Markets and Securities Services

October 2017 | Issue 131

Welcome

Gavin Callan EMEA Head Product Management Agency Securities Lending

I want to take this opportunity to provide an update from two recent beneficial owner events that took place: the 22nd Annual European Beneficial Owners’ Securities Finance & Collateral Management Conference and a Citi-hosted event titled “The Evolution of Securities Financing & Collateral Optimization”. For both events there was a strong turnout from the beneficial owner community, including a number of first-time client attendees. The dominant theme during both sessions was the changing nature of the market place. For many years after the financial crisis, there was a recognition that the regulatory environment was going to change, but it is only more recently that a number of these changes have become tangible. As a result, market participants are now redefining their strategies and approaches to securities lending to ensure that their operating models are compatible. It should be noted that the regulations are not harmonized by region or by stakeholder and at times are directly opposed. For example, on the demand side, traditional borrowing counterparties are required to have term financing in place, and hence seek to borrow high-quality liquid assets (HQLA) on a termed basis, while a key source of supply in the market, UCITs funds, are required to maintain liquidity by not entering into transactions greater than 7 days’ duration. So it is not surprising to find that the industry is dynamically evolving. One area of interest is the rationale for clients to participate in securities lending. Traditionally for -only managers, the focus has been on obtaining as a result of participating in securities lending. With the changes in the derivatives collateralization space, clients are looking at securities lending as an efficient and flexible mechanism to generate the necessary for derivatives as required. This is naturally a positive development for the industry and reaffirms the important role that securities lending plays in the overall financial markets. Another key area to highlight is the array of new structures that are under review or already live. Examples include pay- to-hold transactions, peer-to-peer lending, CCP routed trading, collateral in the form of a pledge instead of title transfer, and vendor-based platforms to connect peer-to-peer market participants. The one thing in common with all of these structures is that the driver is regulation. As an agent lender, we are engaged on all of these structures and we will be a key participant in their evolution. Beneficial owners can expect to hear a lot more about the development and evolution of these structures over the coming months. Additionally, it is worth noting that regulation impacts organizations in different ways and this helps to explain why so many alternative structures are under consideration. In summary, the industry is evolving quickly — so watch this space! October 2017 | Market Monitor 2

US equities 1

JinkoSolar Holding Co (JKS) suffered as conversations continue regarding sharp increase in demand coupled a lackluster earnings report on 6 the Trump Administration’s decision with thin supply across the street September. reporting a miss on on the tariff. has significantly elevated the cost and, despite to borrow. Applied Optoelectronics Inc (AAOI) shipments surging, a fall in profits. a manufacturer of advanced optical Other notable for the month There is a continued negative semiconductor devices, continues included: stance on the solar industry with to suffer from analyst concerns added this month as it is • AutoNation Inc. (AN) around the company’s operational expected that President Trump will health and from news this month • SNAP Inc. (SNAP) approve a tariff that will more than that one of Applied’s largest double the cost of cheap foreign • ELF Beauty (ELF) customers, Amazon (AMZN), is solar panels that have assisted in the • Revlon Inc Class A (REV) replacing parts typically provided industry’s success in recent years. by Applied with that of a competitor. • Eros International PLC (EROS) The ended down approximately This has created relentless negative 13% for the month, and we saw • Best Inc (BSTI) sentiment among , thus strong demand with supply remaining • Baozun Inc (BZUN) during September, we saw an thin across the street, thus keeping increase in interest to a • Blue Apron Holdings Inc (APRN) cost to borrow at a premium. We staggering 73% of the float. This expect the rates to remain elevated

