Kyle Kolasingh, Associate Director, Securities Finance at RBC Investor & Treasury Services, discusses the impact of the COVID-19 pandemic on securities lending and how it may reshape future transactions.
1. What were some of the early impacts of COVID-19 on securities lending activities?
The market volatility experienced globally translated into a significant surge in securities lending activity. Beneficial owners took broad-based positions, in efforts to hedge rapidly changing market conditions, which resulted in increased transaction volumes as well as the number of loan reallocations and recalls. This was all evolving amidst the unprecedented global move to work from home.
Opportunities to
optimize portfolios
through securities
lending continue
to exist
Overall, this led to a temporary tightening in lending supply resulting in higher fees for some asset classes and securities. For example, we saw an increase in the demand to borrow exchange-traded funds (ETFs), specifically those tracking North American indexes. Additionally, demand to borrow on HQLA (High Quality Liquid Assets) surged placing upward pressure on lending fees.
Despite the downturn in markets, opportunities to optimize portfolios through securities lending continue to exist, and may now be of greater importance and interest to beneficial owners considering this additional source of revenue.
2. How have clients been reacting during this time?
Along with the rise in transaction volumes, we noted that clients were also reassessing their investing strategies more holistically which resulted in some choosing to make risk-based adjustments to their securities lending program. Examples included adjustments to internal funding requirements and revisiting liquidity assessments on certain asset classes. As our lending program is tailored to a client's overall risk appetite, changes made in response to market events can also influence their securities lending strategies.
As a result, we have been having a lot of conversations with our clients about the parameters in place to support their lending activities and reassuring them of the rigorous risk management protocols within our securities lending program.
Such program realignments were common in March and April but have since stabilized as market volatility has reduced.
3. Can you further expand on the conversations you are having with clients?
During periods of market volatility, risk management becomes a prominent discussion point.
Securities lending is generally considered a low risk-adjusted portfolio optimization tool given the very strict risk management frameworks we have in place. For example, anytime a security is lent, it is fully collateralized by the borrower with securities that exceed the value of the security they borrowed, and which are marked-to-market daily. That protection is a fundamental component of a securities lending program.
During the recent period of exceptional market volatility, we had no under-collateralized positions, which reflects the soundness of our risk management framework.
Additionally, we also continue to provide clients with an additional protection in the form of indemnification, another key feature that is particularly important to our clients. If the event of collateral shortfall during a borrower default, for example, the onus is on RBC I&TS to make the position whole. This additional ‘insurance’ gives clients peace of mind and is an important aspect of our conversations with clients.
In the 35 years that RBC I&TS has been providing securities lending, we have never had a client experience a loss, even during the financial crisis in 2008. It is a further testament to the risk management practices we have in place, as well as the strength of RBC.
Risk management has always been a key discussion point with clients, but it is now more top of mind. Clients need that sense of security and can rely on RBC's strong balance sheet and the protections that our contractual indemnifications provide.
4. Any lessons learned from the COVID-19 experience to date?
As with many firms, the pandemic required us to think and act differently. When a global workforce is shifted to ‘work from home’, normal protocols and processes are challenged. Whether it is finding communication alternatives or streamlining processes, you gain efficiencies along the way.
We continue to
be very engaged
with our clients
throughout this
journey
One of our takeaways is that a market services and execution business can operate effectively away from the traditional trading floor. That would have previously been considered impossible. Both RBC I&TS and many if not all our counterparties have found ways to continue lending from alternate locations. This is a significant change from the norm and these flexible arrangements may have a lasting impact across the industry.
The experience has also reinforced the power of client engagement, despite changes in the way we communicate. We continue to be very engaged with our clients throughout this journey. Our clients need relevant, timely data and insights to help them make informed decisions.
5. In your view, how will the COVID-19 experience impact securities lending in the long term?
It may still be too early to comment on what the long term effects will be as market conditions continue to evolve, although we have already seen changes on both the demand and supply side of the industry. Generally securities lending shifts with market trends and as a result demand to borrow has changed as the macro-economic impact of COVID-19 has affected some sectors such as airlines, retail and energy creating greater intrinsic value opportunities for beneficial owners.
On the supply side we continue to see client behaviours change as some rebalance their investment priorities and realign how their future (or even current) objectives coexist with securities lending. With any significant market event change is to be expected, but as the economic path to the COVID-19 recovery continues to evolve, we can say with certainly that so too will the securities lending market.
What won’t change? Our responsibility, as the agent, is to keep our clients up-to-date and informed on demand changes and identify opportunities as we move forward, together.