Australia
25 June 2012
Can borrowing and lending in Australia step up from a marginalised activity to a significant outlay? SLT finds out
Image: Shutterstock
When securities lending first grew roots in the 1970s, by way of some fairly relaxed transactions between stock brokers, Australia took note.
In the mid 1980s, the country saw a growing trend in the arena, but it tended to be confined to the margins, due to high borrowing costs. The practice was made up of mostly brokers who were covering failed trade settlements, with the big lenders being nominee arms of major trading banks, which accessed securities from their domestic and international custody clients.
A feature of Australian markets is that they have developed in a balanced way, with foreign exchange, fixed interest, money and equity markets all increasing at broadly similar rates over the period.
As the late 1980s saw the Australian stock market take off, securities lending volumes grew. The only hindrances were two pieces of tax legislation.
The capital gains tax legislation (CGT) of 1985 deemed security loans to be effective disposals for CGT purposes, causing many taxable lenders to bring their activities to an abrupt halt. Superannuation funds lucky enough to be tax exempt continued to supply the market until they themselves became taxable in May 1988.
With these changes, failed trade borrowing, which was so popular among brokers, diminished, while larger arbitrage driven borrowing was sourced offshore.
Consequently, as the handiness of offshore securities increased, there was considerable downward pressure on rates. Overseas lenders who were historically used to lower returns in their markets were prepared to undertake Australian lending for lower fees than the domestic lenders had been. Reforms made in 1989 and 1991 sought to ease the competitive disadvantages of domestic lenders.
Realisation of T+5 settlement in 1992 saw lending volumes fall, as domestic and offshore market participants became familiar with its administration, and failed trade volumes decreased.
However, the securities lending and borrowing operations of most market participants were originally part of their administration areas. As staff matured in the field, and the market became more complex, securities lending desks became distinct departments of their own right.
The rise in market activity has been accompanied and underpinned by improvements in market infrastructure. With Australia adopting the Basel capital framework for banks early on, the country鈥檚 settlement systems鈥擜ustraclear, RITS and CHESS鈥攃omply with the highest international standards and Australia鈥檚 RTGS system is among the best, with a very high coverage of wholesale transactions and integration of securities and funds flows.
Most recently, Australian securities lending has experienced a lull in activity. Trevor Amoils, the desk head of Asia Pacific trading at RBC Dexia Investor Services, provided some insight in the company鈥檚 2011 report. He stated: 鈥淕eneral flow in Australia continued to be stagnant. Many companies, unfortunately, cancelled the discount on their DRIP programs which impacted revenues on those opportunities. QBE was the standout with a 2.5 percent discount.鈥�
鈥淭he cash and stock deal that attracted some interest was Newcrest鈥檚 takeover of Lihir, resulting in demand for the acquirer, Newcrest. Private placements in Karoon Gas, Ampella Mining and Gryphon Minerals drove short-term demand for these names.鈥�
What, if anything, has changed in the last year? Carolyn Mitchem, managing director and co-head of global Asian equity finance at BMO Capital Markets, Stewart Cowan, executive director and head of financing and markets products at J.P. Morgan Worldwide 麻豆传媒 Services, Australia, New Zealand and Japan, and Giselle Awad, senior vice president at eSecLending, share their thoughts on the potential of this market.
How would you describe the securities lending market in Australia?
Carolyn Mitchem: We have noticed quite seismic changes in the securities borrowing and lending (SBL) market in Australia in the past few years since the crisis. Along with a more pronounced move towards and an increased growth in synthetic access products (as opposed to the more traditional stock borrow and loan), the regulatory landscape has undergone quite dramatic changes as well. Regulatory amendments around short selling (shorts may only be undertaken on a covered borrow basis) have had a major impact on the way brokers (particularly executing brokers) transact their business. New systems and procedures have had to be put into place to help to facilitate the new SBL regulatory requirements, including enhanced reporting obligations highlighting SBL trades passing through the clearing system. This has all added further layers of complexity to the SBL environment when compared to the pre-crisis landscape.
