Demand to borrow securities still lacking, says JP Morgan

Securities balances and lending activity dropped heavily after the global financial crisis, but since October supply has been rising strongly, particularly in equities, although demand has yet to revive to the same degree, according to JP Morgan.

“We’ve spent the past year getting in more supply, getting in more assets we can lend out,” says Colin McKechnie, the bank's New York-based global head of financing and markets products. “We’ve done a good job on bringing in equity and corporate bond assets with more value for our clients. Overall, the demand side is what’s lacking.”

Balances are coming back particularly strongly on the equities side, he told AsianInvestor during a trip to Hong Kong last week. Leading up to the start of the subprime crisis in 2007, there had been a much higher proportion of bonds than equities for lending – in the region of 80/20 bonds/equities – then the markets disappeared, adds McKechnie.

“Now the balance is moving more towards being 60/40 bonds/equities,” he says, “as equities becomes the market that people are taking risk in, so there’s more shorting happening.”

Still McKechnie hasn’t yet seen a big pick-up in demand from borrowers. That's because a major part of broker-dealers' client base is hedge funds, which haven’t come back as strongly yet, and are still not using as much leverage. Where these funds were perhaps leveraged 50 times before, now that figure may be less than 20 times.

McKechnie suggests the current turmoil in the Middle East may be having an effect. “People previously weren’t very worried about Egypt because there is a strong army to take over,” he says, “but they’re more concerned now over developments in Libya. We’ll see how they feel after things settle [in that region].”

JP Morgan is also making efforts to spark activity in the collateral-management market, and says it’s having success with its early-February move to start processing gold as collateral.

“We’ve had phenomenal response from clients, including in Asia, who didn’t realise they needed it until they saw our announcement,” says McKechnie. “There are a lot of people that own gold, and gold to most people is a stale asset; it’s not interest-earning, so if you can earn some value from it, you should do that.”

To facilitate this, a lending agent must have access to gold depositories. JP Morgan has vaults in London, New York and Singapore, notes O’Delle Burke, product manager for collateral management in Hong Kong. The firm is in the process of expanding the gold-processing capability from London and Singapore.

Unallocated gold is used as collateral, meaning most gold transactions are not physical and the positions are in electronic format, making them very fungible, says Burke.

Hence, it’s easier to manage gold as collateral than bonds or equities, he adds. Since the collateral provider retains beneficial ownership of securities, the collateral must be managed to ensure that the collateral provider continues to receive interest on bonds or dividends on equities.

“As a lender, you think about how exactly am I going to manage that collateral,” says Burke. “With gold it’s a lot easier, because there’s less asset servicing and no corporate actions involved.”