Our Insights

Perspectives on Canada’s securities lending market

In conversation with Don D’Eramo

Donato D’Eramo, Managing Director, Securities Finance, RBC Investor & Treasury Services and president of the Canadian Securities Lending Association (CASLA) discusses the impact cannabis legalization has had on the securities lending market, as well as other opportunities and trends.

What are the main opportunities and challenges borrowers and lenders are seeing in Canada?


Don D’Eramo
Managing Director, Securities Finance,
RBC Investor & Treasury Services

Beneficial owners are demanding greater access to reporting and data insights as they seek more timely and granular information to help identify the precise nature and location of their assets. As a result, we are seeing the development of increasingly sophisticated technology capabilities that provide improved connectivity, as well as enhanced trading platforms that support a high level of straight-through-processing.

By leveraging technology to deliver data to lenders, we are able to move latent revenue directly to the bottom line. Insights can include the provision of information on potential revenue gains from a particular voting decision, the removal of restrictions on a stock or specific aspect of a portfolio, and securities that are not yet part of a lending program.

Fixed income lending opportunities remain strong. Requirements around capital ratios continue to support demand for financing, balance sheet optimization and, in turn, high-quality liquid assets. These pressures may result in terms that extend beyond the current three- to six-month periods.

Emerging market lending volumes are still relatively low but opportunities are growing. We anticipate that emerging market assets will be more prominent in our client discussions going forward. In addition, an increasing number of beneficial owners are expanding into the alternatives space, beyond the traditional long-only lending paradigm and into levered or 130/30 type strategies, which include a borrow component.

Will there be any bumps in the road in 2020? What will be the main challenges for the securities lending market in Canada?

An ongoing topic of discussion is the viability of CCPs in the securities lending industry. As regulatory reform continues to change the dynamics of our industry, the implementation of a CCP model has the potential to address the impact of capital usage and risk-weighted asset (RWA) constraints on securities lending, as well as the way we effect lending transactions. Introduction of CCP services in the Canadian marketplace has been under discussion for a number of years and the conversation among CASLA members is ongoing.

The Canadian securities
lending environment
is experiencing rapid
change on multiple
fronts from changing
collateral management
practices to evolving
routes to market

Consistent with our global peers, the Canadian securities lending industry faces a number of challenges from a regulatory readiness perspective, including Securities Financing Transactions Regulation, Central Securities Depositories Regulation and pledge structures. Significant work is underway by industry participants to ensure that solutions are in place to accommodate these new regulations, which are designed to enhance transparency and risk reduction across the industry.

What effect has the legalization of cannabis had on the securities lending market in Canada?

Despite subdued ‘specials’ activity in the Canadian market, the cannabis sector remained a particular area of interest in 2019, dominating the warm and hot space. Given the volatile market conditions and increasing supply in the lending market, both demand and lending fees for cannabis assets varied widely.

As companies in the sector become more mature, we expect a greater prevalence in large capitalization indices, which ultimately influence demand. In addition, mergers and acquisitions activity has provided opportunities for securities lending revenue, and we anticipate that further industry consolidation will drive increased demand for lending.

Stock borrow costs in the cannabis sector far out-performed the market average last year. Do you see this trend continuing in 2020?

The cannabis sector has largely driven the specials market over the past year and the trend toward higher price points and demand volatility is expected to continue. Prior to Canada’s legalization of cannabis in October of 2018, borrower demand was largely driven by uncertainty around the timing of implementation in conjunction with uncertain revenue forecasts. Post-legalization, demand has been driven by pressure on cannabis companies to meet their revenue forecasts in the context of decreased financing availability and ongoing consolidation.

What other trends are you seeing in Canada’s securities lending market?

The cannabis sector
has largely driven
the specials market
over the past year
and the trend toward
higher price points and
demand volatility is
expected to continue

The Canadian securities lending environment is experiencing rapid change on multiple fronts―from changing collateral management practices to evolving routes to market and a higher pace of technology enablement.

Efforts to streamline collateral through triparty agents and contract-compare functionality have resulted in enhanced efficiency within the front-office, as well as the middle and back offices. As the industry evolves, the scope of non-cash collateral will continue to expand through the addition of exchange-traded funds, new indices and lower-rated corporate bonds.

Securities lending routes to market continue to evolve given increased transparency and changing market demand. This has led to additional alpha-generating opportunities including term trade structures and corporate optionality events.

Beneficial owners are increasingly utilizing emerging technologies to optimize their securities lending programs. For example, Canadian firms have been working to enhance efficiency through automation of the borrow/return process, enabling the trading desk to focus on value-added opportunities. Machine learning has the potential to enhance returns and reduce operational risk from post-trade activities. In addition, distributed ledger technology could be a significant game-changer, providing agents and counterparts with a single view of securities lending transactions in real-time.

Concurrent with advancements in technology and risk management, a growing number of beneficial owners are returning to securities lending or opting to participate in lending programs for the first time. Whether it’s to offset costs or take advantage of leverage strategies, beneficial owners are looking for a more granular, consultative relationship with their agent and a deeper understanding of the dynamics of lending. More and more, lenders view securities lending as an opportunity to enhance competitiveness in today’s volatile marketplace.

What is on CASLA’s agenda for 2020?

During 2020, CASLA will be implementing a number of changes to broaden our membership base and enable greater member participation. As the industry continues to evolve, we will be setting up stakeholder working groups to focus on areas such as regulatory change, tax considerations and beneficial owner engagement.

I anticipate that, given recent headlines around sustainable finance and short selling, there will be in-depth discussions on these topics as well. CASLA will also be looking for opportunities to expand the conversation to include our international counterpart associations. 2020 marks the 10th anniversary of CASLA’s Annual Conference on Securities Lending, which will be held on June 4, 2020, in Toronto.

We are once again planning an ambitious agenda and interesting lineup of speakers. Last year’s conference had a record turnout and we expect delegate numbers to grow even further in 2020.

 

Sources

This article was originally published in Securities Lending Times, Issue 243, January 7, 2020.