Markets and Securities Services

February 2017 | Issue 124

Welcome

Jeff Bonaldi Director Head of Agency Lending Sales, Americas

At the IMN’s 23rd Annual Beneficial Owner’s International Securities Finance & Collateral Management Lending Conference in Fort Lauderdale, Florida, participants reflected on the continued strength and growth in the industry over the past year. Their expectations seemed to be that the marketplace would continue its solid and steady expansion in 2017.

Main themes centred on the regulatory environment, innovative new strategies to optimize lending portfolios, and changes in collateral management.

Regulatory environment There was much discussion on the various regulatory requirements affecting capital costs and the implications of this for the securities-lending industry. Talks focused on the increased cost of capital for agent lenders to offer indemnification. Conference panelists also discussed the changing pricing structure as a result of these changes.

Another topic of interest was the potential for President Trump’s plan to reduce regulations and the potential changes to Dodd- Frank. Action within his first year seems plausible, but without knowing what specific changes will be made, speculating on the effect to the securities lending market would simply be premature.

Optimization of lending programs Conference attendees also engaged in discussion on a general shift that they have been experiencing in program parameters in enhancing their existing programs. These included: new investment options, additional borrowers, and more flexible restrictions for lendable limits.

In addition, the general consensus was that beneficial owners were still concentrating on intrinsic value lending and maintaining indemnification, and that overall gross revenue returns were not so paramount as risk for clients.

Changes in collateral management A number of panels explored the changes in collateral management and how some beneficial owners have been taking a more holistic approach to collateral as part of the overall investment strategy for their firm. One of the innovations discussed was peer- to-peer lending, a program that has been in place at Citi for some time now. In its basic form, clients face off directly with other clients of an agent bank to satisfy either their cash or collateral needs. This structure provides access to funding sources much more difficult to access through traditional routes in recent years.

Overall, the Conference seemed to confirm attendees’ optimism for strong growth in the market, for innovation, and for risk management — all strong signals of the current and future strength of our industry. February 2017 | Market Monitor 2

US equities and corporate bonds

Notable stocks for the month included: stating the company would settle Notable bonds for the month included: with the Federal Communications • Tesla Inc. (TSLA) Committee (FCC) over the the • Micron Technology (595112AY9) • Vmware Inc. (VMW) practice of squatting on spectrum • Gap Inc. (364760AK4) licenses without any meaningful • Nutanix (NTNX) • Oasis Petroleum (674215AG3) effort to put them to good use in a • Under Armour Inc. (UAA) timely manner.1 • Red Hat Inc. (756577AD4) • Lannett Companies Inc. (LCI) Valvoline Inc. (VVV) saw increased • GoPro Inc. (GPRO) demand in the month of January • Ziopharm Oncology (ZIOP) as lenders were recalling the stock ahead of the proxy record Straight Path Communications date on 1/24/17, resulting in a (STRP) saw increased demand after spike of the cost to borrow. the announcement in mid-January

US cash and money markets2

January was accentuated with the Treasury Bill supply may remain the downward pressure on yields.4 ramp of money market issuance constrained in the short term under This has resulted in rich general post-year-end. Heading into January, a looming debt ceiling where the collateral levels in the repo market. commercial paper issuance had Treasury looks to materially reduce The Fed’s Reverse Repo Program (RRP) declined 15%.3 Money market activity its operating cash. Estimates for a has witnessed a precipitous declined in has increased markedly as the reduction of USD160 billion could put usage post-year-end after peaking at prospects for multiple rate hikes this pressure on the short end of the curve, USD468 billion, levelling off to USD100 year has driven demand for floating while the influx of cash-to-government billion by the end of the month. investment vehicles. money market funds might exacerbate

US Treasury and agency

The market was slow to develop meaningful degree of scarcity value. bps, 3-year at 36 bps, 5-year at 32 after year-end. UST GC averaged The new “single-issue” 10s and 30s bps, 10-year at 38 bps, and 30-year 0.65%, which was just inside of the will settle on 15 February. Both will at 18 bps. These were not great for OBFR (Overnight Bank Funding Rate). be single issues until their respective on-the-runs. As previously mentioned, Specials cooled off considerably in reopening on 15 March. This time, as narrow spreads are not unusual for a January relative to the torrid market single issues, is typically their value typical January. Specials tend to move in December. It’s not unusual to have period that has historically shown to to the forefront soon after the new 10s a weak specials market in January be their best opportunity to trade as a and 30s settle at February’s Quarterly with the 10s and long bonds both deeper-than-usual specials. Refunding. reopening for the second time, making them triple issues, which also makes it Spreads for on-the-runs versus GC very difficult for either to trade with a levels for January were: 2-year at 26