US cash and money markets

During the September Fed meeting, nine years in the making and one banks’ capacities to overpromise the Committee brushed aside of the unconventional and truly and underdeliver due to the unique concerns that inflation remained monumental policy decisions pressures on each to conform to the below target. While no change to the undertaken by the Fed to drag various regulatory ratios did keep main policy rate was announced, the the country out of the financial the re-investment desk vigilant until signs pointed towards another hike crisis. Amounts to be rolled off will the last dollar was placed. Four- to to come in the December meeting, be relatively small initially in the six-month activity in bank product a rise that had been discounted attempt to avoid market disruptions attracted attention as spreads by the market for some time. With but will ramp up each month. widened from their near-term lows. no hike in the announcement, the With threats of additional Fed hikes Geopolitical events and especially meeting was not without interest for on the horizon, the preference for weather-related stories did not Fed watchers. The Fed announced floating-rate product still remain dampen the narrative of a steady a well flagged yet important well entrenched. Opportunities climb in economic activity. Most step to unwind the purchases of remained in structured repo analysts expect these trends to Treasuries and mortgages and deals, especially in non-traditional continue into 2018, barring any the first step to normalize the collateral such as equities. large macroeconomic shocks. balance sheet. Securities held in the portfolio will be allowed to Desk activity focused on funding mature without reinvestment. This for quarter-end. While this is a well begins a process that has been rehearsed exercise at this stage,

1 Bloomberg. October 2017 | Market Monitor 3

US Treasury and agency

The specials market was active rate. In the case where the Fed the month. Moreover, there were during September, led by the hasn’t established a specific rate several off-the-run Treasury and current 10-year note (9128282R0 but instead a range, the charge agency issues in demand as well. 2.25 8/15/27), which traded would be 200 bps below the low end The street began preparing for through the TMPG (Treasure Market of the Fed Funds range. In today’s quarter-end in earnest by mid- Practice Group) fail charge on environment, with the 1.25/1.00 month. Market participants began several occasions. It’s not unusual Funds range, the fail charge to throttle back on their balance- for the 10-year note to trade as would be -2.00% or 200 bps. The sheet intensive, marginally special a deep special during the first remainder of the specials market borrows as they began to lighten leg of its 90-day cycle, as this was quite good. The 2-year note their balance sheets’ load in is its “single-issue” time period. 9128282T6 1.25 8/31/19, 3-year note preparation for the quarter-end However, what was unusual was the 9128282V1 1.375 9/15/20, 5-year statement day. On the actual 10-year commanded a rebate rate note 9128282S8 1.625 8/31/22, and quarter-end, Friday 29 September, through the TMPG fail charge, and even the 7-year note 9128282U3 GC backed up 1.27%, which was a it happened on multiple occasions. 1.875 8/31/22 (it’s unusual to see full 20 bps higher than the previous The TMPG fail charge scheme the 7s trade special) — these all day’s GC level. The back-up in rates enables the entity being failed to traded with a healthy amount of lasted 3 days as the actual quarter- charge the failing entity a penalty scarcity value, averaging 35 to end fell on the weekend. fee of 200 bps below the Fed Funds 50 bps through GC on average for

Asia-Pacific equities 2

Australia Syrah, which is hoping to capitalise price this week, the stock has Harvey Norman (HVN AU) on the growth markets for lithium- advanced 467% this year to rank franchisees may face less ion batteries used in electric vehicles among the world’s top performing favourable trading terms with and energy storage, will use most stocks. Chairman Sun Hongbin suppliers following the retailer’s of the funds to continue developing has overseen a buying spree that decision to make it clear it was not a graphite mine in Mozambique. has elevated the company’s net liable to pay for their stock. Days gearing to almost 400%, according Beach Energy (BPT AU) agreed after Harvey Norman changed to analyst estimates. Some of the to buy Origin Energy’s (ORG AU) the accounting treatment for acquisitions, such as an investment conventional oil and gas business, franchisee receivables in its 2017 in a struggling internet company, Lattice Energy, for AUD1.59 accounts, analysts were still trying have raised concerns at ratings billion (USD1.25 billion) in a deal to understand the implications companies. set to triple the Adelaide-based for franchisees and Harvey company’s reserves. Beach will ZhongAn Online P&C Insurance Co. Norman’s future competitiveness fund the acquisition through an (6060 HK), whose shares surged as amid increased competition from AUD301 million share sale and a much as 18% on its debut in Hong local rivals and the imminent new AUD1.58 billion debt facility. Kong on 28 September, plans to arrival of Amazon (AMZN US). focus on selling higher-premium Macquarie Atlas Roads (MQA Hong Kong policies to make the company AU) announced the successful China Huarong Asset Management profitable following its USD1.5- completion of the institutional Co., a state-owned entity whose billion IPO. Backed by Ant Financial, component of its 1 for 6.62 businesses include lending, asked the owner of Alipay, and Tencent underwritten pro-rata accelerated units to temporarily suspend new Holdings Ltd., ZhongAn is targeting non-renounceable entitlement offer project financing to Sunac China health, auto and consumer-finance at the offer price of AUD5.12 per Holdings Ltd. (1918 HK) effective 18 insurance to augment its range of new stapled security. Completion of September, according to an internal low-cost policies covering things the Institutional Entitlement Offer email seen by Bloomberg. While like cracked smartphone screens, represents the first stage of MQA’s Huarong says it’s not acting on Chief Executive Officer Jeffrey Chen AUD450 million equity raising. instructions from regulators, the said. Chen also said the change email noted authorities were paying would improve the profit outlook Syrah Resources (SYR AU) raised more attention to Sunac’s high debt for the firm, which flagged in a AUD74 million via an institutional load and aggressive acquisition document that it expected a placement and entitlement offer. strategy. Despite the drop in share “significant” loss this year.