Stewart Cowan: We have seen some early signs that demand is returning for Australian equities. However, it is still well below 2008 levels. In contrast, demand for Australian Government Bonds remains firm. There is limited supply in the repo market and we have no trouble utlilising supply. Demand is being driven by Basel III tier one capital ratio requirements.
Giselle Awad: In terms of participates, there is a proliferation of providers with a local presence, from both the lender and borrower side. In more recent years, we have also seen an increase in third party programmes being offered by both third party specialists and custodians, though the concepts of unbundling and utilising multi-providers are still gaining momentum. In terms of trade flow, demand for Australian equities is relatively subdued. However, focus on the fixed income and repo space is occurring, which is being driven by both regulatory changes and economic forces.
Is the Australian compulsory superannuation scheme still the most active fund in the market?
Cowan: There is a mix of local lenders. The superannuation funds continue to be a major supplier to the market and we expect that this will continue as funds consolidate and grow organically due to the government鈥檚 mandated and increasing contributions (moving from 9 to 12 percent)
Awad: The Australian pension market is the fourth largest in the world. Funds under management are approximately A$1.3 trillion, with a forecast to grow at 10 percent per year. Additionally, compulsory superannuation contributions will be moving up from 9 percent to 12 percent progressively during the next seven years. Naturally, this means that Australian lenders are predominately from the superannuation sector, but we are seeing increased dialogue with fund managers and insurance firms.
Mitchem: The Australian compulsory superannuation scheme cannot be viewed holistically as just one fund. Employees in Australia have a choice of which funds their superannuation contributions are deployed for management. There are approximately 500,000 super funds available in Australia and this has led to a very competitive marketplace for the management of funds. However, only 300 to 400 funds handle assets totalling greater than A$50 million. The Australian government has also set up the Australian Government Fund in conjunction with this. The purpose of this fund is to meet future obligations for the payment of superannuation to retired civil servants from the Australian public sector.
Do you fear over-regulation?
Mitchem: The increase in tighter regulation has now been in place in Australia for a number of years, so we envisage no immediate change to current policy. There was a marked effect, however, upon introduction during the financial crisis and we saw a very noticeable drop in activity, coupled with a real drawback of funds/clients (beneficial owners) from lending programmes. There was palpable fear from this section of the market and this fed down into many areas of the SBL landscape.
Once clients, and also by extension to a varying degree the regulators, began to get our (the Australian 麻豆传媒 Lending Association and SBL market participants) message and grasp a better understanding of the changes and how to best negotiate them, we noticed a slow and steady return to the marketplace of some of the participants who had initially exited.
We certainly feel that, when looking at the beneficial owners perspective, they feel a much greater degree of comfort and certainty than they did a couple of years ago. However, there still remains a general market-wide feeling of caution, which is in large part a response to the quite severe reaction of regulators to events in the recent past. This may take several more years to remedy.
Cowan: The Australian lending market has had its fair share of regulations to deal with since 2008, when a total short selling ban was replaced with a naked short selling ban, and both short sell and loan reporting. As most of the lenders and borrowers are global players, we are keeping a close eye on the global situation.
Awad: The Australian regulator introduced a number of changes throughout 2008 to 2010 to improve the regulatory and disclosure framework surrounding both securities lending and short selling activities in Australia. These reporting and disclosure requirements have now been integrated as part of normal market practices. It is the potential regulatory changes out of the US and Europe that are currently being monitored, as most participants are part of global businesses and therefore they will be affected.
How have choices of collateral types changed in recent years?
Awad: For Australian lenders; not significantly, as both non-cash and cash have been accepted and continue to be. Lenders are always encouraged to have a diversified collateral profile, within their specific risk parameters, as this allows them to take advantage of market opportunities as they occur.
Mitchem: Collateral requirements/usage is a moving target. After 2008, there was a big move to non-cash collateral, as cash became expensive. However, some domestic lenders required prepayment of non-cash collateral prior to borrowing (as opposed to end of day settlement for the day鈥檚 exposure). There was movement away from these lenders at the time due to restrictions.
