Choppy waters ahead as “the year of the vote” closes

As we start the new year, we expect volatility and divergence to come into play, which could result in an uptick in demand. Investors may become more hedged and balanced towards increasing short exposure as they take advantage of increased market volatility and perhaps less correlated markets.

It's likely that the newly elected political regimes will create an environment of uncertainty (some of which we are already observing in South Korea and France) and there will be winners and losers as policy promises and budgets come into effect.

Divergence may be more likely in terms of specific sectors and even single stocks as investors look to take advantages of opportunities which might provide an uptick in securities lending activity as we go further into 2025.

The Backdrop

It was hailed the year of the elections with nearly 40% of the world’s population going to the polls in 2024. In the end, one arguably will matter more than most: the election of former President Donald Trump in the US. The historical Republican party sweep of both the House of Representatives and Senate will likely provide President-elect Trump the platform to deliver on electoral campaign promises that will shape the economic and political agenda in the US and globally for the foreseeable future.

Separately, in a year where investors grappled with significant geopolitical uncertainty in the Middle East and in Ukraine, as well as the long-awaited pivot in interest rates by policymakers, global markets overall remained buoyant and risk assets trended higher. From a securities lending perspective this resulted in a more muted, particularly hard to borrow environment as investors gravitated towards a long bias. Conversely, this long bias put greater focus on financing demands and counterparties all looking to manage tight capital requirements.

2024 Review

Asia-Pacific

Activity in the Asia-Pacific region was overall mixed with robust lending demand in Taiwan and gains in Japan offset by softer returns in other regional markets. Continuing from 2023, equities rallied in Japan and Taiwan spurred by both strong foreign and domestic inflows. After a soft start to the year, Hong Kong equities initially rebounded as supportive central government stimulus measures and low valuations provided some encouragement to investors, particularly from mainland China. However, investor enthusiasm was somewhat tempered toward the end of the year.

Taiwan: The standout lending market was Taiwan spurred on by the global euphoria in the AI, chipmaker, and semiconductor sectors.

• While the broader market benefited from the market rally, several companies were in focus from a securities lending perspective due to increased competitive pressures such as semiconductor manufacturer.
• Increased convertible bond arbitrage demand drove robust demand for Gigabyte Technology while outside of the tech sector, Jinan Acetate Chemical generated strong lending returns on increased directional interest.

Hong Kong: Lending activity in Hong Kong was strong, though lending revenue was softer vis-a-vis 2023 due to lower valuations and 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 edtech provider East Buy Holdings and digital pharmaceutical firm YSB Inc.

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

• Poor earnings by Aozora Bank and Hokuetsu Corp. and a public share sale by Sakura Internet Inc. helped drive strong directional activity and lending returns.
• The ban on short selling in South Korea, implemented in 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.

EMEA

It was a softer year for securities lending in the EMEA markets as equities rallied which led to less short exposure and increased short covering as a result.

• Despite a difficult landscape for securities lending, there was strong demand for stock specific securities in the industrial and real estate sectors with companies such as Aroundtown, Samhallsbyggnadsbolaget, SGL Carbon, and Varta generating robust demand.
• There were also key securities lending drivers from specific corporate events opportunities such as the long-awaited spin-off of Vivendi.
• The first half of the year saw a strong platform for rights issues as many companies struggled with the higher for longer interest rates.
• As interest rates started to fall, there was a reduced need for capital injections from companies as the year progressed.
• Like rights issues, the M&A landscape was strong for the first half of the year with notable names of interest being Atos, Alstom, Encavis, Meyer Burger, Nobia, TOD’s, PureTech Health, and Petershill Partners.
• As geopolitical uncertainty increased ahead of the US elections during the second half of the year, we saw reduced deal activity.

North America

In the first three quarters of 2024, the US securities lending market saw a general decrease in activity both in terms of revenues and on-loan volumes. While it was certainly not a disappointing year, 2024 was still unable to build on the strong specials’ performance of the previous two years, focusing instead on an abbreviated list of crowded shorts which were concentrated in the electric vehicles, media, regional banking, and tech sectors, along with some targeted ETFs.

