Canada
07 January 2020
Canada’s cannabis stocks were one of the major hot topics for the securities lending industry in 2019, but, as we look into 2020, there are further developments that we can expect to see for the country in the new year
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Compared to images of swathes of untamed wilderness, sweet, syrupy treats and violent ice-based sports, cannabis is an unlikely addition to the themes synonymous with Canada – but, for short sellers, 2019 was the year of the pot stock.
Cannabis was legalised in Canada on 17 October 2018 as part of the government’s attempt to combat criminal involvement in the drug market and reduce its availability to youth, along with lowering barriers to medical research.
The subsequent business boom for pharma, farming and other auxiliary service providers caused stocks in those companies to explode on the promises of mega revenue projections to come from this budding industry. However, a lack of historical data to back up some of the wilder earnings speculation, along with legal, political and social controversies around the drug’s reintroduction into accepted society also attracted the attention of short sellers.
Data from S3 Partners shows that despite a slight hiccup in December, short sellers banked roughly $993 million last year from the 20 most-shorted cannabis stocks, most of which are listed in both Canada and the US.
Meanwhile, Sam Pierson of IHS Markit explained that, more broadly, Canada’s total equity lending revenue year-to-date (17 December) was $603 million, which is up 29 percent compared with the same period from 2018. Canadian equities, Pierson explains, are similar to US, where Q4 has been a letdown relative to a stellar Q3, although the final quarter still outperformed the same period in 2018.
Pierson added that this is to some extent qualified by the decline in market valuation in Q4 2018, which reduced revenues as fees did not increase to offset the decline in revenues.
On Canadian cannabis, Pierson observed that equity revenue was $356 million year-to-date, which was up 163 percent compared with 2018 [see figure one], and means that cannabis stocks contributed 59 percent of total equity revenues for 2019, up from 29 percent in 2018. Excluding the cannabis sector, Canada equities delivered $247 million in revenue last year, a decline of 25 percent compared with 2018.
Beyond the headlines
Aside from cannabis, Canada is also facing the potential of changes to its short selling rules that may include the re-introduction of an up-tick rule.
A new lobbing effort known as the Save Canada Mining group is seeking to bring in an up-tick rule that would restrict traders to only shorting a stock if it was on an upward trajectory. The group is also pushing to see short selling of small cap markets banned all together but this does not appear to have gained much traction so far.
The group is lobbying the Investment Industry Regulatory Organization of Canada and the country’s exchanges to revive the rule to protect smaller participants against what it describes as ‘predatory short selling’.
Canada’s TSX Venture Exchange has confirmed it is in discussions with the group on the matter.
Aside from short selling, advancements in technology in Canada has been something of note as the demand for greater access to reporting and data from beneficial owner is seeing this push for newer and sophisticated technology.
More broadly and in line with the rest of the securities finance world, regulation is one of the challenges facing Canada, and in particular how this relates to the viability of a long-awaited central counterparties (CCPs).
Looking to the year ahead, Canada may see further changes to its laws. At the start of last year, withholding tax rules applicable to certain cross-border share lending arrangements were amended in response to perceived withholding tax avoidance, and further changes are in the pipeline.
To address these themes and others, SLT sits down with Donato D’Eramo, the managing director, securities finance of RBC I&TS, and president of the Canadian Â鶹´«Ã½ Lending Association (CASLA).
What are the main opportunities and challenges borrowers and lenders are seeing in Canada?
Beneficial owners are demanding greater access to reporting and data insights as they seek more timely and granular information to help identify the precise nature and location of their assets. As a result, we are seeing the development of increasingly sophisticated technology capabilities that provide improved connectivity, as well as enhanced trading platforms that support a high level of straight-through-processing.
By leveraging technology to deliver data to lenders, we are able to move latent revenue directly to the bottom line. Insights can include the provision of information on potential revenue gains from a particular voting decision, the removal of restrictions on a stock or specific aspect of a portfolio, and securities that are not yet part of a lending programme.
Fixed income lending opportunities remain strong. Requirements around capital ratios continue to support demand for financing, balance sheet optimisation and, in turn, high-quality liquid assets. These pressures may result in terms that extend beyond the current three- to six-month periods.
