One of our favorite trading phrases when I started on the desk was “they are not house numbers, they do move.” This phrase was used when trade term renegotiations became protracted due to a counterparty’s unwillingness to engage in such a discussion. Eventually, the phrase would be said a few more times upon which reality would finally dawn on them that compromise was needed.

In some ways, much of the first half of the year has felt like this protracted negotiation - a tussle of sorts between the markets and policymakers. With stubbornly high inflation and a buoyant job market the conviction to pivot on interest rates is taking longer than expected, forcing many commentators to push out their forecasts as they react to the prevailing sentiment. As we reach the halfway point the competing pressures of growth versus inflation is building. Yet most policymakers seem to be staying exactly where they are, at least for now.

Outlook

Europe
We think an extended period of slow growth is highly likely rather than an outright recession. Most economies have maintained better than expected growth trajectories helping offset the negative impact of persistent higher interest rates. However, with forces such as a sustained period of higher interest rates, households’ reluctance to spend, and lenders’ risk aversion are likely to strain corporate borrowers’ profit margins, which in turn we expect to exacerbate credit pressure.

We expect European securities lending activity to remain steady and the corporate action theme that we have seen driving demand in H1 to continue as companies struggle with the higher financing costs. We expect those with stronger balance sheets to expand and make use of economies of scale by merging, which may bring about increased securities lending opportunities. However, challenges persist with global geopolitical concerns and a higher for longer interest rate environment.

Asia- Pacific
We expect robust lending demand to continue in Taiwan from activity in the chipmaking and technology sectors. The recent turnaround in Hong Kong equities could potentially provide new lending opportunities, particularly those with a view that the rally has been overdone. Ongoing geopolitical tensions between China and U.S. over trade tariffs and Taiwan could also impact demand, especially ahead of November’s U.S. presidential election. We expect corporate deal activity to remain steady in Japan, which may boost lending demand, and in Australia, interest is likely to continue in the lithium mining sector as producers grapple with softer demand and prices.

U.S.
We anticipate securities lending demand to remain steady, with a potential increase in capital markets and corporate restructuring activity. The remaining global elections of 2024 and the impact they will have on the global markets and the interest rate environment will affect demand. The U.S. economy has remained strong thus far, to the bewilderment of many observers. A reversion back to more reasonable levels remains a concern.

Among the many outcomes at stake in the U.S. election is the fate of the Federal Reserve’s plan that would require the country’s largest bank lenders to set aside an estimated 19% more in capital to avoid future bank failures and another financial crisis. Also at issue is U.S. approach to its trade policy, where a President Trump-proposed 10% tariff on all imported goods and a potentially even larger tariff on Chinese goods stands in contrast to views that such tariffs would lead to further inflation.

In the capital markets space, IPO activity has returned as the backlog of stalled IPO deals make their way through the system. The U.S. has over 400 IPO/Equity offers pending, with 24 priced and imminent to trade. We anticipate such activity will have a positive effect on demand as the need to borrow around IPO activity remains strong.

Regional Highlights

Asia-Pacific
Securities lending activity in the Asia-Pacific region in the first half of 2024 was mixed with robust interest in Taiwan offset by softer returns in several regional markets. Continuing from the previous year, equities rallied in Japan and Taiwan spurred on by both strong foreign and domestic inflows. After a soft start to the year, Hong Kong equities also rebounded strongly from February as supportive central government measures and low valuations encouraged investors, particularly from mainland China. However, foreign investors appear to be slowly increasing their allocations.

Taiwan was a standout market, driven by global interest in the AI, chipmakers, and semiconductor sectors.

• Despite the market rally, companies such as Global Unichip and Vanguard International were in focus from a securities lending perspective due to either missing earnings estimates or facing increased competitive pressures.
• Increased convertible bond arbitrage demand drove robust demand for Gigabyte Technology.
• Outside of the tech sector, Jinan Acetate Chemical also generated strong lending returns on increased directional interest.

Lending activity in Hong Kong was strong, though lending revenue was softer vis-a-vis 2023 due to depressed valuations, limited capital raising, and M&A activity.

