The sheer volume of likely regulatory change on its way suggests that participation in securities lending is going to become more complex and costly. At the same time lower levels of leverage in the system probably mean hedge fund demand for flow business will remain subdued and dividend arbitrage is likely to reduce, as tax regimes harmonise (although it feels like that’s been said for years!) So where can lenders look for new revenue opportunities?
It’s a dilemma and one many lenders should be grappling with. After all, funds still need to show good performance and the risk return ratio and/or ROCE of securities lending should be compelling relative to other investment strategies, if it is presented correctly. It is in times when performance is hard fought for that funds should be considering increased lending activity, and this is best achieved by considering lending activity in the context of the broader portfolio strategy and risk profile. A more pro-active approach is needed, with lenders actively identifying and pursuing opportunities.
The age old solution is to look to new markets where returns can be significant, and if you have a large enough EM portfolio, this may still be the right option. However, it is surprising how quickly new markets become old markets and rates fall accordingly, so unless you have a significant portfolio in a particular market, consideration needs to be given to, not just the headline rates, but their durability to ensure they will produce reasonable profits once you have considered the reputational risks and costs of entering (and remaining in) these markets. Whilst there may be big profits to be made for early entrants with access to a large supply, just opening up in another new market to increase returns always feels a bit tactical to me.
Opportunities within existing programs are often event driven or structured around funding requirements and establishing the right strategy for maximising them for each individual fund beforehand is critical. In order to get the engagement needed from the lender, agents must be able to provide detailed information about the activity undertaken and potential opportnities in a format and risk language that the lender can easily understand and interpret. This is achieved by understanding the fund objectives, dynamics and risk measurements. Being able to present new innovative structures (or even apparently minor tweaks to existing programs) in the context of the broader portfolio strategy and in risk adjusted language that the lender is familiar with and therefore able to compare to other investment strategies is key. Building confidence and understanding in this way helps the agent maximise opportunities efficiently when they arise.
MX can help develop strategies and client reporting solutions to help lending business stay in front.