Emerging market lending volumes are still relatively low but opportunities are growing. We anticipate that emerging market assets will be more prominent in our client discussions going forward. In addition, an increasing number of beneficial owners are expanding into the alternatives space, beyond the traditional long-only lending paradigm and into levered or 130/30 type strategies, which include a borrow component.
Will there be any bumps in the road in 2020? What will be the main challenges for the securities lending market in Canada?
An ongoing topic of discussion is the viability of CCPs in the securities lending industry. As regulatory reform continues to change the dynamics of our industry, the implementation of a CCP model has the potential to address the impact of capital usage and risk-weighted asset (RWA) constraints on securities lending, as well as the way we effect lending transactions. Introduction of CCP services in the Canadian marketplace has been under discussion for a number of years and the conversation among CASLA members is ongoing.
Consistent with our global peers, the Canadian securities lending industry faces a number of challenges from a regulatory readiness perspective, including Â鶹´«Ã½ Financing Transactions Regulation, Central Â鶹´«Ã½ Depositories Regulation and pledge structures. Significant work is underway by industry participants to ensure that solutions are in place to accommodate these new regulations, which are designed to enhance transparency and risk reduction across the industry.
What effect has the legalisation of cannabis had on the securities lending market in Canada?
Despite subdued ‘specials’ activity in the Canadian market, the cannabis sector remained a particular area of interest in 2019, dominating the warm and hot space. Given the volatile market conditions and increasing supply in the lending market, both demand and lending fees for cannabis assets varied widely.
As companies in the sector become more mature, we expect a greater prevalence in large capitalisation indices, which ultimately influence demand. In addition, mergers and acquisitions activity has provided opportunities for securities lending revenue, and we anticipate that further industry consolidation will drive increased demand for lending.
Stock borrow costs in the cannabis sector trended far out-performed the market average last year. Do you see this trend continuing in 2020?
The cannabis sector has largely driven the specials market over the past year and the trend toward higher price points and demand volatility is expected to continue. Prior to Canada’s legalisation of cannabis in October of 2018, borrower demand was largely driven by uncertainty around the timing of implementation in conjunction with uncertain revenue forecasts. Post-legalisation, demand has been driven by pressure on cannabis companies to meet their revenue forecasts in the context of decreased financing availability and ongoing consolidation.
What other trends are you seeing in Canada’s securities lending market?
The Canadian securities lending environment is experiencing rapid change on multiple fronts―from changing collateral management practices to evolving routes to market and a higher pace of technology enablement.
Efforts to streamline collateral through triparty agents and contract-compare functionality have resulted in enhanced efficiency within the front-office, as well as the middle and back offices. As the industry evolves, the scope of non-cash collateral will continue to expand through the addition of exchange traded funds, new indices and lower-rated corporate bonds.
Â鶹´«Ã½ lending routes to market continue to evolve given increased transparency and changing market demand. This has led to additional alpha-generating opportunities including term trade structures and corporate optionality events.
Beneficial owners are increasingly utilising emerging technologies to optimise their securities lending programmes. For example, Canadian firms have been working to enhance efficiency through automation of the borrow/return process, enabling the trading desk to focus on value-added opportunities. Machine learning has the potential to enhance returns and reduce operational risk from post-trade activities. In addition, distributed ledger technology could be a significant game-changer, providing agents and counterparts with a single view of securities lending transactions in real-time.
Concurrent with advancements in technology and risk management, a growing number of beneficial owners are returning to securities lending or opting to participate in lending programmes for the first time. Whether it’s to offset costs or take advantage of leverage strategies, beneficial owners are looking for a more granular, consultative relationship with their agent and a deeper understanding of the dynamics of lending. More and more, lenders view securities lending as an opportunity to enhance competitiveness in today’s volatile marketplace.
What is on CASLA’s agenda for 2020?
During 2020, CASLA will be implementing a number of changes to broaden our membership base and enable greater member participation. As the industry continues to evolve, we will be setting up stakeholder working groups to focus on areas such as regulatory change, tax considerations and beneficial owner engagement.
I anticipate that, given recent headlines around sustainable finance and short selling, there will be in-depth discussions on these topics as well. CASLA will also be looking for opportunities to expand the conversation to include our international counterpart associations. 2020 marks the 10th anniversary of CASLA’s Annual Conference on Â鶹´«Ã½ Lending, which will be held on Thursday, 4 June in Toronto.
