色花堂lending: 2023 reflections and 2024 market outlook
23 January 2024
State Street鈥檚 Chelsea Grossman, managing director and head of North America client management for agency lending, breaks down the key events of 2023 and how last year鈥檚 performance will shape the lending environment in 2024
Image: stock.adobe/wacomka
In looking forward to the securities lending landscape of 2024, there are a few key themes to focus on, some carrying over from 2023 and others posing new opportunities and challenges.
We kicked off 2023 with a re-emergence from the pandemic in terms of a return to client events, travel and in-office attendance. This provided a general outlook of improvement from the year prior as it related to lending activity. However, as we neared the end of the first quarter, the US regional bank crisis and its impact on the market quickly shifted sentiment. From there, central banks鈥� efforts to combat inflation, the resulting interest rate environment, and the geopolitical events arising in the Middle East are just a few contributors to what was ultimately a challenging lending environment to close out the year.
Despite the headwinds, opportunities in certain asset classes and trade structures arose where traditional US equity specials may have fallen short. In the following sections, we will elaborate on some of these themes experienced in 2023 across the various global asset classes, their impact on the trading environment and what we can expect moving into 2024.
US fixed income
Starting with US fixed income, this market exhibited considerable volatility in 2023, primarily influenced by Federal Reserve policy. The year began with a series of four rate hikes in the first half, creating 鈥渟pecial鈥� situations in various issues. US Treasury bills became the focal point as counterparties preferred the front-of-the-yield curve due to the active Federal Reserve. However, market uncertainties surfaced with the collapse of Silicon Valley Bank and Signature Bank in early March, raising concerns about the survival of regional banks.
This uncertainty persisted into mid-2023 as negotiations surrounding the US debt ceiling created apprehensions about a potential default. Counterparties were cautious about facing securities with maturity dates around the default date. Once the debt ceiling issue was resolved in early June, the threat of default disappeared, leading to a surge in new treasury bill supply. The markets proceeded with another rate hike in the July Federal Open Market Committee (FOMC) meeting and the second-half of 2023 saw limited specials.
As this market looks ahead to 2024, the prevailing theme is expected to be Fed policy yet again. Projections have indicated 150 basis points priced-in for cuts by the end of the year, with the majority anticipated later in 2024. This outlook is poised to increase volatility, both in terms of when the rate cuts commence and their impact on the US Treasury (UST) market.
International fixed income
The landscape of international fixed income in 2023 was shaped by the efforts of central banks, including the Federal Reserve, Bank of England (BoE), and the European Central Bank (ECB), to combat inflation, collectively through 15 rate hikes. Despite these measures, the global cost of living crisis persisted, creating challenges for portfolios and guidelines.
A number of trends resulted from these considerations, with client portfolios diversifying away from core European high-quality liquid assets (HQLA) 鈥� as central banks were buying HQLA as part of quantitative easing (QE) 鈥� and a noticeable increase in loans of supranational paper (still highly rated, but with higher yields) and US Treasury trades against Japanese Government Bonds (JGBs).
Looking ahead to 2024, the global backdrop of high inflation is beginning to abate and potential easing is coming into the conversation. That said, HQLA demand remains strong and the global trend around unwinding central bank funding facilities leaves more collateral to be funded across the street.聽A trend of lower money market spreads and a shift towards non-cash upgrade trades might therefore be expected as these considerations materialise.
US equity
In 2023, the US equity market faced challenges amid an initial public offering (IPO) drought and limited M&A opportunities, which impacted lending dynamics significantly when compared with initial expectations for the year. Despite this, revenue attributed to specials resulting from select events was strong to end the year. Notable corporate events, such as Johnson & Johnson with Kenvue Inc (JNJ/KVUE US) and VMware LLC with Broadcom Inc (VMW/AVGO US), contributed to revenue generation.
While corporate activities drove late-year specials revenue, strong directional performance in the first eight months proved favourable for the US equity product. The overall revenue picture was primarily driven on a name-by-name basis in certain sectors.
