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Lending Vs Derivatives: tools for the trade

06 March 2017

Accessing Asia Pacific markets in a timely manner can be challenging, which makes both futures and securities lending invaluable for efficient trading. Dan Barnes investigates

Being able to take risk on or off quickly can make the difference between banking alpha and taking a big hit. In the markets across Asia Pacific in 2017 – which will be characterised by "low returns and high volatility" according to asset manager Newton Investments – investment windows will be tight and speed is of the essence.

 In many markets around Asia this can present challenges. Limits on ownership of cash instruments, liquidity quality, market maturity and local regulation all have a bearing on market accessibility.

"As an investment professional you are always looking at the risks and the cost for entry and exit of an investment, and the risk associated with sustaining an investment in a specific market," says Hong Kong-based hedge fund manager Stephen Howard, who left Enhanced Investment Products on 27 February 2017. "Markets with sufficiently liquid hedging solutions are going to be gravitated towards by most institutional investors or investment firms because they need to have decent two-way liquidity for the risk pricing of those hedging solutions."

Given the diversity of market structures and rules within local Asia Pacific jurisdictions, portfolio managers and trading desks across institutional and alternative investment firms need to be aware of the mechanisms available for accessing liquidity quickly, for example using repos, listed derivatives or exchange-traded funds in lieu of cash instruments.

"At the individual security level, it really comes down to liquidity and cost," says Paul Solway, regional head of securities finance in Asia Pacific at BNY Mellon. "Markets with good depth of inventory where borrowing fees are low would suit borrowing, whereas markets that do not allow for or restrict borrowing/lending or shorting in any way, such as India and Taiwan, presents access to futures and options as useful alternatives."

 Among asset owners, as a consequence of the low rate environment, there is growing interest in alternative routes of alpha generation that can be used to help enhance performance.

"There is a spotlight being shone on products such as securities lending, where there can be opportunities for a stream of revenue that comes at relatively low risk," says Dane Fannin, head of capital markets at Northern Trust. "We are seeing beneficial owners that previously had no interest in securities lending suddenly now showing a lot of interest in it. That dynamic is probably going to continue in the near term."

The volatility of emerging markets relative to developed ones can make trading them as much an art as a science. The depth of lending liquidity can present challenges, says Solway, noting that putting on a loan can be easier than taking it off.

 "That is where the skill comes in," he says. "As history has shown, some regional markets have resorted to short-sell bans in times of extreme volatility. Fines or penalties, buy-ins, and trading restrictions are all in play for failing trades [as is] timely short-reporting across many markets – so you need to do your homework."

 Regulators can impose hurdles for investors that would not typically be a consideration in other markets, for example relating to settlement.

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