Securities lending: The view from Canada

In this Q&A with Global Investor, Donato D’Eramo, Managing Director and Global Head, Securities Finance and Kyle Kolasingh, Associate Director of Securities Finance at RBC Investor & Treasury Services, provide an overview of how the Canadian market fared in 2020 and what the bank did to support its clients.

How has the Canadian securities lending market evolved over the last 12 months?

Kyle Kolasingh's Image

Kyle Kolasingh
Associate Director, Securities Finance,
RBC Investor & Treasury Services

Kyle: The Canadian securities lending market has gone through a number of changes over the past year, primarily as a result of COVID-19. In the spring, when markets were particularly volatile, we witnessed the repositioning of portfolios and a flight-to-liquidity in response to the market downturn, resulting in an influx of transactions. This subsequently led to a steep increase in the number of recalls across the industry. Such a period of volatility and heightened activity highlighted the resiliency of the securities lending market and its ability to support financial markets in periods of stress.

In addition, the demand for structured term lending softened over the course of the year. In prior years and leading into 2020, there was high demand for HQLA (high quality liquid assets), specifically level 1 assets with a variety of duration structures. However, due to the pandemic and central bank intervention, there has been lower demand for these types of loans from the borrowing community as alternative liquidity avenues opened.

Looking at equities, we have seen the demand for cannabis stocks decline to levels significantly below the pre-COVID period as share issuances continued across the sector, adding supply to the market. This was in addition to a general de-leveraging from the hedge fund market, resulting in fewer new shorts and additional refinancing. Notwithstanding this, the fall of 2020 showed significant intrinsic value opportunities for beneficial owners when specials in some COVID-19 affected sectors heated up.

On a more positive note, the corporate event space produced meaningful pockets of intrinsic value in 2020.

Generally speaking, initial public offerings continued to be attractive from a lending perspective, although they looked slightly different this time round, emerging as SPACs (Special Purpose Acquisition Companies).

What steps have been taken to ensure that the Canadian securities lending market remains efficient in what has been a turbulent year?

Kyle: The Canadian securities lending industry is well-established within the global financial market, evolving over the past three decades to its current resilient state. The risk mitigation practices previously implemented within Canada were integral to the efficient operation of the securities lending market during March and April 2020. From an RBC Investor & Treasury Services (RBC I&TS) perspective, our counterparty networks remained strong despite the influx of transactions and heightened volatility during the peak of the first COVID-19 wave.

In response to the “new normal,” we placed an even stronger emphasis on communication with our clients, particularly in the area of aligning their portfolios with the securities lending program. This provided them with additional assurance around our risk management protocols regarding counterparty and collateral monitoring, as well as the strength of the indemnification process in the event of any adverse scenarios.

Donato: The significant increase in transaction volumes during the early months of the pandemic highlighted the robust nature of the Canadian securities lending market and tested a number of recent developments, particularly in terms of technology.

What steps has RBC I&TS taken to ensure it continues to meet demand in this environment?

Don D'eramo's Image

Don D’Eramo
Global Head of Securities Finance,
RBC Investor & Treasury Services

Donato: From an efficiency perspective, COVID-19 underscored our ongoing focus on automation. At RBC I&TS, we continue to implement a digitised experience for our clients, providing them with timely metrics on their securities lending programme in a much more visual context. Enhancing connectivity and the transfer of knowledge are top priorities for us.

The risk aspect of the market has not changed dramatically over the past year and our programme has been able to withstand the impact of the pandemic thanks to the effective risk mitigation tools that we have in place. We continue to fine-tune this part of the programme, but the pandemic has demonstrated that the securities lending offering continues to deliver, while safeguarding clients in adverse circumstances.

What has RBC I&TS done to meet this demand?

Donato: As a major Canadian agent lender, we have one of the broadest non-cash collateral profiles in the marketplace. If you look at other markets, such as the U.S., which is predominantly cash collateral, or Europe, which is largely non-cash, we are seeing our experience of managing non-cash collateral as a crucial benefit in this environment.

Kyle: We will continue to focus on our collateral acceptance policies in 2021 and are currently assessing opportunities to expand our programme from both an asset class and tri-party perspective. We were one of the first agent lenders to accept exchange-traded funds (ETFs) as collateral, something that we have been doing for over a year now as an important part of our commitment to meeting client demand and evolving market trends.

How has the demand for ESG-compliant investing impacted the Canadian market?

We expect that
ESG collateral
sets will emerge
within the next year

Kyle: A number of practices under the ESG umbrella have existed within the Canadian securities lending market for quite some time, although there is currently a heightened focus on this area. Industry bodies such as the International Securities Lending Association and the Global Principles for Sustainable Securities Lending initiative continue to drive further developments among all stakeholders.

ESG practices continue to evolve in securities lending. Participation remains voluntary and there are currently no specific regulatory requirements in this regard. The interpretation and application of ESG will differ depending on who you talk to and what region they come from. As an agent lender, it is our responsibility to work with our clients and develop a securities lending programme that meets their ESG needs. There’s little doubt that, going forward, ESG will have a significant impact on the investment strategies and practices adopted by asset managers and owners.

Donato: At RBC I&TS, we tailor our securities lending programme to the particular risk profile of our clients. One of the topical areas regarding ESG and securities lending is proxy voting. We manage proxy voting recalls based on the preferences of our clients. Some clients recall in principle while others only recall based on specific events. Regardless, RBC I&TS is able to accommodate our clients’ needs.

We are also starting to see a higher ESG focus on the collateral side and expect that ESG collateral sets will emerge within the next year. RBC I&TS is ready to accommodate bespoke collateral sets.

How will the Canadian securities lending market fare in 2021 and what can we expect to see?

Kyle: I doubt many would have been able to predict what occurred in 2020 and, similarly, it is difficult to forecast the future of securities lending. That being said, we are noticing that the current market is becoming more stable almost on a weekly basis and anticipate this to continue, barring any unforeseen circumstances.

During 2021, we expect to see a greater focus on intrinsic value opportunities in the form of corporate events and pockets of strong conviction in directional interest trades, as opposed to the more broad-based sector specials to which we are accustomed. As global financial markets react to new developments, regardless of whether they relate to the pandemic, I am confident that we will continue to identify securities lending opportunities for beneficial owners.

We are also monitoring the demand for HQLA on an ongoing basis, including Canadian government bonds and U.S. treasuries. The actions of central banks are likely to have an impact, and if liquidity continues to be added to the financial system, we can expect to see more softening on the term loan side.

Donato: The term loan aspect, the optionality with respect to corporate events and conviction in relation to specials are the three broad themes that we will be focusing on in 2021.

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  1. Originally published by Global Investor Group (Winter 2020/21 edition)