2 Bloomberg. October 2017 | Market Monitor 4

Japan its stock listing to South Korea’s Taiwan The Japanese government said main bourse, KOSPI, from KOSDAQ. Google agreed to buy part of HTC it would sell additional shares in The switch is forecast to take place Corp.’s engineering and design Japan Post Holdings (7182 JP) worth sometime in January or February 2018. teams for USD1.1 billion to bolster the around USD12 billion. The company, US internet giant’s nascent hardware with a network of 24,000 post Malaysia business. Google is taking on some offices and workforce of 400,000 AirAsia appointed BDO Unibank 2,000 employees with experience people, has been hurt by a constant for its Philippine IPO. The AirAsia working on its signature Pixel decline in mail delivery volume. Philippine venture is doing very devices. The deal also comes with a well and its IPO may happen in Q1 non-exclusive licensing agreement Invincible Investment Corp (8963 2018, President Tony Fernandes said for HTC intellectual property. JP) sought to raise as much as in an interview in Davao City. The JPY22.9 billion in Japan, JPY16.6 venture is looking at IPO proceeds of Delta Electronics (2308 TT) billion abroad, and up to JPY1.9 around USD200 million. AirAsia will announced it has acquired 40.26 billion in overallotment from a share start flying for times a week from million shares of Vivotek Inc. (3454 sale. A portion of the funds raised Kuala Lumpur to Davao City on 21 TT), constituting 49.22% of Vivotek are to be used to acquire real estate December, its fourth direct route to Inc.’s total outstanding shares. The properties. the Philippines from Malaysia after move is likely to reinforce Delta Electronics’ deployment efforts in Toshiba (6502 JP) signed a final Manila, Cebu, and Kalibo. the field of automation solutions. agreement to sell its flash memory The China Banking Regulatory chip business to a group led by Commission has approved CIMB Bain Capital for about JPY2 trillion Group Holdings Bhd’s (CIMB MK’s) (USD18 billion), moving a step closer proposed divestment of a 18.21% to completing the deal after months equity stake in the Bank of Yingkou of contentious negotiations. Co. Ltd (BYK). In December last year, CIMB announced it had entered into Korea a share-transfer agreement to sell Kumho Tire ( 073240 KS) creditors its 18.21% stake in BYK to Shanghai rejected a request by Doublestar to Guozhijie Investment Development reduce the asking price for a stake Co., Ltd. for MYR972 million. in the South Korean tire maker, according to a statement from main Singapore creditor Korea Development Bank. Capitaland Commercial Trust (CCT China’s Doublestar signed a KRW SP), Singapore’s biggest office 955 billion contract in March and landlord, agreed to buy BlackRock asked creditors to reduce the price Inc.’s Asia Square Tower 2 for SGD2.1 to KRW720 billion for a 42% stake billion (USD1.5 billion) in the city’s owing to weak earnings. Creditors second-largest-ever sale of an office say they’re considering court building. The acquisition will be receivership as a worst case and partially funded by a rights issue of demand that company chairman 166 for 1,000 to raise gross proceeds submit a recovery plan. of around SGD700 million. Orion Holdings (001800 KS) plans Mandarin Oriental International Ltd. to issue 42 million new shares at (MAND SP) scrapped the sale of The KRW22,660 apiece to purchase 10 Excelsior hotel in Hong Kong after million shares of Orion Corp (271560 bids failed to meet expectations, a KS) at KRW 96,524 to increase its rare setback in a city where property stake from 12.1% to 37.4%. The prices have continued to hit fresh subscription period will be between record highs. The Singapore-listed 25 October and 13 November. company’s shares slumped by as much Celltrion (068270 KS) held an as a record 32 % after surging 86% extraordinary general meeting on through 26 September since saying it 27 September and decided to move would test interest in the property. October 2017 | Market Monitor 5

