- Rich Marquis, Americas (excluding Canada) Regional Trading Head for Securities Finance at BNY Mellon Markets
- Phil Zywot, Canada Regional Trading Head, Securities Finance at BNY Mellon Markets
- Pat Garvey, Global Co-Head of Fixed Income Trading at BNY Mellon Markets
As it fades into history, 2016 is assuming the guise of a vintage year for securities financing – at least relative to the tepid market conditions in the US so far during 2017.
The first 10 months of 2016 saw strong – albeit declining – levels of market volatility driven in part by geopolitical events such as the UK vote to leave the European Union and the US presidential election.
This volatility largely dissipated toward the end of the year as November witnessed the start of the sustained equities rally that continues to the present day, weakening investor appetite for equities securities financing, especially in commodity-related securities.
Despite these challenges, Canada has navigated this year’s choppy waters relatively deftly. Demand for resource sector securities financing has diminished with the ongoing improvement in commodity markets, but concerns over a possible housing bubble in the nation’s largest cities has created incremental demand for securities lending in Canada – as has the reemergence of specials.
With at least two more interest rate rises anticipated from the Federal Reserve before year’s end and speculation over how much longer the US equities rally can sustain itself, the outlook for securities financing markets across the Americas during the remainder of 2017 is currently stable, at best.
US equities: A lack of conviction
If one term succinctly captures how 2017 has developed in the US equities securities financing, it is “lack of conviction”. Industry veterans attest that current conditions – characterized by a dearth of shorting activity amid waning volatility – have not been witnessed in the US equities market since late 1993.
In recent months, demand for equity securities lending has taken on a similar look to the latter part of 2016, where ETFs focused on main indices and high-yield bonds were in strong demand.
This macro style of hedging has been a recurring theme in the ever-ascending US equity market this year. “In the US, the equity finance market has been acting strangely, and requires careful navigation to optimize returns.
There are fewer opportunities in securities with high intrinsic value and inventory is at a historic low,” explains Rich Marquis, Americas (excluding Canada) Regional Trading Head for Securities Finance at BNY Mellon Markets.
“In light of these sub-optimal market conditions there is a single theme that drives the ability to outperform the competition: collateral flexibility.”
Collateral flexibility can take a number of forms: the ability to move further out along the yield curve for cash reinvestment, the ability to expand the offering in the non-cash space, or it could mean giving a level of optionality in the duration of a trade.
“While for some beneficial owners the decision to add or extend collateral flexibility is an internal one, many are governed by rules that constrain that expansion. With potential changes being considered to US collateral regulations like rule 15c3-3 some of these constraints could be addressed,” says Marquis.
US fixed income: Grappling with downward pressures
Regulatory reform and the ability to manage balance sheets are continuing to have a significant impact on participants in US fixed income markets in 2017.
Since money market reform rules were implemented in October 2016, over $1trn in prime fund assets has transitioned into government money funds, creating significant downward pressure on General Collateral (GC) levels.
Triggered by the US presidential election and combined with renewed anticipation of a stronger US economy and a December rate hike, the market also witnessed a strong sell-off in US Treasuries during the last two months of 2016.
GC levels remained soft at the start of 2017 with ongoing demand for government repo and a reduction of Treasury bill supply. That reduction was attributable to constraints stemming from the US debt ceiling suspension agreed in 2015 which expired on March 15.
As a result, over $150bn in US Treasury bills were paid-down in the first two-and- a-half months of the year. The decrease in supply and government money fund liquidity created further pressure on overnight GC levels during this time period.
“The first half of 2017 was highlighted by a continued US equity rally, while the US bond market operated more cautiously, awaiting updates on the Federal Reserve’s fiscal and monetary policies. Continued strong employment numbers and a surprisingly high CPI have the Fed aggressively signalling a more hawkish near-term policy.
The market has priced in a near-certainty of a Fed hike of 25bps for June 15, as well as another later in the year,” says Pat Garvey, Global Co-Head of Fixed Income Trading at BNY Mellon Markets.
Canadian equities: Market charges on amid diminishing returns
The Canadian equity lending sector continues its forward progress from last year despite the rebound in the commodity sector weighing down on securities financing returns.
The volume-weighted average fees for Canadian equities more than doubled within a year of the commodity correction, but demand for the resource sector levelled off with the corresponding rebound and stabilization of commodity prices that occurred in the first quarter of 2016.
“Today, the daily chatter about the Canadian housing bubble, specifically in Toronto and Vancouver, continues to drive demand for Canadian equity securities lending,” says Phil Zywot, Canada Regional Trading Head, Securities Finance at BNY Mellon Markets.
“With housing prices soaring, demand has been growing for securities related to real estate, such as financing companies. Some have questioned the potential continuation of higher housing valuations and hence the viability of some of the alternative mortgage lenders. This has put the sector right in the cross hairs of short sellers.”
The views expressed within this article are those of the author only and not those of BNY Mellon or any of its subsidiaries or affiliates.