1 http://www.streetinsider.com/Corporate+News/Straight+Path+(STRP)+Settles+With+the+FCC%3B+to+Review+Strategic+Alternatives/12419143.html , last accessed on 3 February 2017. 2 Bloomberg. 3 Federal Reserve at www.federalreserve.gov. 4 US Treasury at www.treasury.gov. February 2017 | Market Monitor 3

Asia-Pacific equities1

Australia involving faulty Takata (7312 JP) designated stocks will be removed Tabcorp (TAH AU) is experiencing airbag inflators affecting more than from the eligible list. Stocks that ongoing court action into allegations 652,000 vehicles in the US. Takata’s will be eligible for shorting include: of money laundering and ambitious inflators degrade over time and can Fullshare Holdings Ltd (607 HK), plans to expand the business that explode with too much force, sending Coolpad Group Ltd (2369 HK), have dragged down the profit of the pieces of metal shrapnel flying into and Alibaba Health Information wagering giant. Its first-half net profit the vehicle cabin. Over a dozen people Technology Ltd (241 HK). Stocks that dropped 28% to AUD58.9 million, and have been killed as a result with will be removed from the list include the company has also suspended its hundreds more injured. Zall Group Ltd (2098 HK). dividend reinvestment plan. GungHo (3765 JP) and Colopl (3668 Malaysia Bellamy’s (BAL AU) chief executive, JP) saw their shares rise after Berjaya Land Bhd (BLand) has Laura McBain, resigned as a director Nintendo’s (7974 JP) president said acquired 10 million ordinary shares this week. McBain stepped down from the company wouldn’t rule out seeking from Berjaya Retail Bhd in 7-Eleven the CEO position on 11 January after support from mobile game partners Malaysia Holdings Bhd via a direct the company’s stock was suspended other than DeNA (2432 JP). business transaction for MYR14 million for five weeks following missteps in cash or MYR1.40 a share. BLand said the key Chinese baby formula market. Hong Kong the shares represented a 0.9% equity Bellamy is facing the possibility of Aluminium Corp. of China Ltd. (Chalco, interest in 7-Eleven and the share several class actions. 2600 HK), the nation’s largest purchase was funded with internally- state-owned producer, said profit generated funds. Bega (BGA AU), best known for its surged about 85% last year as prices cheddar cheese, mentioned in a jumped and the company cut costs. My EG Services Bhd (MYEG MK) statement that it would be buying a Aluminium in China advanced in 2016 bagged a MYR553.85 million suite of brands for AUD460 million from as government stimulus and a credit project to provide online renewal of Illinois-based Mondelez International binge boosted demand for the metal temporary employment passes for (MDLZ US). The debt-funded deal will in property and infrastructure. foreign workers for the Immigration transform dairy producer Bega into a Department of Malaysia. The tenure of consumer-goods company. Shenzhen Metro agreed to buy China the project is five years, and will last Resources Co.’s (1109 HK) 15.3% stake until 22 May 2020. Japan in China Vanke Co (2202 HK) for USD Toshiba (6502 JP) said it may 5.4 billion. China Evergrande Group Malaysia’s UMW Oil & Gas Corp (UMWH write down billions of dollars of (3333 HK), which has a 14.1% stake MK) agreed to acquire rival petroleum an acquisition made by US unit in Vanke, said it has “no intention” of service providers Icon Offshore Bhd. Westinghouse Electric, fuelling a share increasing its stake in its rival after and Orkim Sdn. as part of a USD650 decline that wiped out about JPY800 Shenzhen Metro struck the deal to million deal to bulk up and weather billion (USD6.8 billion) in market become the developer’s second- a downturn in the industry. As part value. The Tokyo-based company biggest shareholder. of the transaction, UMW Oil will seek was recovering from a profit-padding to raise about MYR1.8 billion selling scandal last year that claimed the China Mengniu Dairy Co (2319 HK), stock to existing investors through a jobs of three presidents, led to record the country’s second-largest dairy rights offering. It will also separate losses, and prompted the company to company, offered to buy out China from its parent company, automobile cut staff and sell off businesses. Modern Dairy Holdings Ltd. (1117 HK) distributor UMW Holdings Bhd., which for HKD6.92 billion (USD892 million) will distribute its majority stake in McDonald’s Japan (2702 JP) is to gain control over the country’s UMW Oil to its shareholders through a inviting bids for a stake of as much biggest raw milk supplier amid a dividend in specie. as 33% in its Japanese unit, national push to improve food safety. The Wall Street Journal reported, The deal comes after Mengniu said it Korea citing unidentified people familiar expected to report a substantial loss China cancelled nine joint military with the situation. A spokesman related to the underperformance of schedules including annual vice for McDonald’s said the company is an infant-formula maker it acquired minister-level talks with South Korea continuing to explore a potential sale control of in 2013. owing to tensions over deployment of a portion of its ownership. of the Thaad anti-missile system. From 10 February, 58 additional Stocks in tourism and retail sectors More than a dozen automakers are securities will be eligible for short are said to be most affected. Names engaging in another round of recalls selling in Hong Kong and 12 existing

