An upward trajectory: Q1 2024 securities lending market revenues
30 April 2024
Matthew Chessum, director of securities finance at S&P Global Market Intelligence, evaluates the performance of the market during Q1 2024, and how geopolitical tension, as well as the US presidential elections, could set the future of the global economy
Image: Shutterstock
Resilient fourth quarter corporate earnings, a continuation of AI exuberance, and further dovish tones from central bankers encouraged global equity markets to continue their upward trajectory during the first three months of the year. The S&P 500 experienced its strongest opening three months since 2019, after gaining just more than 10 per cent over the period. The Eurostoxx 600 also hit an all-time high, as momentum generated by blowout Q4 US technology company earnings helped to push global indices to new highs. A tentative turnaround in Chinese equities was also seen.
Over the period, the general deflationary trend continued, despite a few bumps in the road. Central banks have consistently warned that the final stages in getting inflation back to target would be the toughest, and while the latest decreases have been less pronounced than previous readings, its retrenchment into low single figures has continued.
Markets took confidence from the fact that it does appear to be under control, which helped to boost valuations. The fact that higher interest rates have been able to tame inflation without damaging economic growth has also extended further confidence to investors.
Although investors may be rejoicing over the recent surge in valuations worldwide, and the decline in inflation, it is crucial to acknowledge and evaluate the significant risks that do persist. One of the most major of these, comes in the form of geopolitical uncertainty.
Tensions grow as wars in the Middle East and Ukraine continue, and as the year proceeds, focus will move to the US presidential elections — voters face a choice between two very different candidates, who offer different perspectives on the future of the global economy. This is having an impact on commodity prices which may in turn have an impact upon inflation. In short, it is increasingly becoming a stock pickers market, which is positive news for the securities lending landscape as volatility starts to edge back in.
A breakdown of performance
In the securities finance markets, revenues continued to cool throughout the quarter, as Q1 produced US$2.75 billion. This represents a 20 per cent decrease year-on-year (YoY) but a slight uptick quarter-on-quarter (QoQ). The securities lending markets faced a number of headwinds during the period. Short loan interest fell to its lowest level in a decade across EMEA equities, with revenues during January and February falling to all-time lows. Revenues derived from specials activity declined during the period across all regions, and further headwinds in Asia in the form of short sale bans and ongoing weakness across the Chinese economy, held revenues back.
Cash reinvestment revenues also fell during Q1 for the first time in six quarters. It appears that the high tide for interest rates may well have passed, as most central banks are now at least considering reducing borrowing costs. The pace of easing looks less likely to mirror the aggressive speed at which tightening first took hold, and the lag in transmission means easing effects are taking more time to feed through across the globe. Expectations of rate cuts have now fed through to reinvestment pools however, which is reflected in the revenue declines.
Equity lending generated just over US$2 billion during the quarter. This represents a decline of 20 per cent YoY. The largest contributor to these revenues continued to be Americas equities, which generated just over US$1.07 billion (53 per cent). US equities generated US$959 million during the period, which represents a 26 per cent reduction YoY. From the other markets that make up this region, Canadian equities performed well over the quarter as average fees continued to increase YoY.
Average fees in Canada topped 74bps — an eight per cent increase YoY. Canada was the only market to experience a single-digit decline in revenues across the region. Elsewhere, revenues declined by 12 per cent YoY in Brazil, 37 per cent YoY in Mexico, and 23 per cent YoY across American depository receipts (ADRs). Balances did increase across the South American markets, however, as did lendable value.
Across EMEA, securities lending revenues suffered further substantial declines, pushing the quarterly total down 40 per cent YoY. This follows a YoY reduction of 47 per cent during Q4. Balances declined by 30 per cent and utilisation fell by 36 per cent.
The region suffered from a lack of demand and specials trading. Short interest fell to its lowest level in a decade during Q1, but it started to increase towards the beginning of April. All the top 10 revenue generating European markets experienced double-digit declines in revenues YoY, with the UK, France and Germany, all seeing YoY revenue dips of over 40 per cent. Average fees are a different picture however, with YoY increases seen across Germany, France, and the Netherlands.
APAC equities generated US$490 million during the quarter, with Japan, Taiwan and Malaysia, leading the charge. Japan generated US$186 million in revenues, which is an eight per cent increase YoY, the market also experienced a two per cent YoY increase in balances and a six per cent increase in average fees. This was against a backdrop of an equity market that continued to hit record highs during the period.
The region did continue to see a strong degree of divergence during Q1 however, with Hong Kong and Singapore experiencing declines in revenues of 31 per cent and 36 per cent respectively. South Korea also experienced a 34 per cent YoY decrease in average fees, while Hong Kong experienced a slight two per cent increase.