As we look through to 2024, the move to T+1 settlement in May is expected to increase initial volatility around recalls, returns and fails until the industry acclimatises to the accelerated settlement cadence.聽This said, third-party vendor solutions and the adoption of straight-through processing (STP) for recalls will hopefully help to ease the burden on all parties involved.
With the FED at terminal rate and uncertainty around the outlook for 2024 with regards to rate cuts, we expect stock picking to become in vogue with an increased focus on sector rotation moving through the earnings cycle. Expectations are for a robust IPO and M&A calendar, where M&A names could include Cummins Inc with Atmus Filtration Technologies Inc (CMI/ATMU US), Softbank Group Corp with ARM holdings (SFTBY/ARM US), Bausch Health Cos Inc with Bausch & Lomb Corp (BHC/BLCO US), Intel Corp with Mobileye Global Inc Class A (INTC/MBLY US). The IPO market has less certainty. However, a backlog persists from what has been an 18-month drought, which could prove to bear some fruit as the year progresses.
EMEA and APAC equities
European, Middle East and African (EMEA) equities presented challenges and opportunities across various markets in 2023, but ultimately returns from this asset class were positive.
In EMEA, economic recovery enabled companies to reinstate or enhance previously reduced dividends, providing for greater yields. Record profits for energy companies, resulting from sanctions imposed on Russian supply due to the war with Ukraine, also helped to boost dividends in the energy sector as demand for supply from western producers significantly increased in the region.
Those companies looked to return some of that revenue to shareholders, often through issuing special dividends on top of already inflated cash dividends that had been planned. On the other hand, while corporate activity in the region was generally less in focus, there were strong revenue opportunities in pockets from companies dealing with debt burdens and supply chain issues (i.e. VLP LN, SBBB SS, and HLAG GY).
A few challenges also developed in this region, particularly in Norway and France. In Norway, positions were reassessed resulting from news that the Norwegian Tax authorities had approached some market participants to claim withholding taxes on historic manufactured dividends. In France, following publication of new regulations by the French tax authority in February 2023, there was some softening in demand across the market. While those rules were challenged and ultimately overruled, there remains a level of uncertainty given the expectation that similar legislative action may be forthcoming.
In the Asia-Pacific region, the Australian economy demonstrated resilience in 2023, despite aggressive rate rises by the Reserve Bank of Australia (RBA). Nonetheless, lending revenues were challenged due to a quieter corporate actions front and a decrease in specials in the mining and exploration sector (i.e. LTR AU, CXO AU).
In Hong Kong, 2023 started with heavy deal flow, along with a large number of capital-raising events.聽Borrow demand then quickly moved to sector related interest, specifically in electric vehicle (EV) stocks (i.e. 9868 HK, 9866 HK) and AI related companies (i.e. 1357 HK). From Q2 onwards, we began to see securities in the housing sector attract strong demand from borrowers as the Chinese property sector continued to suffer from deteriorating fundamentals along with increasingly stringent regulations.
In Japan, 2023 experienced robust demand, mainly driven by corporate action activity, collateral transformation trades and demand for positions in the Taiwanese market. South Korea, however, was impacted by a short-sell ban effective until June 2024, resulting in muted activity to end the year.
In summary, given all of these dynamics in play across the globe, there are a few points that permeate throughout as we look forward to 2024. The health of global economies and resulting actions by central banks, plus events such as the US election coming up in late 2024, will continue to set the stage. From a regulatory standpoint, automation and tightening of processes are top-of-mind as the market moves into a T+1 settlement cycle in the US and Canada. Capital-efficient trade structures also remain in focus as Basel III endgame approaches and counterparties look to lessen their risk-weighted asset (RWA) usage. With that, initiatives such as CCPs and alternative pledge structures are being developed to address these growing considerations on top of existing peer products and alternative forms of indemnification.