More recently, there has been a bigger push for financing of equity longs, mainly having the mechanism in place to be able to turn them into cash quickly, due to regulatory requirements, and in turn, using the resultant cash as collateral.
There has been growth in triparty arrangements, which has helped with collateral usage. However, all arrangements have their own set of parameters, such as from which part of the index are the equity names acceptable. This in itself has relaxed in recent times with a bit more stability in the market. Settlement of trades DVP versus Australian dollars has the least risk for intraday exposure (as stock and cash move together in the clearing system for DVP/RVP trades). When it comes to cash, Australian and US dollars are the preferred choices. US treasuries and G10 debt remain expensive and cumbersome.
Cowan: The introduction of regulations (Basel III, for example) specific to strengthening banks鈥� balance sheets is creating a ripple effect within collateral management. Acceptable collateral is an important dynamic in every loan trade and there has been increased focus on efficiently and flexibly managing collateral for balance sheet purposes.
A curious dynamic for collateral is the variance between each financial institution and line of business, depending on internal funding dynamics. These dynamics result in preferred forms of collateral from one borrower to another. As a lender, the greater the collateral options available, the more loan opportunities we can extract on behalf of our clients. Specific to the local market, this means we can accept Australian dollars, government bonds and equities. We also link into global collateral solutions using our global securities collateral management platform.
What are the major obstacles to enhancing returns and how can they be negotiated?
Cowan: As loan demand for Australian equities remains subdued, we have focused on emerging markets (for example, we have just completed our first trade in Malaysia) and working with clients on bespoke trade solutions.
Mitchem: Market demand has just not returned to pre-crisis levels. In part, this is cyclical and understandable. There is not the directional short interest that there once was, as well as a marked effect from the deleveraging of the wider market. We also see traditional index arbitrage participants being predominantly long as opposed to short.
There has been some recovery in mergers and acqusitions and some upside resultant from a slow re-emergence of corporate activity. But this is a slow process. We are also noticing a more crowded group participating in the various Delta One trading strategies, which has tightened spreads considerably in these types of trades. All of this has combined to make the environment a lot more competitive than it once was and we would really hope for some real demand-side growth to aid SBL returns in the future. SLT
In the mid 1980s, the country saw a growing trend in the arena, but it tended to be confined to the margins, due to high borrowing costs. The practice was made up of mostly brokers who were covering failed trade settlements, with the big lenders being nominee arms of major trading banks, which accessed securities from their domestic and international custody clients.
A feature of Australian markets is that they have developed in a balanced way, with foreign exchange, fixed interest, money and equity markets all increasing at broadly similar rates over the period.
As the late 1980s saw the Australian stock market take off, securities lending volumes grew. The only hindrances were two pieces of tax legislation.
The capital gains tax legislation (CGT) of 1985 deemed security loans to be effective disposals for CGT purposes, causing many taxable lenders to bring their activities to an abrupt halt. Superannuation funds lucky enough to be tax exempt continued to supply the market until they themselves became taxable in May 1988.
With these changes, failed trade borrowing, which was so popular among brokers, diminished, while larger arbitrage driven borrowing was sourced offshore.
Consequently, as the handiness of offshore securities increased, there was considerable downward pressure on rates. Overseas lenders who were historically used to lower returns in their markets were prepared to undertake Australian lending for lower fees than the domestic lenders had been. Reforms made in 1989 and 1991 sought to ease the competitive disadvantages of domestic lenders.
Realisation of T+5 settlement in 1992 saw lending volumes fall, as domestic and offshore market participants became familiar with its administration, and failed trade volumes decreased.
However, the securities lending and borrowing operations of most market participants were originally part of their administration areas. As staff matured in the field, and the market became more complex, securities lending desks became distinct departments of their own right.
The rise in market activity has been accompanied and underpinned by improvements in market infrastructure. With Australia adopting the Basel capital framework for banks early on, the country鈥檚 settlement systems鈥擜ustraclear, RITS and CHESS鈥攃omply with the highest international standards and Australia鈥檚 RTGS system is among the best, with a very high coverage of wholesale transactions and integration of securities and funds flows.
