Amidst Global Trade Wars, The Securities Finance Market Responds
As the so-called trade wars rage on, DataLend investigates the impact—or surprising lack thereof, in some cases—on securities finance markets across the globe
By Chris Benedict, Product Specialist & Senior Analyst, DataLend
THE UNITED STATES’ trade war with its various trading partners around the world officially kicked off in April 2017 when an investigation was launched into whether or not steel and aluminum imports into the U.S. proved a national security threat. This was the first indication to the global markets that the administration was seriously considering widespread protective tariffs on imports.
Other U.S. investigations followed, and the first safeguard tariffs manifested themselves in the form of more than $10 billion on imported solar panels and washing machines in January 2018. The fight escalated from there as China slapped a hefty 178% duty on grain sorghum imported from the U.S., imposed retaliatory tariffs on $2.4 billion worth of aluminum scrap, pork, fruits, nuts, chemicals and other U.S. products and filed a dispute with the World Trade Organization (WTO) against the U.S. solar panel tariff.
By the middle of 2018, the U.S. was embroiled in tariff disputes with China, Canada, Mexico, Brazil, the European Union, Great Britain, South Korea, Australia and many other global trading partners. Tariffs were quickly imposed, but trade negotiations led to many exemptions after the U.S. realized it would need to subsidize American farmers for up to $12 billion in lost export sales.
Although negotiations with China and other trading partners are currently still in flux, it is estimated that the U.S. has placed tariffs on approximately $250 billion worth of Chinese goods thus far. China in turn has retaliated with $110 billion worth of tariffs on U.S. imports, targeting politically delicate industries such as farming, while threatening “qualitative measures” against U.S. companies to make doing business in China more difficult. The rhetoric between the two countries ratcheted up significantly in May of this year when China’s state broadcaster boldly declared: “If you want to fight, we’ll fight you to the end,” sending global markets into a tailspin. The recent economic data indicates that the trade wars are beginning to take a toll: China’s retail, export and industrial growth all saw significant declines in late 2018. DataLend reviewed securities lending activity in 2018 to see what impact the ongoing trade wars have had on the demand to borrow various assets across the world.
While the trade wars may have caused some longs to sell off, the U.S. securities lending market has had only a moderate reaction. Volume-weighted average fees to borrow U.S. equities dropped in 2018 to 48 bps, down from an average of 55 bps in 2017; fees averaged around 40 bps further into 2019. Utilization was also down very slightly over the same timeframe from 10.6% to 8.6%, and that average utilization figure has continued into 2019.
However, when drilling down into impacted industries, DataLend saw a significant increase in volume-weighted average fees to borrow stocks in the U.S. Automobiles and Components industry in the spring of 2018 after China announced sweeping tariffs on $50 billion worth of U.S. goods, including autos.
Fees shot up from an average of 68 bps in February to reach a peak of 266 bps in mid-April before easing back down to 50 bps by the end of last year. However, fees in this industry appear to be on the incline again, having reached over 300 bps in early March 2019.
The average utilization in this industry also rose from 24% to 28% during the same timeframe. Some of the names contributing to the fee increase during this time included Peugeot ADR (PUGOY), Geely Automobile Holdings ADR (GELYY), Adomani Inc. (ADOM), Sorl Auto Parts (SORL) and Tesla (TSLA). The U.S. Automobiles and Components industry grossed $172.3 million in revenue for securities lenders in 2018, up 72% from $100.1 million in 2017. As previously noted, this industry has started off 2019 trending hotter as a result of heavy demand for NIO Inc. (NIO) and Kandi Technologies (KDNI), Chinese electric automotive ADRs trading in the U.S.
FIGURE 1: VOLUME-WEIGHTED AVERAGE FEES, U.S. AUTOMOBILES AND COMPONENTS, MARCH 2018-19
China is the world’s largest importer of soybeans, and in 2017 the U.S. exported $14.5 billion worth of the product to China in 2017, according to the Iowa Farm Bureau. U.S. soybean exports to China plummeted by 98% in 2018 as a result of the trade wars, per research from Deutsche Bank.
The securities lending market reacted to the massive drop in exports in the Teucrium Commodity Trust Soybean Fund (SOYB). This ETF saw its volume-weighted average fees rise twofold from March to May 2018. Fees remained high during the summer as soybean futures dropped, and the ETF share price slumped by 19%, similar to patterns observed in the soybean futures market during the same timeframe. Fees remained in the higher range more recently as share prices of the ETF remained depressed in early 2019. The securities lending market also saw strong demand to borrow Chinese and other Asian ADRs trading on U.S. exchanges in 2018, particularly in the Information Technology sector.
Companies such as JA Solar (JASO), Cheetah Mobile (CMCM), Xunlei Limited (XNET), Daqo New Energy (DQ), GDS Holdings (GDS), Gridsum Holdings (GSUM) and Semiconducter Manufacturing International (SMI) made a combined $13.1 million for securities lenders last year. Other Asian ADRs such as AU Optronics (AUO), Himax Technologies (HIMX), Silicon Motion (SIMO) and Taiwan Semiconductor Manufacturing (TSM) also saw strong demand in 2018, generating $14.4 million in securities lending revenue.
Canada and Mexico
In addition to the tariff tussle with China, the Trump administration sought to rewrite the North American Free Trade Agreement (NAFTA) in fall last year. The new United States-Mexico-Canada Agreement (USMCA) wasn’t a radical change from NAFTA, and it doesn’t seem to have made an impact on the securities lending market.
