Diversification is “key” to success

Diversification is “key” to success

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In a closed-door roundtable discussion in Amsterdam, European market participants highlighted the importance of diversification in today’s securities finance market, emphasising that it will be “key” moving forward, particularly during an era of low volatility.

Discussing the performance of the European securities finance market in 2019, Steve Kiely of BNY Mellon said: “A lack of volatility and a drop-off in demand for HQLA is where we have seen the biggest impact. While lower revenue has been the overall trend, there are pockets of strong demand and healthy revenues. Trends used to come and go for two or three years in this market, recently trends have come and go in the space of three or four weeks.”

As highlighted by IHS Markit’s Kabin George, as of September 2019, year-to-date revenues were down by 16% and BNY Mellon observed a similar trend, with Kiely noting that “most (securities lending) programmes are down”. However, he argued that “diversification is key”.

“Clients that have done best are the ones with the widest spread of asset classes and the widest collateral parameters and the broadest borrower base, e.g., those that can use pledge and CCPs,” he said, adding: “Those that embrace new structures are insulating themselves from this period of lower earnings.”

Keily explained that the “paradox of volatility” is often neglected by market participants, but underlined that during this era of financial and geopolitical volatility, “no one’s taking investment decisions”, which therefore leads to a lack of volatility.

Simon Heath of JP Morgan echoed Keily’s comments, adding that “lenders need to have diversification to achieve success”.

“There have been some very interesting moments this year (2019), especially September’s events in the repo market and strong directional performers in a number of IPO’s as well as corporate action activity earlier in the year. It’s also been a repositioning year on a number of levels: we’ll touch on UMR later but liquidity provision is much more important in 2019,” Heath added.

In 2018, the securities finance market had the most profitable year since the 2008 financial crisis, with Heath describing it as “watermark revenue year”, so it is fair to say that 2019 had a lot to live up to. He noted that supply had increased in 2019, adding that the assets under management (AUM) in lending programmes is “fairly buoyant”. Despite this, broadly speaking, he said demand for securities lending has remained “relatively static”.

Although revenues dipped in 2019, the trajectory of higher revenue remained and industry earnings were higher than those seen in 2017. In fact, IHS Markit revealed on January 31 that 2019 generated $10.1 billion in global revenue, the second-highest in the last decade.

NN Investment Partner’s Xavier Bouthors explained that the firm had seen a decline in equity lending revenue over the past few years, which it attributed to weaker demand. However, he added that diversifying their portfolio is one of the methods the firm has used to improve its revenue on the equity side.

“Incorporating high yield portfolios with emerging market debt from various regions is one way in which we’ve enhanced our programme,” he said. “We’ve seen an increase in demand and interest for emerging market debt, so we have been developing this type of asset class to compensate for the lower revenue on the equity side.  We have also been developing government bond lending within non-UCITS portfolios and we’ve witnessed a sharp increase in revenue and balances, mainly due to the collateral flexibility but also the type of trade you can do versus a UCITS fund.”

In looking at various asset classes and expanding into other areas, Bouthors stated that NN Investment Partners “managed to keep overall securities lending revenue fairly stable”.

This is an extract from Global Investor’s European Securities Finance Roundtable, held in Amsterdam in September. The discussion features in the December/January edition of Global Investor magazine.

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