Most recently, Australian securities lending has experienced a lull in activity. Trevor Amoils, the desk head of Asia Pacific trading at RBC Dexia Investor Services, provided some insight in the company鈥檚 2011 report. He stated: 鈥淕eneral flow in Australia continued to be stagnant. Many companies, unfortunately, cancelled the discount on their DRIP programs which impacted revenues on those opportunities. QBE was the standout with a 2.5 percent discount.鈥�
鈥淭he cash and stock deal that attracted some interest was Newcrest鈥檚 takeover of Lihir, resulting in demand for the acquirer, Newcrest. Private placements in Karoon Gas, Ampella Mining and Gryphon Minerals drove short-term demand for these names.鈥�
What, if anything, has changed in the last year? Carolyn Mitchem, managing director and co-head of global Asian equity finance at BMO Capital Markets, Stewart Cowan, executive director and head of financing and markets products at J.P. Morgan Worldwide 麻豆传媒 Services, Australia, New Zealand and Japan, and Giselle Awad, senior vice president at eSecLending, share their thoughts on the potential of this market.
How would you describe the securities lending market in Australia?
Carolyn Mitchem: We have noticed quite seismic changes in the securities borrowing and lending (SBL) market in Australia in the past few years since the crisis. Along with a more pronounced move towards and an increased growth in synthetic access products (as opposed to the more traditional stock borrow and loan), the regulatory landscape has undergone quite dramatic changes as well. Regulatory amendments around short selling (shorts may only be undertaken on a covered borrow basis) have had a major impact on the way brokers (particularly executing brokers) transact their business. New systems and procedures have had to be put into place to help to facilitate the new SBL regulatory requirements, including enhanced reporting obligations highlighting SBL trades passing through the clearing system. This has all added further layers of complexity to the SBL environment when compared to the pre-crisis landscape.
Stewart Cowan: We have seen some early signs that demand is returning for Australian equities. However, it is still well below 2008 levels. In contrast, demand for Australian Government Bonds remains firm. There is limited supply in the repo market and we have no trouble utlilising supply. Demand is being driven by Basel III tier one capital ratio requirements.
Giselle Awad: In terms of participates, there is a proliferation of providers with a local presence, from both the lender and borrower side. In more recent years, we have also seen an increase in third party programmes being offered by both third party specialists and custodians, though the concepts of unbundling and utilising multi-providers are still gaining momentum. In terms of trade flow, demand for Australian equities is relatively subdued. However, focus on the fixed income and repo space is occurring, which is being driven by both regulatory changes and economic forces.
Is the Australian compulsory superannuation scheme still the most active fund in the market?
Cowan: There is a mix of local lenders. The superannuation funds continue to be a major supplier to the market and we expect that this will continue as funds consolidate and grow organically due to the government鈥檚 mandated and increasing contributions (moving from 9 to 12 percent)
Awad: The Australian pension market is the fourth largest in the world. Funds under management are approximately A$1.3 trillion, with a forecast to grow at 10 percent per year. Additionally, compulsory superannuation contributions will be moving up from 9 percent to 12 percent progressively during the next seven years. Naturally, this means that Australian lenders are predominately from the superannuation sector, but we are seeing increased dialogue with fund managers and insurance firms.
Mitchem: The Australian compulsory superannuation scheme cannot be viewed holistically as just one fund. Employees in Australia have a choice of which funds their superannuation contributions are deployed for management. There are approximately 500,000 super funds available in Australia and this has led to a very competitive marketplace for the management of funds. However, only 300 to 400 funds handle assets totalling greater than A$50 million. The Australian government has also set up the Australian Government Fund in conjunction with this. The purpose of this fund is to meet future obligations for the payment of superannuation to retired civil servants from the Australian public sector.
Do you fear over-regulation?
Mitchem: The increase in tighter regulation has now been in place in Australia for a number of years, so we envisage no immediate change to current policy. There was a marked effect, however, upon introduction during the financial crisis and we saw a very noticeable drop in activity, coupled with a real drawback of funds/clients (beneficial owners) from lending programmes. There was palpable fear from this section of the market and this fed down into many areas of the SBL landscape.