1 Bloomberg. February 2017 | Market Monitor 4

include Hotel Shilla (008770 KS), LG TT) for TWD4,323.52 million, million. The record date for this event Household (051900 KS) and Cosmax resulting in a share exchange of was for 9 February 2017, and the (192820 KS). 1 (Ralec) to 0.78 (Chilisin). The subscription period will run from 15 transaction was announced on February to 16 March 2017. Korea Air (003490 KS) seeks to sell 23 January , and is expected to 22 million new shares to existing be completed by 30 June 2017. Singapore shareholders to raise KRW450 billion United Engineers Ltd’s (UEM SP) for working capital. The expected Nanya Technology (2408 TT) offered largest shareholders have started price of the new share is KRW2,450, USD500 million in 5 year-zero coupon formally assessing buyer interest in which will be finalized at the end USD convertible bonds due on 24 the century-old Singapore property of February. Korean Air’s foreign January 2022. Bonds had 1.75% yield group. The major shareholders of the currency debt accounts for more than and conversion price represented company, which has a market value 70% of the total borrowings, and has 10% premium against a share price of of SGD1.7 billion (USD1.2 billion), around USD589 million in loans due in TWD 47.7 on 17 January, according to have been sending preliminary 2017. Its debt-to-equity level stood at Bloomberg calculation. financial information on United about 917% as of the quarter ended Engineers’ business to potential Ennoconn Corp (6414 TT) priced 30 September 2016. The weakening of bidders since the end of December. USD200 million convertible bonds due the Korean won has negative impact At least 10 parties, including on 10 March 2022 at TWD488. The to the cost of foreign debt. regional property developers, issuance will be available for trading private equity firms, and real estate on 10 March. Taiwan funds, have indicated interest. Chilisin Electronics Corp (2456 Hota Industrial (1536 TT) announced TT) announced the acquisition right issues with total shares of 15 of Ralec Electronic Corp (2437

