Specials lending has become a key driver of increased lending revenues in Asia Pacific over the last few years, boosted by a variety of regional and national developments. By Paul Golden.
Any discussion of specials lending in Asia tends to focus on the high percentage, specialised markets such as Korea and Taiwan. Korea remains a significant driver of securities lending returns in Asia, but in recent years this has been due to a small number of stocks commanding very high fees. Hong Kong is still a key contributor of returns in the region with its links to China, but once again the smaller number of stocks means revenue can fluctuate from year to year.
Experienced observers stress that the largest market in Asia – Japan – should not be discounted. “Japan is a perennially strong market due to its size and the number of securities,” notes Andrew McCardle, head of EquiLend Asia. “While specials do not make up as large a percentage of securities finance trades in this market, the significant volumes mean it is a great source of securities lending activity in the region.”
In the more established Asian securities lending markets of Japan and Hong Kong, specials lending typically accounts for 10-20% of all transactions by volume in HSBC’s client programmes, whereas in less established markets (South Korea, Malaysia, Taiwan) such strategies form a much higher portion of an overall programme, representing as much as 80% of total volume.
“We see increased opportunities and anticipate this to continue as wider Asian cash markets mature and in the corporate event space due to pricing arbitrage opportunities between the market and offer prices for M&A, capital raising and tender offers,” explains Reshad Mullboccus, acting co-global head of securities lending at HSBC Securities Services.
Additionally, some Asian security classes are exposed to regional or country-specific factors that are not so relevant elsewhere creating opportunities for lenders, such as directional interest in the gaming industry due to China’s slow approval of games for domestic release.
“In Hong Kong, we saw renewed confidence in the local and mainland Chinese economies early in the year, which led to an increase in IPO and secondary capital activity,” he says. “In the second half of 2018, US/China trade tensions and rising US interest rates resulted in increased market volatility and consequently increased directional trading opportunities for hedge funds.”
In Japan, activity was boosted by corporate deal flow with standouts including Takeda Pharmaceutical’s record $62bn acquisition of UK-listed Shire and Softbank’s spinoff of its mobile business, which raised $23.5bn. Other themes included increased corporate governance concerns and accounting scandals such as those at Suruga Bank and real estate brokerage firm Tateru, as well as increased manufacturing competition from China, which negatively impacted some leading Japanese consumer electronics firms including Sharp.
South Korean lending demand was once again strong due to renewed interest in the heavy industry and shipbuilding sectors which struggled with declining orders, adds Nizami. “Biotech and pharmaceuticals also generated demand on speculation of industry consolidation and concerns the sector was overvalued.”
Another reason for the strong focus on specials in Asia is the current state of the global economy. China, Korea, Japan and Taiwan tend to be strongly impacted by rapid changes in both global trade patterns and broader economic issues. Escalating trade tensions between the US and China, rising interest rates in the US, renewed concerns over the state of the Chinese economy and the ensuing market volatility have all provided additional themes for specials lending in the region.
“From a trader’s perspective, Asia is typically a fundamental equity long-short playground with lending fees ranging from 15bps all the way up to 1000bps and above. So ‘specials’ lending (defined as fees trading higher than 200bps) is prevalent across all active markets with the highest intrinsic fees most often seen in Japan, Taiwan, South Korea, Malaysia, Thailand and Hong Kong,” explains Paul Solway, head of securities finance Asia at BNY Mellon.
Equity lending fees depend heavily on the liquidity and accessibility of lendable pools, which generally tends to be tighter in emerging markets. Many Asian markets are still considered emerging, having relatively smaller, riskier or more illiquid capital markets than their developed peers.
Therefore if capitalisations are smaller, lending pools are less, which results in an imbalanced supply-demand. “Combine this with the additional rules and regulations that are often seen in nascent markets and fees naturally become higher as sourcing ‘borrow’ for shorting and other fundamental trading strategies becomes more difficult,” says Solway.
He notes that in 2018, Japan, Hong Kong and South Korea generated some of the highest lending revenue returns in the region. “Such returns often follow the 80/20 adage but in some cases as much as 90% of the revenue will come from 10% of the portfolio, especially when securities are trading at 1000bps and above.”
While fundamental interest in specific companies like BYD (Hong Kong) and Celltrion (South Korea) still dominates the market, the market has also seen the emergence of a number of thematic drivers including technology in Taiwan, bio-pharmaceuticals in Korea and a lithium-related focus in Australia.
Although supply and demand dynamics are the cornerstone to securities lending pricing and therefore the incidence of specials activity, numerous other factors can influence whether a stock is deemed to be ‘special’.
The trend in Asia over recent years has been for specials revenue to become a more important revenue-generating factor within securities lending portfolios, driven by borrowers more efficiently managing capital consumption challenges and navigating balance sheet capacity, explains Northern Trust’s head of capital markets Asia Pacific, Mark Snowdon.
“Demand for specials is influenced by a multitude of micro and macro factors, meaning that one region will not always be more reliant on specials lending than another,” he observes.
“Recently, there have been numerous specials globally that have contributed greatly to securities lending returns. In Asia, emerging market activity makes up a strong element of the revenue that is generated from the region - on a normalised basis these markets can yield more attractive returns than the US or EMEA.”
Asian stock markets tend to be more volatile than Eurozone markets, which results in a greater demand to borrow securities, while bespoke rules and regulations found in many of the smaller Asian markets (for instance, no fail rules) result in supply/demand dislocations that ultimately create a unique focus for both borrowers and lenders.
That is the view of Jim Moroney, managing director, global head of equity trading and corporate bonds trading at eSecLending, who notes that Taiwan has been a growing source of lending returns as demand continues to grow in that market.
“Furthermore, Japan has enjoyed a resurgence with more specials and a few mergers that have created new opportunities for lending returns,” he says.
Greater intra-day market volatility across the Asian markets is a result of global trade links and the geopolitical climate which leads to greater event driven and directional short opportunities in the region.
“We see examples of this regularly with Hong Kong, which remains a strong lending market for us,” says Simone Broadfield, APAC head of agency securities lending at BNP Paribas Securities Services.
Shorts can become crowded very quickly due to the limited depth of lendable supply in Asia, even in developed markets such as Hong Kong, so demand from borrowers often outweighs supply and assets become hard to borrow at a relatively quick pace.
“There are growth opportunities across the Asia Pacific markets with South Korea continuing to lead securities lending returns based on individual fee levels,” adds Broadfield.
Wayne Burlingham, fellow acting co-global head of securities lending at HSBC Securities Services observes that IT, industrials, telecoms and utilities account for an increasing proportion of the overall Asian specials space with the IT sector alone contributing a quarter of all Asia specials balances, particularly in Japan.
Equity specials in the technology space (MLCC, DRAM) were very relevant in 2018 given the downturn from 2017, when there was a significant appreciation of valuations, explains Solway.
“Asia has many downstream suppliers for big tech companies like Apple and these suppliers - especially in Korea and Taiwan - were impacted by Apple’s performance, with borrow volumes that are often seen as indicators of future trouble upstream.”
Telecoms is driving large fundamental borrows with the sector facing challenges related to competition and pricing, but Solway refers to a more prominent impact on specific markets like Malaysia (DIGI, MAXIS) and Singapore (StarHub, SingTel).
“More often than not, Asian key specials have their own unique reasons for their respective borrow interests,” he concludes. “Good examples of this include BYD (earnings), Sharp (corporate restructuring), Takeda (Shire deal), Cyberdyne (long term fundamental short) and Zhaojin Mining (sector short).”