Once clients, and also by extension to a varying degree the regulators, began to get our (the Australian 麻豆传媒 Lending Association and SBL market participants) message and grasp a better understanding of the changes and how to best negotiate them, we noticed a slow and steady return to the marketplace of some of the participants who had initially exited.
We certainly feel that, when looking at the beneficial owners perspective, they feel a much greater degree of comfort and certainty than they did a couple of years ago. However, there still remains a general market-wide feeling of caution, which is in large part a response to the quite severe reaction of regulators to events in the recent past. This may take several more years to remedy.
Cowan: The Australian lending market has had its fair share of regulations to deal with since 2008, when a total short selling ban was replaced with a naked short selling ban, and both short sell and loan reporting. As most of the lenders and borrowers are global players, we are keeping a close eye on the global situation.
Awad: The Australian regulator introduced a number of changes throughout 2008 to 2010 to improve the regulatory and disclosure framework surrounding both securities lending and short selling activities in Australia. These reporting and disclosure requirements have now been integrated as part of normal market practices. It is the potential regulatory changes out of the US and Europe that are currently being monitored, as most participants are part of global businesses and therefore they will be affected.
How have choices of collateral types changed in recent years?
Awad: For Australian lenders; not significantly, as both non-cash and cash have been accepted and continue to be. Lenders are always encouraged to have a diversified collateral profile, within their specific risk parameters, as this allows them to take advantage of market opportunities as they occur.
Mitchem: Collateral requirements/usage is a moving target. After 2008, there was a big move to non-cash collateral, as cash became expensive. However, some domestic lenders required prepayment of non-cash collateral prior to borrowing (as opposed to end of day settlement for the day鈥檚 exposure). There was movement away from these lenders at the time due to restrictions.
More recently, there has been a bigger push for financing of equity longs, mainly having the mechanism in place to be able to turn them into cash quickly, due to regulatory requirements, and in turn, using the resultant cash as collateral.
There has been growth in triparty arrangements, which has helped with collateral usage. However, all arrangements have their own set of parameters, such as from which part of the index are the equity names acceptable. This in itself has relaxed in recent times with a bit more stability in the market. Settlement of trades DVP versus Australian dollars has the least risk for intraday exposure (as stock and cash move together in the clearing system for DVP/RVP trades). When it comes to cash, Australian and US dollars are the preferred choices. US treasuries and G10 debt remain expensive and cumbersome.
Cowan: The introduction of regulations (Basel III, for example) specific to strengthening banks鈥� balance sheets is creating a ripple effect within collateral management. Acceptable collateral is an important dynamic in every loan trade and there has been increased focus on efficiently and flexibly managing collateral for balance sheet purposes.
A curious dynamic for collateral is the variance between each financial institution and line of business, depending on internal funding dynamics. These dynamics result in preferred forms of collateral from one borrower to another. As a lender, the greater the collateral options available, the more loan opportunities we can extract on behalf of our clients. Specific to the local market, this means we can accept Australian dollars, government bonds and equities. We also link into global collateral solutions using our global securities collateral management platform.
What are the major obstacles to enhancing returns and how can they be negotiated?
Cowan: As loan demand for Australian equities remains subdued, we have focused on emerging markets (for example, we have just completed our first trade in Malaysia) and working with clients on bespoke trade solutions.
Mitchem: Market demand has just not returned to pre-crisis levels. In part, this is cyclical and understandable. There is not the directional short interest that there once was, as well as a marked effect from the deleveraging of the wider market. We also see traditional index arbitrage participants being predominantly long as opposed to short.
There has been some recovery in mergers and acqusitions and some upside resultant from a slow re-emergence of corporate activity. But this is a slow process. We are also noticing a more crowded group participating in the various Delta One trading strategies, which has tightened spreads considerably in these types of trades. All of this has combined to make the environment a lot more competitive than it once was and we would really hope for some real demand-side growth to aid SBL returns in the future. SLT
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