In the fixed income markets, Q1 saw a significant shift in the landscape of inflation and interest rates. Most central banks proceeded with caution, avoiding any further moves to interest rates, with only a couple making any changes during the quarter. The Bank of Japan moved rates back into positive territory during the quarter for the first time in 17 years, signalling an end to negative rate policy, and the National Bank of Switzerland surprised markets with a 25bps rate cut.
Global economic data remained strong, and the US economy continued to perform well. A recovery also took hold across China, although the property sector continued to face issues. This improvement in data led to a rise in government bond yields during the quarter, with increases seen across UK, German and US 10-year issues. In the securities lending markets, government bond revenues increased by two per cent YoY to US$173.4 million. Average fees declined by nine per cent YoY to 17bps, but balances increased by three per cent.
Figure 1. Q1 revenues by asset class
Corporate bond performance stayed strong over the quarter, with revenues remaining robust. Despite Q1 revenues declining by 20 per cent YoY, they only fell two per cent QoQ, which may point towards the beginning of a stabilisation in returns. Looking at Q1 revenues in comparison to other Q1 periods, they remain elevated, and corporate bonds continue to perform well. Q1 2024 produced the second highest Q1 revenues over the last six-year period.
In conclusion, revenues have continued to cool across most asset classes during Q1, but it is important to remember that the market had been firing on all cylinders during 2023, generating some of the best returns ever experienced — any YoY comparisons and declines in revenues must be kept in context.
Looking ahead to Q2
General market conditions were not very supportive for securities lending activity during the previous quarter, with low volatility, low short loan interest and continually rising asset prices. Given the momentum that has been building throughout Q1, the second quarter is likely to focus more on company fundamentals, to see whether they can catch up with market moves. If not, and investors become complacent, Q2 could see a more volatile trading environment than has been experienced since the beginning of the year.
There was positive momentum in IPOs, with new companies coming to market. Corporate events such as the Cummins spin off have also been positive for securities lending participants. With valuations and interest rates at recent highs, we expect to see more corporate activity in the coming months as firms look for cheaper financing options.
Heading into Q2 and Q3, investors are also likely to become increasingly reactive to central bank decision making, as expectations of multiple rate cuts have already been priced into market valuations. As the rhetoric surrounding the impending presidential election in the US starts to increase, given the stark difference in economic outlook from the two candidates, investors will also become increasingly responsive to moves in voter sentiment.
Regarding securities lending revenues, a general improvement across most asset classes and regions has started to emerge during the first few weeks of Q2. Volatility is starting to creep back into markets, and some of the blind AI exuberance seen during Q1 seems to be coming to an end.
Q2 is going to be a good barometer for securities lending activity, as the higher for longer narrative takes hold in the US and central bank divergence starts to take place. S&P Global Market Intelligence believes that revenues will remain strong but below those achieved last year. There is still a lot to play for, and when compared to any year other than 2023, 2024 appears to be off to a good start.
Over the period, the general deflationary trend continued, despite a few bumps in the road. Central banks have consistently warned that the final stages in getting inflation back to target would be the toughest, and while the latest decreases have been less pronounced than previous readings, its retrenchment into low single figures has continued.
Markets took confidence from the fact that it does appear to be under control, which helped to boost valuations. The fact that higher interest rates have been able to tame inflation without damaging economic growth has also extended further confidence to investors.
Although investors may be rejoicing over the recent surge in valuations worldwide, and the decline in inflation, it is crucial to acknowledge and evaluate the significant risks that do persist. One of the most major of these, comes in the form of geopolitical uncertainty.
Tensions grow as wars in the Middle East and Ukraine continue, and as the year proceeds, focus will move to the US presidential elections — voters face a choice between two very different candidates, who offer different perspectives on the future of the global economy. This is having an impact on commodity prices which may in turn have an impact upon inflation. In short, it is increasingly becoming a stock pickers market, which is positive news for the securities lending landscape as volatility starts to edge back in.
A breakdown of performance
In the securities finance markets, revenues continued to cool throughout the quarter, as Q1 produced US$2.75 billion. This represents a 20 per cent decrease year-on-year (YoY) but a slight uptick quarter-on-quarter (QoQ). The securities lending markets faced a number of headwinds during the period. Short loan interest fell to its lowest level in a decade across EMEA equities, with revenues during January and February falling to all-time lows. Revenues derived from specials activity declined during the period across all regions, and further headwinds in Asia in the form of short sale bans and ongoing weakness across the Chinese economy, held revenues back.
Cash reinvestment revenues also fell during Q1 for the first time in six quarters. It appears that the high tide for interest rates may well have passed, as most central banks are now at least considering reducing borrowing costs. The pace of easing looks less likely to mirror the aggressive speed at which tightening first took hold, and the lag in transmission means easing effects are taking more time to feed through across the globe. Expectations of rate cuts have now fed through to reinvestment pools however, which is reflected in the revenue declines.
