Last year was a somewhat challenging one for the Toronto Stock Exchange (TSX), with the TSX Composite Index down 11.64% at the end of 2018, says Phil Zywot, managing director and Canada regional securities finance trading head at BNY Mellon Markets. However, 1Q19 experienced a rebound. “It’s been the best start to any year in the last 19 years, with the TSX Composite Index coming up 12.42% in the first quarter,” Zywot adds.
Cannabis stocks continue to drive momentum in the Canadian securities finance market. According to data from IHS Markit, Canadian equity securities lending revenue reached $144.82 million in 1Q19, up 11.5% on 1Q18. Canadian cannabis stocks accounted for $63 million of 1Q19’s equity lending revenue, an increase of 32% year on year. In North America, four of the top 10 revenue-generating stocks in the first quarter of the year were in the Cannabis sector.
Mark Skowron, senior vice president, global securities lending trading at Northern Trust, says: “In Canada, one of the main themes of 2018, and likely into 2019, was borrower interest in shares of cannabis-related companies, as the country legalized the use of recreational marijuana. Ongoing borrower demand and elevated lending fees should drive good opportunities for holders of these companies’ shares as the sector is broadly viewed as overpriced.”
While mining and energy stocks have historically been a key driver of demand for specials in Canada from a short-selling perspective, recent demand has been more subdued in these areas and cannabis stocks currently represent the lion’s share of growth in the Canadian market, explains Sam Pierson, director, securities finance at IHS Markit. “There are hedge funds that seem to have a long-term view that it is going to be hard for Canadian cannabis players to grow into their market caps,” he says. “As the market caps have grown so have the short balances, as share price volatility continues to attract a lot of trading on both sides.”
Meanwhile, on the fixed income side, there has been continued strength on the back of Canada’s AAA rating and the need for high quality liquid assets (HQLA), notes BNY Mellon’s Zywot. This trend is expected to continue over 2019.
The country’s securities finance market has also seen a move towards greater collateral diversification. Zywot says: “Canada has generally been a non-cash collateral, sovereign debt market. Now we are seeing more equities as collateral, other sovereign debt options as collateral, and an expansion into corporate bonds as collateral. We have even seen an expansion into different forms of cash collateral and different currencies.”
The industry continues to push for broader collateral options for Canadian mutual funds. The Canadian Securities Lending Association (CASLA) is advocating for changes to National Instrument 81-102 in order to allow mutual funds to accept equities as collateral for securities lending transactions.
The Canadian Federal Budget, announced on March 19 2019, laid out proposed reforms with a bearing on the securities lending industry. This includes changes to the tax treatment surrounding securities lending transactions where a non-resident lends Canadian stocks to a Canadian resident, which aim to ‘prevent non-resident taxpayers from avoiding Canadian dividend withholding tax on compensation payments made under cross-border share lending arrangements with respect to Canadian shares’.
“These regulatory changes have been proposed but not yet implemented,” says Zywot. “If they do pass, they will be retroactive back to March 19. Participants both globally and here in Canada are monitoring the situation closely.”
2019 has already seen the introduction of new rules that provide retail investors with access to liquid alternatives, which came into effect on January 3. Zywot says: “This is potentially a new market opportunity for the Canadian industry. It may be off to a slow start as the retail sector gains a better understanding of what the product offer is, but it should be an avenue of growth over the upcoming years for the Canadian marketplace.”
Beneficial owner engagement
While Canadian beneficial owners are typically au fait with, and accepting of, securities lending practices, Zywot believes there has been a trend towards increased utilisation of securities lending as a tool to help generate incremental revenue for their underlying funds.
He says: “We have seen more engagement from securities lending beneficial owners on all fronts, whether that’s getting into a securities lending programme if there isn’t one, or looking at an existing programme to see how they can expand it or consider new trading strategies, ideas or collateral to further increase the incremental revenue that it can generate.”