US: Consistent gains in the broader US stock market, coupled by the uncertainty of the presidential election, prompted many hedge funds to reduced short exposure and seek to capture gains on outstanding long positions while the uncertainty unfolded.

• Chinese ADRs saw a surge in trading activity to start the third quarter as hedge funds trimmed positions following the weeklong Chinese holiday and in response to the stimulus measures in China that had promised much but ultimately underwhelmed.
• US single stocks saw an influx of sales by the same funds due to an increase in short selling volumes.
• Sirius XM was by far the most dominant equity throughout the year along with newly trending names such as Trump Media & Tech Group, which listed in March as a SPAC. The social media platform, created as an alternative to Twitter, became a favorite of investors as its stock price was extremely volatile and its performance was largely tied to its founder, President-elect Donald Trump.
• ETF demand remained constant throughout the year, focusing on the corporate credit, construction, and REIT sectors.
• Apart from the completion of the long-awaited Sirius/Liberty Media merger in Q3, corporate activity slowed for most of the front half of 2024, until the Federal Reserve and presidential roadmaps came into clearer focus from a corporate financing perspective.

Canada: The Canadian market remained consistent year over year with falling asset valuations across sectors in demand. This created a negative impact on lending revenue.

• The cannabis industry continues to be challenged with regulatory headwinds and fierce competition leading to significant declines in share prices.
• Investor conviction stayed relevant throughout the year in the mining industry, such as crypto, EVs, precious metals, and lithium stocks.

Fixed Income

Fixed income demand continued from a strong base set in 2023. Strong growth and corporate earnings, declining inflation, and central bank rate cuts saw strong bond prices rally. However, the resilient growth and inflation has favored equity markets rather than fixed income with lower year to date total returns for global government bonds, global investment grade, and high yield bonds. The higher for longer interest rate horizon resulting from resilient growth in 2024 has supported credit.

• The fundamental backdrop for fixed income has been positive for securities lending demand for both corporate and government bonds with average balances exceeding 2023.
• Despite higher balances, corporate bonds revenue fell during the year – 2023 was a stellar year so earnings are more aligned to previous years. However, there has been a boost to earnings towards year end for US Treasuries due to uncertainty surrounding interest rates. The main driver has been lending demand for HQLA verses cash and non-cash assets, driven from the need for borrowers to be able to finance their long hedge fund positions, which continue to grow.

2025 Outlook

We expect several key themes to drive securities lending demand in the coming quarters. Risk assets will likely stay on a precarious footing with the inflation environment remaining persistently stubborn and growth will likely be relatively tepid. This will likely result in an uptick in volatility in asset prices as investors look to recalibrate their interest rate expectations particularly around the strong equity market gains observed during the year. 

We also expect the backdrop of a “down but not out” inflationary environment to create divergence in terms of timing on future interest rate cuts between various key central banks, creating the potential need to hedge between regional exposures.

In terms of regional themes, ongoing geopolitical tensions between China and the US over trade tariffs could also have a broader regional impact on demand across sectors such as technology and shipping. 

The temporary short selling ban in South Korea is expected to be lifted at the end of March 2025 and will likely lead to an increase in lending activity.

We believe lending demand will remain robust in Taiwan driven by interest in the chipmaking and technology sectors.

European export sectors will be in focus in the first quarter as the EU-US trade showdown is played out as the President-elect tariff plan is unveiled.

Finally in the US, securities lending activity will likely be mixed. On one hand we expect an uptick in deal making activities buoyed by lower interest rates and a more favorable regulatory environment backed by the Trump administration. On the other hand, we expect more volatile equity markets with interest rate policy and the Trump administration driving much of the narrative in the coming quarters.

Overall, it is likely to be a choppy start to the year with an increased need to hedge against more volatile and less correlated markets. Geopolitics, central bank policy, and the new elected political parties will create an environment where investors will look to capture opportunities on divergence and protect against the downside.  In terms of securities lending, we believe that we will observe an increase both in overall demand as well as more varying interests across markets, sectors, and stocks.