On the demand front, a strong M&A pipeline provides a glimmer of hope for an uplift of equity specials, which would be a welcome positive given some of the challenges mentioned. HQLA demand is also expected to remain strong. Against this background, 2024 should prove to be another eventful year for lending.
We kicked off 2023 with a re-emergence from the pandemic in terms of a return to client events, travel and in-office attendance. This provided a general outlook of improvement from the year prior as it related to lending activity. However, as we neared the end of the first quarter, the US regional bank crisis and its impact on the market quickly shifted sentiment. From there, central banks鈥� efforts to combat inflation, the resulting interest rate environment, and the geopolitical events arising in the Middle East are just a few contributors to what was ultimately a challenging lending environment to close out the year.
Despite the headwinds, opportunities in certain asset classes and trade structures arose where traditional US equity specials may have fallen short. In the following sections, we will elaborate on some of these themes experienced in 2023 across the various global asset classes, their impact on the trading environment and what we can expect moving into 2024.
US fixed income
Starting with US fixed income, this market exhibited considerable volatility in 2023, primarily influenced by Federal Reserve policy. The year began with a series of four rate hikes in the first half, creating 鈥渟pecial鈥� situations in various issues. US Treasury bills became the focal point as counterparties preferred the front-of-the-yield curve due to the active Federal Reserve. However, market uncertainties surfaced with the collapse of Silicon Valley Bank and Signature Bank in early March, raising concerns about the survival of regional banks.
This uncertainty persisted into mid-2023 as negotiations surrounding the US debt ceiling created apprehensions about a potential default. Counterparties were cautious about facing securities with maturity dates around the default date. Once the debt ceiling issue was resolved in early June, the threat of default disappeared, leading to a surge in new treasury bill supply. The markets proceeded with another rate hike in the July Federal Open Market Committee (FOMC) meeting and the second-half of 2023 saw limited specials.
As this market looks ahead to 2024, the prevailing theme is expected to be Fed policy yet again. Projections have indicated 150 basis points priced-in for cuts by the end of the year, with the majority anticipated later in 2024. This outlook is poised to increase volatility, both in terms of when the rate cuts commence and their impact on the US Treasury (UST) market.
International fixed income
The landscape of international fixed income in 2023 was shaped by the efforts of central banks, including the Federal Reserve, Bank of England (BoE), and the European Central Bank (ECB), to combat inflation, collectively through 15 rate hikes. Despite these measures, the global cost of living crisis persisted, creating challenges for portfolios and guidelines.
A number of trends resulted from these considerations, with client portfolios diversifying away from core European high-quality liquid assets (HQLA) 鈥� as central banks were buying HQLA as part of quantitative easing (QE) 鈥� and a noticeable increase in loans of supranational paper (still highly rated, but with higher yields) and US Treasury trades against Japanese Government Bonds (JGBs).
Looking ahead to 2024, the global backdrop of high inflation is beginning to abate and potential easing is coming into the conversation. That said, HQLA demand remains strong and the global trend around unwinding central bank funding facilities leaves more collateral to be funded across the street.聽A trend of lower money market spreads and a shift towards non-cash upgrade trades might therefore be expected as these considerations materialise.
US equity
In 2023, the US equity market faced challenges amid an initial public offering (IPO) drought and limited M&A opportunities, which impacted lending dynamics significantly when compared with initial expectations for the year. Despite this, revenue attributed to specials resulting from select events was strong to end the year. Notable corporate events, such as Johnson & Johnson with Kenvue Inc (JNJ/KVUE US) and VMware LLC with Broadcom Inc (VMW/AVGO US), contributed to revenue generation.
While corporate activities drove late-year specials revenue, strong directional performance in the first eight months proved favourable for the US equity product. The overall revenue picture was primarily driven on a name-by-name basis in certain sectors.