Equity lending generated just over US$2 billion during the quarter. This represents a decline of 20 per cent YoY. The largest contributor to these revenues continued to be Americas equities, which generated just over US$1.07 billion (53 per cent). US equities generated US$959 million during the period, which represents a 26 per cent reduction YoY. From the other markets that make up this region, Canadian equities performed well over the quarter as average fees continued to increase YoY.
Average fees in Canada topped 74bps — an eight per cent increase YoY. Canada was the only market to experience a single-digit decline in revenues across the region. Elsewhere, revenues declined by 12 per cent YoY in Brazil, 37 per cent YoY in Mexico, and 23 per cent YoY across American depository receipts (ADRs). Balances did increase across the South American markets, however, as did lendable value.
Across EMEA, securities lending revenues suffered further substantial declines, pushing the quarterly total down 40 per cent YoY. This follows a YoY reduction of 47 per cent during Q4. Balances declined by 30 per cent and utilisation fell by 36 per cent.
The region suffered from a lack of demand and specials trading. Short interest fell to its lowest level in a decade during Q1, but it started to increase towards the beginning of April. All the top 10 revenue generating European markets experienced double-digit declines in revenues YoY, with the UK, France and Germany, all seeing YoY revenue dips of over 40 per cent. Average fees are a different picture however, with YoY increases seen across Germany, France, and the Netherlands.
APAC equities generated US$490 million during the quarter, with Japan, Taiwan and Malaysia, leading the charge. Japan generated US$186 million in revenues, which is an eight per cent increase YoY, the market also experienced a two per cent YoY increase in balances and a six per cent increase in average fees. This was against a backdrop of an equity market that continued to hit record highs during the period.
The region did continue to see a strong degree of divergence during Q1 however, with Hong Kong and Singapore experiencing declines in revenues of 31 per cent and 36 per cent respectively. South Korea also experienced a 34 per cent YoY decrease in average fees, while Hong Kong experienced a slight two per cent increase.
In the fixed income markets, Q1 saw a significant shift in the landscape of inflation and interest rates. Most central banks proceeded with caution, avoiding any further moves to interest rates, with only a couple making any changes during the quarter. The Bank of Japan moved rates back into positive territory during the quarter for the first time in 17 years, signalling an end to negative rate policy, and the National Bank of Switzerland surprised markets with a 25bps rate cut.
Global economic data remained strong, and the US economy continued to perform well. A recovery also took hold across China, although the property sector continued to face issues. This improvement in data led to a rise in government bond yields during the quarter, with increases seen across UK, German and US 10-year issues. In the securities lending markets, government bond revenues increased by two per cent YoY to US$173.4 million. Average fees declined by nine per cent YoY to 17bps, but balances increased by three per cent.
Figure 1. Q1 revenues by asset class
Corporate bond performance stayed strong over the quarter, with revenues remaining robust. Despite Q1 revenues declining by 20 per cent YoY, they only fell two per cent QoQ, which may point towards the beginning of a stabilisation in returns. Looking at Q1 revenues in comparison to other Q1 periods, they remain elevated, and corporate bonds continue to perform well. Q1 2024 produced the second highest Q1 revenues over the last six-year period.
In conclusion, revenues have continued to cool across most asset classes during Q1, but it is important to remember that the market had been firing on all cylinders during 2023, generating some of the best returns ever experienced — any YoY comparisons and declines in revenues must be kept in context.
Looking ahead to Q2
General market conditions were not very supportive for securities lending activity during the previous quarter, with low volatility, low short loan interest and continually rising asset prices. Given the momentum that has been building throughout Q1, the second quarter is likely to focus more on company fundamentals, to see whether they can catch up with market moves. If not, and investors become complacent, Q2 could see a more volatile trading environment than has been experienced since the beginning of the year.
There was positive momentum in IPOs, with new companies coming to market. Corporate events such as the Cummins spin off have also been positive for securities lending participants. With valuations and interest rates at recent highs, we expect to see more corporate activity in the coming months as firms look for cheaper financing options.
Heading into Q2 and Q3, investors are also likely to become increasingly reactive to central bank decision making, as expectations of multiple rate cuts have already been priced into market valuations. As the rhetoric surrounding the impending presidential election in the US starts to increase, given the stark difference in economic outlook from the two candidates, investors will also become increasingly responsive to moves in voter sentiment.
Regarding securities lending revenues, a general improvement across most asset classes and regions has started to emerge during the first few weeks of Q2. Volatility is starting to creep back into markets, and some of the blind AI exuberance seen during Q1 seems to be coming to an end.
Q2 is going to be a good barometer for securities lending activity, as the higher for longer narrative takes hold in the US and central bank divergence starts to take place. S&P Global Market Intelligence believes that revenues will remain strong but below those achieved last year. There is still a lot to play for, and when compared to any year other than 2023, 2024 appears to be off to a good start.
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