Kyle Kolasingh, Director of Securities Finance at RBC Investor and Treasury Services, shares his insights on the Canadian securities lending market in an interview with Global Investor.
What has activity been like in the Canadian market in the past two years?
The Canadian fixed income market saw a bit of suppression in 2020 on the back of the economic conditions surrounding the pandemic, but has rallied back in the past year. In early 2021 we started to see a lot more activity, particularly demand for term structures, which is now stronger than pre-pandemic levels.
Demand in this category of level 1 assets—both in sovereign and provincial issues—steadily increased over the year, particularly in term structures initially on a 35-day basis, but more recently extending beyond 95 days. Expectations in 2022 are for an increase in demand driven by a hawkish interest rate environment. This is reminiscent of pre-pandemic conditions where we witnessed six-month, nine-month or 12-month term structures, which were predicated off the back liquidity and funding requirements.
The Canadian fixed income market saw a bit of suppression in 2020
The equity market has had a bit of a different path. The cannabis space pre-pandemic drove significant portions of revenue in the Canadian equity market. Since then, we’ve seen lower demand for specials with the same level of conviction. There have been a few corporate events, mainly event-driven specials, which have popped up but nothing that has had persistently high levels as the directional interest in the cannabis sector.
An interesting development is the ETF space which has heated up in the last two years and continues to be a lucrative category of lending opportunities both at home in Canada and in the US, albeit driven by differing conditions. US ETF demand is driven by hedging activity against increasing interest rates compared to Canada where demand for ETFs is driven by hedging against broad-based market volatility.
One key market driver is regulation. What is currently making an impact in Canada, or expected to influence activity there in the next few months?
While we may not have seen significant home-grown regulatory change in the last couple of years, the global regulatory landscape continues to play a very important part in the securities lending activity of Canadian beneficial owners due to their diversified global characteristics. Recently, SFTR and CSDR have had an equally significant impact, from a reporting and behavioural perspective, on any beneficial owner invested within Europe. We are also looking at some of the proposed rules coming out of the US including the SEC’s proposed new Rule 10c-1 and Rule 13f-1, which can also impact the Canadian securities financing landscape.
It is still too early to speculate precisely how these proposed changes will affect Canadian beneficial owners or the Canadian market of lendable securities. It could have an impact on reporting requirements (similar to SFTR for offshore entities) and on demand to borrow from US counterparties, from which a significant portion of demand is derived. As the industry progresses through these SEC consultations and more information comes to the market, we’ll have a better understanding as to how it will impact both the agent lenders and the beneficial owners themselves.
That said, at the start of the year in Canada we recently saw additional guidance from the CSA via its Staff Notice 81-334 on ESG Related Investment Fund Disclosures. In a very similar fashion to SFDR, this guidance on the disclosure practices of investment funds as it relates to ESG aims to reduce the potential for “greenwashing”.
Lastly, T+1 is a very hot topic across the Canadian securities industry and will have applications to securities finance as it did when we moved from T+3 to T+2 in 2017. It is still early days but all indications are leading towards a H1 2024 timeline, which is expected to be conducted simultaneously and in conjunction with the US T+1 implementation, given the interconnectivity of the Canadian and US markets. The Canadian Capital Markets Association is leading this charge.
While ESG is on the radar of many market participants, it’s not something that people are expecting to have an immediate impact like it is having in Europe. What’s the situation in Canada?
Personally, I find ESG fascinating because of how it has recently evolved and its interpretation, application and intersection with all levels of our industry – either abroad or at home. The governance aspect of ESG has for the most part been at the forefront of the conversation within the securities financing industry. The ability to apply and promote good corporate governance has been a non-issue for securities lending for more than a decade. It is important for beneficial owners to know that options are available depending on their own requirements and through discussions with their agent lenders. For example a securities lending and an ESG strategy integrating active corporate governance policies is feasible. This is an area across the industry that we need to vocalize and promote greater understanding. The recently formed Global Alliance of Securities Lending Associations (GASLA) is leading the charge.
