markets, Erste Group Bank AG, there is real potential in the Eastern European region, particularly with the region’s “relatively friendly” regulatory rules and an absence major constraints. Also, from the perspective of someone in retail banking, McLeod indicates a natural shift into the asset management industry. In fact, the industry can visualize the development of each of these economies and go with the flow in terms of larger investments, which, in turn, actually require larger securities financing.
Analyzing the region in more detail, McLeod reflects on the benefits of financing and lending operating titles outside of the spot market. With increasing pressure on all banks in the region and an influx of balance sheet constraints, the situation in the MENA region is becoming “extreme” for various reasons. He continues: “The more you can optimize the guarantee, the more the situation will improve or strengthen. I see that happening right now in the sense that we’re starting to see increased volumes. »