• The real estate and property sector remained under pressure due to mounting debts and a poor outlook.
•  Strong lending returns were seen in Country Garden Holdings, New World Development, and Sino-Ocean Group.
• Significant lending interest was also seen in e-commerce and educational technology provider East Buy Holdings and digital pharmaceutical firm YSB Inc. 

In Japan, corporate deal activity remained strong, boosted by the sustained market rally and corporate governance reforms.

• Poor earnings by Aozora Bank and Hokuetsu Corp. helped drive strong directional activity and lending returns.
• The ban on short selling in South Korea, implemented in early November 2023, has continued to dampen lending demand.
• In Australia there was increased interest in semiconductor firm Weebit Nano as well as the lithium sector as low prices continued to drag down miners such as Core Lithium and Sayona Mining.

U.S.
The U.S. lending market saw pickup in a small number of single stock bets from investors in the electric vehicle sector and, more prominently, the AI sector. Lucid, C3.ai Inc., Arm Holdings, and Symbotic were in high demand in the first half of 2024, with decidedly high engagement from hedge funds as AI’s potential to revolutionize global markets began to crystallize.

The M&A space saw a lucrative deal on the Cummins Inc./Atmus Filtration spinoff in March and smaller Dutch auctions in June – Monster Beverage (MNST), Incyte Corp (INCY), and Talen Energy Corp (TLNE). The SiriusXM/Liberty media merger, announced at the end of 2023, presented a long lending-runway on the open book as the deal is still pending and expected to close in Q3 2024.

While corporate activity was active in the U.S. market, such activity unfortunately did not translate into securities lending activity as many M&A deals were mandatory, lacking the optionality component needed for arbitrage.

EMEA
The region saw a sluggish start to the first half of the year. Short interest has continued to decline from the end of 2023 as European equities rallied which led to both fewer new short positions and increased short covering. A reset of interest rate cut expectations from the Federal Reserve alongside increased geopolitical concerns kept investors cautious of increasing short exposure.

Despite these headwinds there has been continued strong demand seen for specific securities in the industrial and real estate sectors with names such as Aroundtown, Samhallsbyggnadsbolaget, SGL Carbon, and Varta generating robust demand.

Elsewhere the key demand drivers have been from specific corporate restructuring opportunities. There has been a strong platform for rights issues as many companies have struggled with the higher for longer interest rates, as well as mergers via cash or share tender offers. Notable names of interest have been Atos, Alstom, Encavis, Meyer Burger, Nobia, TOD’s, PureTech Health, and Petershill Partners.

Fixed Income
Demand for global corporate debt remains high despite higher benchmark yields. Leveraged loan issuance thus far in 2024 is closer to 2021. Issuance for high yield bonds are also performing better than 2023 and catching up to 2021 records.

In addition, downgrades in the first part of the year have been below parity and indicate improving credit quality.

• Investment grade (IG) companies remain on a solid footing with more fixed rate debt secured with very long maturities and low fixed coupons.
• Consumer products have led downgrades, and homebuilders/real estate saw a higher downgrade ratio indicating more downgrades are likely.
• With the recent increase in European defaults interest rate burden has struggled particularly in media and entertainment, consumer products, and health care industries.

Government and corporate fixed income volumes and revenue remain healthy despite a slight year- over-year decline in corporate and government bond revenues. 2023 proved to be a robust year, driven mainly by lending demand for high quality liquid assets (HQLA) versus cash and non-cash assets. This demand was driven from the need for borrowers to be able to finance their long hedge fund positions, which continue to grow.

Conclusion
The first half of the year has reflected wider markets trends with investors’ sentiment tilted towards a ‘wait and see’ approach. After last year’s banner returns for U.S. equities, demand in the first half has softened and spreads have compressed, with deal flow remaining relatively muted. European equities demand remains subdued, driven by limited deal activity and a weaker environment, though deal flow began to pick up towards the end of the first half. Asia-Pacific has generally stayed range-bound, buoyed by healthy demand in both Japan and Taiwan but crimped by the short sale ban in South Korea.

We expect a slight pickup in the second half in global demand as central banks gain conviction that inflation is under control and the prospect to shift to a more accommodative stance becomes more visible. Until then we expect that securities lending revenues will continue to be highly targeted to a concentrated set of opportunities and the threshold for short exposure becomes high in the face of a dynamic and potentially reactive market.