As we look through to 2024, the move to T+1 settlement in May is expected to increase initial volatility around recalls, returns and fails until the industry acclimatises to the accelerated settlement cadence.聽This said, third-party vendor solutions and the adoption of straight-through processing (STP) for recalls will hopefully help to ease the burden on all parties involved.
With the FED at terminal rate and uncertainty around the outlook for 2024 with regards to rate cuts, we expect stock picking to become in vogue with an increased focus on sector rotation moving through the earnings cycle. Expectations are for a robust IPO and M&A calendar, where M&A names could include Cummins Inc with Atmus Filtration Technologies Inc (CMI/ATMU US), Softbank Group Corp with ARM holdings (SFTBY/ARM US), Bausch Health Cos Inc with Bausch & Lomb Corp (BHC/BLCO US), Intel Corp with Mobileye Global Inc Class A (INTC/MBLY US). The IPO market has less certainty. However, a backlog persists from what has been an 18-month drought, which could prove to bear some fruit as the year progresses.
EMEA and APAC equities
European, Middle East and African (EMEA) equities presented challenges and opportunities across various markets in 2023, but ultimately returns from this asset class were positive.
In EMEA, economic recovery enabled companies to reinstate or enhance previously reduced dividends, providing for greater yields. Record profits for energy companies, resulting from sanctions imposed on Russian supply due to the war with Ukraine, also helped to boost dividends in the energy sector as demand for supply from western producers significantly increased in the region.
Those companies looked to return some of that revenue to shareholders, often through issuing special dividends on top of already inflated cash dividends that had been planned. On the other hand, while corporate activity in the region was generally less in focus, there were strong revenue opportunities in pockets from companies dealing with debt burdens and supply chain issues (i.e. VLP LN, SBBB SS, and HLAG GY).
A few challenges also developed in this region, particularly in Norway and France. In Norway, positions were reassessed resulting from news that the Norwegian Tax authorities had approached some market participants to claim withholding taxes on historic manufactured dividends. In France, following publication of new regulations by the French tax authority in February 2023, there was some softening in demand across the market. While those rules were challenged and ultimately overruled, there remains a level of uncertainty given the expectation that similar legislative action may be forthcoming.
In the Asia-Pacific region, the Australian economy demonstrated resilience in 2023, despite aggressive rate rises by the Reserve Bank of Australia (RBA). Nonetheless, lending revenues were challenged due to a quieter corporate actions front and a decrease in specials in the mining and exploration sector (i.e. LTR AU, CXO AU).
In Hong Kong, 2023 started with heavy deal flow, along with a large number of capital-raising events.聽Borrow demand then quickly moved to sector related interest, specifically in electric vehicle (EV) stocks (i.e. 9868 HK, 9866 HK) and AI related companies (i.e. 1357 HK). From Q2 onwards, we began to see securities in the housing sector attract strong demand from borrowers as the Chinese property sector continued to suffer from deteriorating fundamentals along with increasingly stringent regulations.
In Japan, 2023 experienced robust demand, mainly driven by corporate action activity, collateral transformation trades and demand for positions in the Taiwanese market. South Korea, however, was impacted by a short-sell ban effective until June 2024, resulting in muted activity to end the year.
In summary, given all of these dynamics in play across the globe, there are a few points that permeate throughout as we look forward to 2024. The health of global economies and resulting actions by central banks, plus events such as the US election coming up in late 2024, will continue to set the stage. From a regulatory standpoint, automation and tightening of processes are top-of-mind as the market moves into a T+1 settlement cycle in the US and Canada. Capital-efficient trade structures also remain in focus as Basel III endgame approaches and counterparties look to lessen their risk-weighted asset (RWA) usage. With that, initiatives such as CCPs and alternative pledge structures are being developed to address these growing considerations on top of existing peer products and alternative forms of indemnification.
On the demand front, a strong M&A pipeline provides a glimmer of hope for an uplift of equity specials, which would be a welcome positive given some of the challenges mentioned. HQLA demand is also expected to remain strong. Against this background, 2024 should prove to be another eventful year for lending.
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