How would you describe securities lending business in Asia over the past year?
The securities lending business has been relatively lackluster over the past year. We see a few main trends having a material impact. The overall compression of margins in a world of high liquidity is not favourable, while the hedge fund world appears to have struggled in the second half of 2015, particularly smaller funds that strive to differentiate themselves to keep the interest of investors.
On the other hand, the second part of the year provided opportunities on very select names and exchange-traded funds (ETFs), especially on those tracking China. However, most clients remained on one side only, and unwinding/de-risking was the prevalent mood.
How far have the markets progressed in terms of development?
The widely anticipated opening of China’s stock lending market didn’t materialise in 2015. To a lesser extent, we could say the same about Taiwan’s efforts. We believe, however, that the positive direction towards a more open environment is making significant inroads and hope to see further progress in 2016.
Japan is resisting to a certain extent in this volatile environment and, indeed, we find that clients occasionally forget that it is still a tremendously big, albeit not ‘exciting’, market.
What’s in store for the future?
As does the overall economy of Asia, the future of securities borrowing and lending relies heavily on China. Indeed, the pressing question is whether we are going to see the emergence of a securities borrowing and lending market on the mainland.
Furthermore, clients are looking at Thailand, Indonesia and Malaysia.
We believe interest for those Southeast Asia economies will progressively deepen as the various foreign exchange regulations loosen. However, we anticipate this to be a slow evolution.
Meanwhile, enthusiasm for Taiwan seems to be wavering as the securities borrowing and lending market failed to materialise in 2015, as many clients expected.
How healthy are Asia’s equity markets?
The health of equity markets is essential to the securities borrowing and lending business. We need end-user clients, such as hedge funds and asset managers, to be active and successful in their trading to be the catalyst for securities lending markets.
Furthermore, a lack of liquidity and light volumes do not favour the securities borrowing and lending markets We also believe that unhealthy market valuations are not conductive to the long term development of our businesses.
Beyond liquidity, depth and market valuation, the securities borrowing and lending business requires healthy legal, regulatory and fiscal environments. There are complex legal environments in Asia, while stamp duties are another form of unfortunate restrictions to the business.
What is your opinion on Asian economies’ links to China?
It is a relative disadvantage, as non-Asian investors and clients often lack the breadth to focus on smaller economies, where we believe there could be interesting opportunities for them. Also, the flows are massively macro-driven, with monetary policies playing a major role and somehow swamping more local factors.
If we dig further, we can observe a pattern; local investors are focused on their own markets but very few are going into other Asian markets. Asia, in that respect, displays very little unity.
The link to China benefits the small number of sophisticated cross-border sellers in Asia (outside of Japan) because most of the sectors are somehow linked to the Chinese economy. This explains the short selling of sectors across Asia, such as the recent action in the commodities markets. In other words, excluding Japan, many Asia Pacific markets have benefitted from the Chinese market. Australia is a clear example.
The link does not favour autonomous development of smaller Asian markets, and sometimes penalises local long-term investors.
From our perspective, this is not a positive environment and it is unlikely to change rapidly. One rebalancing factor for the longer term could be the expansion of India.
Volatility is tipped to continue in Asia. How will this play out over the next 12 months?
Overall, global equity markets have been expensive. Indeed, equities are very much in a bull market, so it is therefore not surprising to see it undergo a correction. However, given the steep losses so far, it will take some time to recover, so I expect some volatility in the first half of 2016 and improvements later in the year.
We need further transparency before the uncertainty will subside, including on US Federal Reserve interest rate decisions, the Bank of Japan’s path to reach its inflation target, and Chinese growth. As decisions unfold and clarity sets in, a relief rally in the second part of the year is a plausible scenario.
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