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 long-only managers, the focus has been on obtaining alpha 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 margin 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 earnings per share and, despite to borrow. Applied Optoelectronics Inc (AAOI) shipments surging, a fall in profits. a manufacturer of advanced optical Other notable stocks for the month There is a continued negative semiconductor devices, continues included: stance on the solar industry with to suffer from analyst concerns added momentum 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 stock ended down approximately This has created relentless negative 13% for the month, and we saw • Best Inc (BSTI) sentiment among investors, thus strong demand with supply remaining • Baozun Inc (BZUN) during September, we saw an thin across the street, thus keeping increase in short 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.