Lynn Strongin Dodds, chair
Chair: Each region has its own issues, but what are the common trends that you are seeing?
Sebastien Thiebault: Over the past year, we witnessed changes in terms of what was needed by market participants. Needs are evolving away from standard short covering towards more structured solutions with a focus on improved balance sheet management and liquidity usage.
Cash rich clients are also looking at new ways to improve yield and therefore are diversifying away from traditional government bond repo. Equity repo offers higher yield than the typical treasury repo product. We see the emergence of a market where investment banks and prime brokers refinance their equities using repo.
Chair: You mention the search for yield – is that the main driver behind the move that you have seen this past year?
Thiebault: Over the past year, the financing cost of equity assets has increased globally. This in turn impacted equity repo levels making the product more attractive in terms of yield for cash reinvestment activities.
Richard Deroulede: Investors, as well as regulators, have forced banks to reduce the amount of unsecured financing in favour of collateralised financing. Equities were one of the main asset classes to benefit from this trend and we have seen a significant increase in the size of the equity financing business.
Ariel Winiger: Furthermore, tenors have increased, with a greater emphasis on longer term financing, including evergreens/extendables. Since the 2011 crisis, there is an increased focus on securing part of financing needs for a longer duration.
Also, there is a shift to having a greater overlap of financing and flow activities. More banks are trying to optimise inventories internally as much as possible before they go out to the street to borrow or raise assets.
Chair: How has this impacted your business? Did you have to adjust your business model, to adapt to those changes?
Deroulede: We needed to adapt. First, all our traders can trade a wide range of wrappers, from stock loan and repo to total return swap and stock futures. That enables us to see a broad range of markets and better answer our client’s requests.
Secondly, we are very well integrated with the rest of our derivative franchise. As a consequence, we are seeing different parameters moving ahead, typically on the index future business, which has an impact on the financing business. Such organisation helps us better understand and anticipate movements on the financing market, but also enables us to find new distribution channels for equity financing interests.
Another advantage of integration is our ability to take risk and to hold some positions. Typically, when we have to finance clients on a long-term basis, we are not able to hedge ourselves directly in the market so we need to be able to hold some risk on our balance sheet until we find the right hedge.
Winiger: I think Societe Generale (SG) CIB’s equity finance business is more diversified than most others, especially among the big prime brokers, which are mainly focused on servicing hedge funds. We have many other pillars, which we started to develop a few years ago, and this has helped us cope with the challenging environment. One area is corporate action arbitrage.
Another is financing, where we have a more integrated set up that allows us to trade different wrappers. We take into consideration the scarce resource impacts (balance sheet, RWA, LCR, etc.) of these products to price them accurately and recommend the most efficient structure to clients.
Chair: What changes have been specifically made to corporate action arbitrage strategies?
Winiger: We developed a website a few years ago where we provide information on specific corporate actions. But also, on a more general level, we describe the dynamics of particular rights issues or script dividends etc. We believe if we provide transparent information our clients make better decisions, which will ultimately help them generate higher revenues.
Deroulede: Throughout the years, agent lenders have typically been asking us for more information and explanation regarding the different types of evolving corporate actions. They wanted documentation, or sometimes just simple explanations, in order to clarify to their own clients their interest to lend positions.
This is an important point because many corporate actions are being missed or not fully optimised – and often this is not being looked at. We have seen that the information we provide through our dedicated website increasingly gain traction.
Chair: Is there any other change that your group has made since 2011?
Winiger: The biggest changes have been implemented on the financing side. We had to improve our infrastructure to accommodate increased volumes and higher complexity in terms of products, risk management and scarce resources.
Thiebault: We saw an increased appetite in volumes on repo, moving away from the traditional stock loan wrapper and, in the US especially, we have started to see money market funds, which are investing their cash in equity repo instead of traditional assets classes. We have also seen the same kind of cash rich funds looking for longer maturities to improve returns.
Deroulede: We have been adding new products to our existing range as well as getting closer to the delta one business, typically on indexes. We have been heavily investing in tools as well as streamlining all the different operational processes in order to be more efficient. This has been particularly true on collateral management, which I think is a challenge for all the banks.
On paper, it looks very simple to move one asset from one place to the other but it starts getting very complicated when several billion euros worth of assets are involved with different clients, each one of them having their own personal constraints.
Chair: Many banks are trying to do the same, so what is your competitive advantage or main differentiator?
Thiebault: We have the ability to trade bonds and equities, across all available wrappers. I believe this makes us more flexible than many competitors.
Deroulede: One of our key aspects is our ability to transform a weakness into strength. By this I mean SG CIB is not a big prime broker in these markets, which makes it difficult to grow balances with lenders and to have the critical size needed to carry out a certain amount of operations. To differentiate us, we have been developing niches such as secured financing and market intelligence.
Chair: Many banks talk about innovation. What does it mean at Societe Generale?