On June 1, 2018, the U.S. ended the exemption for Canada and moved forward with a 25% tariff on steel and 10% on aluminum. The Canadian equities market saw volumeweighted average fees climb from around 64 bps on March 1 to just over 100 bps at the end of July.
While the share prices of Canadian steel and aluminum companies such as Russel Metals (RUS CN), Tree Island Steel (TSL CN), Stelco (STLC CN), First Quantum Minerals (FM CN) and others sold off, fees and utilizations in these names in the securities lending market remained low last year.
Similar to Canada, Mexican equities saw fees rising steadily prior to June 1 to a peak of just under 100 bps before dropping back down to an average of 53 bps. This movement, however, may not have been related to the 25% tariff on $3 billion worth of imported Mexican steel.
Overall, the securities lending markets in Canada and Mexico thus far appear to have ignored any effects from the U.S. tariffs and the USMCA.
Like the U.S., the overall European market appeared relatively stable in 2018 with fees to borrow European equities averaging 58 bps over the last 12 months. Utilization increased to a high of 12.32% during the busy corporate events season in May, but settled back down to a 7% to 8% range for the remainder of 2018. The U.S. threats of tariffs on European products focused on the European auto export market, worth an estimated $150 million, according to the European Automobile Manufacturers Association. When viewing the European Automobiles and Components industries, there was a slight increase in utilization from 12.5% in early March to a peak of 18% by May 2018, but no corresponding increase in fees to borrow.
Volkswagen (VOW GR), BMW (BMW GR) and Daimler (DAI GR) represent a substantial amount of the European import/ export market, and the share prices of all three were down approximately 20% since May 2018. However, the securities lending market has not followed suit: While the utilization of these three large companies did increase slightly in spring 2018, trading in the securities finance market remained relatively calm despite lower share prices. This could be because the Trump administration’s proposed tariffs on European car imports was less punitive than anticipated at just 2.5%.
One of the largest impacts of the trade wars thus far can be observed in the Asian markets, specifically Hong Kong, Taiwan and South Korea, which are typically used as proxies to short China given the operational challenges of borrowing assets in that market (see “Accessing China” in Issue 4 of The Purple for more detail).
For instance, the Transportation industry in some Asian markets saw significant increases in fees to borrow. Asian shipping companies in particular were under selling pressures based on fears that Chinese exports flowing through various ports would slow considerably as a result of U.S. tariffs. Fees to borrow Hong Kong Transportation stocks rose from an average of 125 bps in late February to a high of 210 bps by early June 2018. South Korea Transportation volume-weighted average fees also rose during the same time frame, from 240 bps to approximately 450 bps. Companies contributing to the overall fee increase to borrow Asian transportation companies include Hyundai Merchant Marine Co. (011200 KS), Cosco Shipping Holdings “H” shares (1919 HK), Hutchison Port Holdings Trust (HPHT SP), China Merchants Port Holdings (144 HK) and Orient Overseas (316 HK).
A clear impact to Hong Kong’s Technology Hardware and Equipment industry is visible after the U.S. finalized a 10% tariff on $200 billion worth of Chinese goods, including computer parts and peripherals on July 10, 2018. The securities lending market reacted immediately, sending fees to borrow the industry soaring from 112 bps to 415 bps by July 19. Securities lenders grossed over $33 million in Hong Kong’s Technology Hardware and Equipment industry last year, up a significant 92% from $17.1 million in 2017.
Securities trading hotter during this time included China Youzan Ltd (8083 HK), Yangtze Optical Fibre and Cable (6869 HK), China Goldjoy Group Ltd (1282 HK) and Nanfang Communication Holdings (1617 HK). A similar trading pattern can be seen for the same industry in Taiwan as fees rose from 280 bps in May to reach just under 400 bps by July 2018.
The Taiwanese Technology Hardware and Equipment industry generated $123.7 million in revenue last year, up 63% from $75.8 million observed in 2017. Recently we’ve seen fees to borrow this industry cool a bit, perhaps related to President Trump’s optimistic comments that he wanted a trade deal done with China and that talks were “going very well” in January.
Fee increases to borrow Hong Kong Capital Goods companies also visibly rose during the July 2018 timeframe and beyond. Volume-weighted average fees for this industry rose from 181 bps in early April to 260 bps in mid-July 2018. Fees continued to rise to reach a peak of 323 bps by late October before cooling to 217 bps more recently.
The South Korean Capital Goods industry also saw strong demand as a result of the trade war’s impacts, with fees trading just under 300 bps in June last year. The lending of Hong Kong Capital Goods equities grossed $41.6 million in revenue in 2018, an 87% increase from the $22.2 million generated in 2017, while lending the South Korean Capital Goods industry generated $49.8 million last year, up 53% from $32.5 million in 2017.
The full economic impact of the trade wars has yet to be felt by all parties involved, and the possibility of billions of dollars worth of additional tariffs across a broad array of goods and services are still on the table. With certain countries being excluded or partially excluded from tariffs and intense multilateral negotiations ongoing, expect more volatility in the cash and securities lending markets as deals are reached (or negated).
FIGURE 2: VOLUME-WEIGHTED AVERAGE FEES, HONG KONG TECHNOLOGY & EQUIPMENT COMPANIES, MARCH 2018–19