European equities

European equity markets UK pharmaceuticals business will have a competitive product surged in September, following Clinigen (CLIN LN) announced in time or that the iris scanner a two-month plateau. The the acquisition of its weaker rival will be integrated along with exception was the UK, which saw Quantum Pharma (QP/LN) in a other biometric solutions in the equities taking a hit, following a GBP143-million deal. next few years. strengthening of the pound and a Fingerprint Cards (FINGB SS) saw Active stocks for the month included: hawkish Bank of England. some turbulence in September • Telit Communications (TCM LN) Seadrill (SDRL NO), one of the with its stock price falling 37.21%, world’s largest offshore drilling where it remained for the rest of • Seadrill (SDRL NO) companies, filed for bankruptcy the month. This, in part, was due • Havas (HAV FP) after securing an agreement from to a move away from fingerprint • Provident Financial (PFG LN) its banks to inject USD1 billion of scanning technology for some new capital to effectively wipe mobile phone manufacturers to • Fingerprint Cards (FINGB SS) out existing shareholders. This is in-display sensors. With Goodix, • Songa Offshore (SONG NO) the latest sign of upheaval in the Qualcomm and Synaptics • Clinigen (CLIN LN) offshore drilling market, which has announcing products, there is struggled with the crash in oil prices. little evidence that Fingerprint • Almirall (ALM SM)

European money markets and government bonds

Tri-repo collateralized by AA-rated the program to run through to the Headline inflation was stable sovereigns traded the majority of end of June, with forecasts ranging at 1.5% year-over-year in September between -0.70% and from 3 to 12 months. The median September, with core edges down. -0.52%. At quarter-end, the market response for the monthly purchases The The unchanging Eurozone traded between -0.100% and -0.70%. was EUR40 billion, down from headline rate came below market the current EUR60 billion, with a expectations (of 1.6%).4 Economic commentary relatively narrow range of EUR30 The stronger euro is “less favorable to EUR50 billion.The poll sees GDP for an exit and a stronger argument growth at 0.5% quarter-over-quarter for a muddle-through option”, three in Q3 and 0.4% in Q4 2017, with sources familiar with discussions inflation averaging 1.5% in 2017 and told Reuters. A stronger euro is 1.4% in 2018, unchanged versus the concerning some ECB members August poll.1 and this is raising the chances that asset purchases will be phased Economic data 3 out only slowly, the sources said. The EA manufacturing PMI rose to Formal talks about what to do with 58.2 in September by 0.8 pts against QE in 2018 are only beginning so expectations for a small decline the ECB is highly unlikely to take (consensus: 57.2; Citi: 57.1), the any decision at next Thursday’s highest since 11 February, despite the meeting, Reuters reported. strength of the euro. A Reuters poll indicates a 6-month The EA services PMI jumped back QE extension in 2018 at EUR40 in September to 55.6 (+0.9 pts vs billion a month will be announced August), well above expectations on 26 October, according to 50 of (consensus: 54.8; Citi: 55.1), after 52 economists who took part in four consecutive monthly declines, the Reuters poll, where 39 expect the highest level since spring 2011.

3 Citi European Economics, September. 4 Europe Sovereign Debt Update, Citi Velocity, 29 September. For more information, contact your Citi representative.

David Martocci Rich Kissinger Gavin Callan Martin Corrall Managing Director Director Director Director Global Head of Agency Lending Global Product Management EMEA Product Management Asia Product Management Tel: +1 212 816 8960 Head for Agency Lending Head for Agency Lending Head for Agency Lending [email protected] Tel: +1 212 723 5287 Tel: +353 1 622 6119 Tel: +852 2868 8087 [email protected] [email protected] [email protected]

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