While ESG is on the radar of many market participants, it’s not something that people are expecting to have an immediate impact like it is having in Europe. What’s the situation in Canada?
Personally, I find ESG fascinating because of how it has recently evolved and its interpretation, application and intersection with all levels of our industry – either abroad or at home. The governance aspect of ESG has for the most part been at the forefront of the conversation within the securities financing industry. The ability to apply and promote good corporate governance has been a non-issue for securities lending for more than a decade. It is important for beneficial owners to know that options are available depending on their own requirements and through discussions with their agent lenders. For example a securities lending and an ESG strategy integrating active corporate governance policies is feasible. This is an area across the industry that we need to vocalise and promote greater understanding. The recently formed Global Alliance of Securities Lending Associations (GASLA) is leading the charge.
The governance aspect of ESG has been at the forefront of the conversation
The next item on the ESG agenda is going to be collateral management, and I think it’s an important time to be discussing this with Canadian beneficial owners. Collectively the industry is working towards common best practices and guidelines to ensure the increasingly sophisticated needs of beneficial owners meet the capabilities of all industry players, agent lenders and tri-party collateral agents in particular. The difficulty in application may lie more on the wide ranging applications to collateral sets and schedules as beneficial owners define their own ESG strategies and policies.
I expect ESG and its varying applications to become more integrated into one’s investment strategy and philosophy as beneficial owners take not only a view on corporate governance but also their fiduciary responsibility, evaluating revenue impacts and potential in as much importance as the ability to vote proxy. This is no different outside of Canada.
A theme that is also at the forefront of conversations is the role that technology plays in securities lending. Where do you think tech can make the most impact and where are you investing?
Technology has been at the forefront of applying reporting and regulatory changes such as SFTR and the same is expected for Rule 10c-1. This has been mostly, if not all led, by progress in enhancements and new developments by the fintechs across the securities financing industry. We first saw this in SFTR but we will continue to see greater usage in readily available technology to facilitate future regulatory reporting capabilities in North America for example Rule 10c-1 and beyond. This is directly correlated to the momentum for greater transparency across the global industry, affecting beneficial owners in Canada as well. These technological developments continue to create significant value in both front- and back-office capabilities by providing products that enable greater automation in the loan life cycle, whether that is upfront in execution to the administrative/reconciliation/downstream life cycle movements of loan transactions. Not only is this driving further cost and benefit growth via higher STP, it is also creating valuable efficiencies to operational processes which not only is monetized but also has a positive impact on overall beneficial owner experience.
Another interesting area in applying emerging technologies is in targeting new areas of untapped lendable inventory such as the fully-lending space. In recent years, Investment Industry Regulatory Organization of Canada’s (IIROC) rules on fully lending have come into fruition, balancing Canada with the US in providing securities lending to the retail investor. It is in this space where fintechs and emerging technologies play an important role. While the premise is the same, the operational and legal side of the transaction can be very different than the typical beneficial owner structure.
What themes do you expect are going to dominate your market this year?
General market sentiment remains positive. The market recovery in 2021 and record level M&A activities could continue to perpetuate into 2022 presenting further optionality-driven demand and event-driven optimization opportunities. While general collateral for both fixed income and equities continues to increase (in comparative revenue proportionality), changes to pricing conditions are not expected in the short term given liquidity. Additionally, the interest rate environment in Canada and more broadly speaking across North America will be closely monitored especially as changes to the Overnight Reverse Repo (ORR) operation facilitated by the Bank of Canada shape out. Collateral is readily available and pricing is set to remain steady in both financing and repo markets.
The interest rate environment will be closely monitored in Canada and more broadly
Lastly, for beneficial owners the integration of securities lending activities into fully formed ESG policies will continue to dominate 2022, as applications and expectations become clearer. Ultimately, it is encouraging to see more ESG funds enter the lending market as it points to the fact that both can work in harmony.