We are once again planning an ambitious agenda and interesting lineup of speakers. Last year’s conference had a record turnout and we expect delegate numbers to grow even further in 2020.
Figure 1
Cannabis was legalised in Canada on 17 October 2018 as part of the government’s attempt to combat criminal involvement in the drug market and reduce its availability to youth, along with lowering barriers to medical research.
The subsequent business boom for pharma, farming and other auxiliary service providers caused stocks in those companies to explode on the promises of mega revenue projections to come from this budding industry. However, a lack of historical data to back up some of the wilder earnings speculation, along with legal, political and social controversies around the drug’s reintroduction into accepted society also attracted the attention of short sellers.
Data from S3 Partners shows that despite a slight hiccup in December, short sellers banked roughly $993 million last year from the 20 most-shorted cannabis stocks, most of which are listed in both Canada and the US.
Meanwhile, Sam Pierson of IHS Markit explained that, more broadly, Canada’s total equity lending revenue year-to-date (17 December) was $603 million, which is up 29 percent compared with the same period from 2018. Canadian equities, Pierson explains, are similar to US, where Q4 has been a letdown relative to a stellar Q3, although the final quarter still outperformed the same period in 2018.
Pierson added that this is to some extent qualified by the decline in market valuation in Q4 2018, which reduced revenues as fees did not increase to offset the decline in revenues.
On Canadian cannabis, Pierson observed that equity revenue was $356 million year-to-date, which was up 163 percent compared with 2018 [see figure one], and means that cannabis stocks contributed 59 percent of total equity revenues for 2019, up from 29 percent in 2018. Excluding the cannabis sector, Canada equities delivered $247 million in revenue last year, a decline of 25 percent compared with 2018.
Beyond the headlines
Aside from cannabis, Canada is also facing the potential of changes to its short selling rules that may include the re-introduction of an up-tick rule.
A new lobbing effort known as the Save Canada Mining group is seeking to bring in an up-tick rule that would restrict traders to only shorting a stock if it was on an upward trajectory. The group is also pushing to see short selling of small cap markets banned all together but this does not appear to have gained much traction so far.
The group is lobbying the Investment Industry Regulatory Organization of Canada and the country’s exchanges to revive the rule to protect smaller participants against what it describes as ‘predatory short selling’.
Canada’s TSX Venture Exchange has confirmed it is in discussions with the group on the matter.
Aside from short selling, advancements in technology in Canada has been something of note as the demand for greater access to reporting and data from beneficial owner is seeing this push for newer and sophisticated technology.
More broadly and in line with the rest of the securities finance world, regulation is one of the challenges facing Canada, and in particular how this relates to the viability of a long-awaited central counterparties (CCPs).
Looking to the year ahead, Canada may see further changes to its laws. At the start of last year, withholding tax rules applicable to certain cross-border share lending arrangements were amended in response to perceived withholding tax avoidance, and further changes are in the pipeline.
To address these themes and others, SLT sits down with Donato D’Eramo, the managing director, securities finance of RBC I&TS, and president of the Canadian Â鶹´«Ã½ Lending Association (CASLA).
What are the main opportunities and challenges borrowers and lenders are seeing in Canada?
Beneficial owners are demanding greater access to reporting and data insights as they seek more timely and granular information to help identify the precise nature and location of their assets. As a result, we are seeing the development of increasingly sophisticated technology capabilities that provide improved connectivity, as well as enhanced trading platforms that support a high level of straight-through-processing.
By leveraging technology to deliver data to lenders, we are able to move latent revenue directly to the bottom line. Insights can include the provision of information on potential revenue gains from a particular voting decision, the removal of restrictions on a stock or specific aspect of a portfolio, and securities that are not yet part of a lending programme.
Fixed income lending opportunities remain strong. Requirements around capital ratios continue to support demand for financing, balance sheet optimisation and, in turn, high-quality liquid assets. These pressures may result in terms that extend beyond the current three- to six-month periods.
Emerging market lending volumes are still relatively low but opportunities are growing. We anticipate that emerging market assets will be more prominent in our client discussions going forward. In addition, an increasing number of beneficial owners are expanding into the alternatives space, beyond the traditional long-only lending paradigm and into levered or 130/30 type strategies, which include a borrow component.