European equities1

After a slow December 2016, 2017 However, the French luxury goods most likely due to falling subsidies and began with welcomed corporate sector would paradoxically appear to the lower price of oil. Short sellers actions news with rights issue be in vibrant health. Shares in Kering appeared to be attracted by the announcements and approvals in were trading at EUR114 12 months failing price, winding up from near- Banco Comercial Portugues SA (BCP ago and closed mid-month at EUR213, zero levels of interest during the first PL), UBI Banca (UBI IM), and EDF (EDF recording a gain of some 86%. Short nine months of 2016 to holding 90% FP). We also saw M&A news, long- sellers steered clear, closing more of the available shares by the end awaited by investors, in Safran SA than 90% of their positions between of January, suggesting that, despite (SAF FP)/Zodiac Aerospace (ZC FP). the 12-month peaks in January to the significant correction that has the low in November. However, since occurred, more turbulence may be Corporate space aside, we have seen the start of December, short interest around the corner. broker interest in various European has grown from around 3% of the names. Euronav (EURN BB), the available shares to almost 17%, Active stocks for the month included: Belgium-based oil transport and suggesting that some short sellers • Banco Comercial Portugues SA storage company, has interested thought a resistance point may have (BCP PL) directional funds for a while now been reached. as its purchasing strategy and the • UBI Banca (UBI IM) slump in oil price throughout 2016 Nordex SE (NDX1 GR) is a German • EDF (EDF FP) saw short interest leap by over 140%, manufacturer and distributor of suggesting that a rising oil price might wind power systems, specializing in • Nordex (NDX1 GR) not be enough to help Euronav find wind turbines. Green energy is big • Erlingklinger AG (ZIL2 GR) calmer waters. business, and Nordex has done much • Banco Popular Espanol (POP SM) over the last 12 months, reflected in Kering SA (KER FP), which includes the advance of the share price from • Fingerprint Cards (FINGB SS) Gucci among is brands, is a French EUR3.93 five years ago to a peak luxury goods retailer and distributor. EUR33.20 in December 2015. Since Currently there is much talk of then, the shares have fallen back, economic issues across Europe.

1 FIS, Astec Analytics. February 2017 | Market Monitor 5

European money markets and government bonds1

Tri-repo collateralized by AA-rated since February 2008.” It also noted Euro-area inflation surged to a 4-year sovereigns normalized just after the “Improved pricing power, combined high of 1.8% year-on-year in January year-end sell-off. It was extremely with the desire to push higher costs on from 1.1% in December 2016 and volatile over this period as banking to customers, led to a further increase 0.2% on average in 2016, well above counterparts shrank balance sheets, in average selling prices for goods and consensus (of 1.5%; Citi: 1.7%). Large therefore reducing supply of collateral, services in January. Although the rate base effects and recent gains in which saw demand for sheet paying as of increase eased marginally, the latest energy prices mainly pushed headline low as -900 bps in the overnight. For the two months have seen the largest – inflation higher in January. Energy remainder of January, we saw it trade in albeit still modest – back-to-back rises in HICP (Harmonised Index of Consumer the normal range of -75 bps to -53 bps. selling prices for five-and-a-half years”.2 Prices) inflation rose to 8.1% from 2.6% in December and -1.1% in November. Economic commentary With regards to the ECB, Draghi The euro area Purchasing Managers’ retained a dovish tone at 19th January Fresh food prices inflation also Index help up well in January, consistent press conference. President Draghi rose substantially in January to with real GDP growth of around 0.5% confirmed the ECB would reduce its 3.3% from 2.1% YY in December quarter-over-quarter in Q1 2017. Euro- monthly pace of asset purchases from and 0.7% in November, probably area manufacturing PMI was roughly EUR80 billion to EUR60 billion from reflecting adverse weather stable at 55.1 in January 2017 versus April 2017 onwards, as announced in conditions in some crop-producing 54.9 in December 2016 (consensus: December, for an additional 9 months European countries in January. 54.8; Citi: 55.1), while service PMI of purchases until December 2017. He The Economic Sentiment Indicator (ESI) came in at 53.6 in January against stressed that underlying inflationary posted the fifth consecutive month- 53.7 in December (consensus: 53.8; pressures remained weak, despite the over-month gain in January, up by 0.4 Citi: 54.2). The composite PMI edged likely increase in headline inflation points to 108.2 above expectations only slightly lower to 54.3 in January expected in the next few months. (consensus: 107.8; Citi: 108.4), taking from 54.4 in December, staying very 2 the index to 0.8 standard deviations close to the post-euro-debt crisis Economic data (SD) above its long-term mean and peak reached in December 2016. The ECB left all key policy rates and its QE programme unchanged at its to the highest level since Q1 2011. Markit noted that January “saw the Thursday 19 January meeting. largest monthly rise in employment

1 Citi European Economics and Citi Velocity. 2 Citi European Economics. 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 Agency Lending, Americas Agency Lending, EMEA Agency Lending, Asia Tel: +1 212 816 8960 Tel: +1 212 723 5287 Tel: +353 1 622 6119 Tel: +852 2868 8087 [email protected] [email protected] [email protected] [email protected]

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