Winiger: As a non-prime broker, we always had to be innovative. This drove us, early on, to find pockets of opportunities. Five or six years ago, there were maybe three banks in Asia looking at corporate action arbitrage whereas in the last year or two, suddenly all the big prime brokers are looking for additional revenues and are trying to muscle in on these type of trades.
Since we were earlier in terms of exploring and acting on those different revenue generating avenues, I believe we are still ahead of the competition in this field in terms of sophistication.
We are also looking for new ways to structure deals on the financing side. For example, in Asia some of the regional banks are looking for yield pick-up. Maybe they don't have the capabilities to do stock lending or total return swaps so we issue collateralised notes, where we raise cash versus some more illiquid assets.
The key here is to make the client comfortable with these products, explain how they work, and find a match between the yields that the clients are looking for and the kind of assets we want to refinance.
Chair: How is it done? Do you have a special team that just focuses on innovation? How do you come up with these solutions?
Winiger: There are two main drivers of innovation. Firstly, clients approach us on a particular problem they have and we aim to find solutions. Secondly, we seek solutions for our own needs. This can be regulation, trading or operations-driven. We don't have a dedicated team as the ideas need to be generated by the people who have the client and product knowledge. They can pinpoint the trends and develop the solutions.
Thiebault: I think that some of the products we have created over the years are in direct response to our clients’ needs. For example, we developed an asset swap that allows the client to cover their short without having to post cash to us, but just another asset. The spectrum of assets that we are accepting is now wider than it was in the past. It used to be only US dollars, but now we are accepting an equity component and government bonds. We can also, as Richard
Chair: How do the various regions differ by product and client? Do you have a global solution that is common to Asia, the US and Europe?
Winiger: Starting with financing, in Asia one must consider the stamp duty or sales tax, present in many markets, which makes it prohibitive to finance existing positions with swaps. Therefore, it’s very stock loan and repo heavy. This results in a heavier balance sheet footprint, which could become problematic. The largest market in the region, in terms of notional value on the secured financing, is Japan, which has undergone political and economic change this year. The long assets in the country have significantly increased, but in the short term, in a less bullish environment, I think the market could be more balanced with a higher percentage of short positions.
There are some large markets that have not yet opened up to the equity finance business. India – even though it has an exchange traded stock lending model – China and Indonesia have potential once the regulators implement changes for equity finance to take place similarly to the developed markets.
Chair: In Asia, financing and flow business are increasingly overlapping. Is that a particularly regional issue, or is it a global problem? Do you have different products in Asia as a result of the different models? Are clients open to new ideas?
Winiger: It’s a global trend. We are using the same products as in other regions, but, as I said, on the financing side we are probably a heavier user of stock loan and repo products compared to Europe and the US, where there is more synthetic financing. I see lenders starting to become more sophisticated. They are hiring people from the broker-dealer and banking community.
Chair: What is the environment like in Europe?
Deroulede: The number of short selling situations has been very poor for about three years, so traditional flow business has been quite difficult to conduct. At the same time, developments have focussed more on financing and collateral management.
The trend to increase the number of countries where we can actively trade stock loan, repos and swaps is not new. We don't see a lot of shortages in these markets, but we are getting more financing requests on different types of countries from those in Central and Eastern Europe to the Middle East and Africa. One of the biggest trends we are currently seeing is in Russia, where we have a number of clients willing to re-finance assets.
There are also several areas such as exchange traded funds that are working very well in the US but not gaining the same type of traction in Europe. These are areas, though, that we hope to generate more business from.
Chair: What about from a regulatory perspective?
Deroulede: There are several pieces of legislation that could have an impact on the markets, adding constraints on haircuts, ability to re-use collateral or increasing the liquidity required to conduct our business. This is a concern but also a source of new opportunities once there is more clarity.
There are also numerous constraints very specific to Europe. First there is the long-lasting story of the financial transaction tax. However, if you look at the French and Italian markets, which already have the FTT, it has not overly affected their equity refinancing markets. There are also rules regarding the ability for funds to do long-term repo transactions under UCITS IV. That’s potentially a real constraint but we haven’t yet seen the impact on the market.
Chair: Finally, what are the main trends in the US?
Thiebault: The regulatory environment is changing and will continue to do so in the near future. The final versions of the rules and regulations are still not clear, but they will alter the general landscape and put some pressure on our industry.
However, I think people will be able to find solutions to conduct their business. The constraints will mainly be on collateral and asset optimisation. I believe we are in a good position to adapt our business model and to provide solutions to clients. For example, equity-for-equity transactions are more developed in the US than in Europe, because under US GAAP rules they are not as capital intensive.
We are also involved in Americas outside of the US. The Brazilian securities lending market, for example, is still in the development phase and I think we will see growth in the near future. This market still has room to grow as many assets are held by foreign investors and not yet available for borrowing. It is similar to the Asian emerging markets, where we don't know when the overall market will be able to trade under security lending. For the rest of Latin America, the stock loan market is either nonexistent or a very thin.