Will there be any bumps in the road in 2020? What will be the main challenges for the securities lending market in Canada?
An ongoing topic of discussion is the viability of CCPs in the securities lending industry. As regulatory reform continues to change the dynamics of our industry, the implementation of a CCP model has the potential to address the impact of capital usage and risk-weighted asset (RWA) constraints on securities lending, as well as the way we effect lending transactions. Introduction of CCP services in the Canadian marketplace has been under discussion for a number of years and the conversation among CASLA members is ongoing.
Consistent with our global peers, the Canadian securities lending industry faces a number of challenges from a regulatory readiness perspective, including Â鶹´«Ã½ Financing Transactions Regulation, Central Â鶹´«Ã½ Depositories Regulation and pledge structures. Significant work is underway by industry participants to ensure that solutions are in place to accommodate these new regulations, which are designed to enhance transparency and risk reduction across the industry.
What effect has the legalisation of cannabis had on the securities lending market in Canada?
Despite subdued ‘specials’ activity in the Canadian market, the cannabis sector remained a particular area of interest in 2019, dominating the warm and hot space. Given the volatile market conditions and increasing supply in the lending market, both demand and lending fees for cannabis assets varied widely.
As companies in the sector become more mature, we expect a greater prevalence in large capitalisation indices, which ultimately influence demand. In addition, mergers and acquisitions activity has provided opportunities for securities lending revenue, and we anticipate that further industry consolidation will drive increased demand for lending.
Stock borrow costs in the cannabis sector trended far out-performed the market average last year. Do you see this trend continuing in 2020?
The cannabis sector has largely driven the specials market over the past year and the trend toward higher price points and demand volatility is expected to continue. Prior to Canada’s legalisation of cannabis in October of 2018, borrower demand was largely driven by uncertainty around the timing of implementation in conjunction with uncertain revenue forecasts. Post-legalisation, demand has been driven by pressure on cannabis companies to meet their revenue forecasts in the context of decreased financing availability and ongoing consolidation.
What other trends are you seeing in Canada’s securities lending market?
The Canadian securities lending environment is experiencing rapid change on multiple fronts―from changing collateral management practices to evolving routes to market and a higher pace of technology enablement.
Efforts to streamline collateral through triparty agents and contract-compare functionality have resulted in enhanced efficiency within the front-office, as well as the middle and back offices. As the industry evolves, the scope of non-cash collateral will continue to expand through the addition of exchange traded funds, new indices and lower-rated corporate bonds.
Â鶹´«Ã½ lending routes to market continue to evolve given increased transparency and changing market demand. This has led to additional alpha-generating opportunities including term trade structures and corporate optionality events.
Beneficial owners are increasingly utilising emerging technologies to optimise their securities lending programmes. For example, Canadian firms have been working to enhance efficiency through automation of the borrow/return process, enabling the trading desk to focus on value-added opportunities. Machine learning has the potential to enhance returns and reduce operational risk from post-trade activities. In addition, distributed ledger technology could be a significant game-changer, providing agents and counterparts with a single view of securities lending transactions in real-time.
Concurrent with advancements in technology and risk management, a growing number of beneficial owners are returning to securities lending or opting to participate in lending programmes for the first time. Whether it’s to offset costs or take advantage of leverage strategies, beneficial owners are looking for a more granular, consultative relationship with their agent and a deeper understanding of the dynamics of lending. More and more, lenders view securities lending as an opportunity to enhance competitiveness in today’s volatile marketplace.
What is on CASLA’s agenda for 2020?
During 2020, CASLA will be implementing a number of changes to broaden our membership base and enable greater member participation. As the industry continues to evolve, we will be setting up stakeholder working groups to focus on areas such as regulatory change, tax considerations and beneficial owner engagement.
I anticipate that, given recent headlines around sustainable finance and short selling, there will be in-depth discussions on these topics as well. CASLA will also be looking for opportunities to expand the conversation to include our international counterpart associations. 2020 marks the 10th anniversary of CASLA’s Annual Conference on Â鶹´«Ã½ Lending, which will be held on Thursday, 4 June in Toronto.
We are once again planning an ambitious agenda and interesting lineup of speakers. Last year’s conference had a record turnout and we expect delegate numbers to grow even further in 2020.
Figure 1
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