By Paul Collard, Global Head of Fixed Income Trading, Deutsche Bank Agency Securities Lending
Securities lending is simple. A holder of either fixed income or equity assets appoints an agent lender to lend their assets into the market against collateral. Straightforward. Simple.
Well, not really. Securities lending has evolved to be so much more than just a simple exchange of securities. Clients have a variety of needs, and although a standard securities loan will generate revenue, it does nothing to solve any other requirements a particular client might have.
Moreover, pure securities lending only works when a client’s asset has some intrinsic value. With an ever increasing cost to the provision of both collateral and haircut, alongside a lending market where the shortdated special value of both fixed income and equity securities is shrinking, there are fewer opportunities to simply put a security out on loan. This leads to a reduction in lending revenue, with client assets sitting idle in their accounts where they are typically accruing custody charges.
This has been especially true in the Asian fixed income market where only USD 10.29m of revenues were generated on USD 34bn on loan (average value) of Asian government bonds in the fourth quarter, according to IHS Markit’s Securities Finance 2018 Year in Review report. While performance figures were up year-over-year, average utilization was only 11.78% compared to 22% for US government bonds and 30% for European government bonds.
Yet so much more can be done with many of these assets.
At its heart, securities lending involves the transfer of securities, collateral and—if the program allows for it—cash. Securities lenders become experts at moving thosethree commodities around the globe, and that makes lenders a valuable, and often underutilized resource.
The key to understanding the additional value that these three factors – securities, collateral and cash – can deliver only becomes clear when each can be moved independently. That understanding applies no matter where the client is situated, or what assets they hold. This is especially true in Asia, where there are a diverse range of portfolios alongside a diverse range of clients.
As soon as the three elements of the securities lending transaction are split into individual transactions, a wealth of new opportunities emerge. A global lender can assist in all manner of collateral management roles, moving collateral where it needs to be in a timely manner or even transforming it into the collateral that is required. In some cases, a client may be pledging high quality collateral in another transaction, when they could instead use those securities to generate revenue and use the collateral received there as their own collateral.
For example, Deutsche Bank’s program lends close to 100% of our clients’ Australian and New Zealand government bonds, despite there rarely being any specific intrinsic value. As anyone in the market is also aware, the largest Asian government collateral market is Japan where JGBs have been used almost exclusively as collateral mainly against US Treasuries for many years.
Introducing cash opens up many more opportunities. Clients that allow securities to be lent against cash collateral can have access to that cash for ad-hoc or daily usage, according to need. If more cash is required than is naturally raised through lending, then additional loans can be transacted to boost the amount of cash available to the client.
This cash management can be extended if required and a lender can look to provide guaranteed liquidity in times of need through the provision of a liquidity facility. Such liquidity facilities and the provision of cash can be done in a range of currencies. If needed, they can be done on a cross-currency basis, opening them up to a wide range of asset holders, including those based in the Asia-Pacific region.
By breaking up the constituent parts of a securities lending transaction, a client can gain access to a much wider range of possible services from the lending agent; services that can be utilized to solve many more problems than just to answer the much simpler question of how to accrue income to offset custody charges.
Securities lending continues to truly evolve everywhere. Whilst it remains a challenge to find true lending value in Asian government bonds, that does not mean they cannot be used in a programme that offers a much greater scope than just traditional securities lending.