The Great White North
11 June 2019
The strength and stability of the country鈥檚 securities lending market was reinforced at the Canadian Securities Lending Association鈥檚 9th Annual Conference, and panellists suggested positive change is happening in Canada
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The Canadian securities lending market鈥檚 reputation for strength and stability was once again reinforced at this year鈥檚 Canadian Securities Lending Association (CASLA) Conference in Toronto.
Panellists at the conference discussed some of the foundations of Canada鈥檚 reputation: its experienced market participants, proven infrastructure and a prudential regulatory regime that works in collaboration with market participants, and the country鈥檚 interaction with the rest of the world.
The conference kicked off with a global economic update presentation by Benjamin Tal, managing director and deputy chief economist, CIBC, who indicated that the global economy is currently in a fog of uncertainty. Tal observed that 2017 saw a peak for the global economy, but it has dipped since then. This was partly down to political concerns, but the speaker said in 2017 there was 鈥渁 rush鈥� for 鈥渃heap money鈥�.
Despite the global economic slowdown, the US pushed against this trend. Tal said this was a 鈥渟hort-term gain鈥�, but could result in 鈥渓ong-term pain鈥� for the US.
Elaborating on this, he added: 鈥淯sually, governments stimulate their economy when it鈥檚 down鈥攏ot up鈥攂ut Trump provided an extra lift that it did not need when it was high.鈥�
Meanwhile, in a panel on regulation and funding, speakers suggested that positive change is happening in Canada after the Canadian government revealed it was to make changes to a variety of federal tax laws earlier this year. Discussing the tax laws, Christopher Steeves, Fasken Martineau DuMoulin LLP, said that 鈥渨ithholding tax rules applicable to certain cross-border share lending arrangements were amended in response to perceived withholding tax avoidance鈥�.
He commented: 鈥淐anadian non-resident withholding tax generally only applies where certain payments (including dividends interest) are made by a resident to a non-resident of Canada. Domestic rate of withholding tax is 25 percent. Rates may be reduced or payments may be exempt under an applicable tax treaty.鈥�
The panel also pointed out that under the Canada-US tax treaty, Article XXI exempts US pension funds from Canadian withholding tax on interest and dividends. According to a speaker, interest and dividends may also be an example of where the beneficial owner is entitled to claim sovereign immunity.
For securities lending arrangements completed prior to 19 March, Steeves explained that compensation payments in respect of loaned corporate shares paid by a Canadian resident borrower to a non-resident lender were characterised as interest for withholding tax purposes unless the loan was fully collateralised.
Steeves noted that fully collateralised means, that throughout the term of the securities lending arrangement, the borrower provided collateral with a value not less than 95 percent of the value of the loaned shares.
He stated: 鈥淪ecurities lending arrangements completed prior to 19 March, where a loan was fully collateralised, compensation payments in respect of loan corporate shares paid by a Canadian resident borrower to a non-resident lender, were characterised as dividends. Dividends would be subject to Canadian withholding tax. The new characterisation rule applies to compensation payments on or after 19 March unless the payments are pursuant to a written arrangement entered into before 19 March.鈥�
In that case, the new rule will apply to compensation payments beginning in October 2019, Steeves added.
The moderator asked panellists if the supply-side is sufficient right now. Speakers confirmed that a number of firms have indicated that there is a significant amount of supply and it could have a significant impact on pricing.
One speaker predicted that there is a big plumbing change coming to the industry. The speaker explained that the changes involve the futures having a liquid market, making sure that the swap conventions are consistent as well.
Meanwhile, during a panel that had a regulatory focus, panellists discussed the European Securities and Markets Authority鈥檚 (ESMA) Securities Financing Transactions Regulation (SFTR) Level III consultation paper and warned that this could present the last opportunity to make changes.
Following ESMA鈥檚 deliverance of its Level III guidance on 27 May, Tamela Merriweather, senior vice president, assistant general counsel, Northern Trust, said: 鈥淪FTR is coming and this consultation paper probably presents the last opportunity to make changes, if any. The consultation paper asks for comment on a number of things and seeks feedback. It also clarifies what is in scope and out of scope for SFTR.鈥�
Merriweather noted that one of the hurdles for non-EU participants will be the need to obtain a legal entity identifier (LEI).
She continued: 鈥淓SMA expects to see reporting on all securities financial transactions whether or not they鈥檙e settled, and it was disappointing to see they took this broad view of the scope of transactions to be reported.鈥�
鈥淚n terms of key risks, I would say that it will be interesting to see what sort of access non-EU beneficial owners will want to have or continue to have to the EU markets. For so many years we have been on a path toward globalisation, will we now see trends toward domestic portfolios or will beneficial owners accept the increased regulatory demands of cross-border activity?鈥�
Glenn Horner, managing director, State Street, cited: 鈥淒ifferent regulators go down different paths in terms of getting the information they want. The US thought the European regulators were going well overboard. We also have the other issue with Brexit. I鈥檓 not sure SFTR is going to offer any stability to the market. And it鈥檚 a huge financial resource for the technology to deal with it.鈥�
Later in the panel, the moderator asked panellists if they thought SFTR is driving technology opportunities.
In response, Michael Norwood, associate director, EquiLend, said: 鈥淭he industry has to become more efficient and precise. Operational processes and reconciliations have to be done in a more timely manner because of the upcoming SFTR and Central Securities Depositories Regulation rules.鈥�
鈥淎s a result, you have to take advantage of tools today, whether it be automation or reconciliation tools. The more you take advantage of the technology, the easier it is going to be to comply with the regulatory regime that is coming.鈥�
Technology, challenges, and opportunities became topics of discussion during one panel entitled 鈥業ndustry leaders鈥攖he current and future state of securities lending鈥�, and Robert Goobie of Healthcare of Ontario Pension Plans, explained that challenges 鈥渆ncourage us to think differently, and to think differently means coming up with new solutions鈥�.
Goobie cited: 鈥淪olutions such as changes to the legal doc combining master repurchase agreement (MRA) and global MRA since all these functions are been centralised. We should consider other forms of credit rating not the standard S&P etc.鈥�
Some of the challenges the panel discussed included trading in different time zones. To help overcome this challenge, one panellist stated that they leverage operational groups and technology, understanding the trading rules for each market, and communicating trading requirements is very important.
On the topic of technology, France Boisjoli, head of securities finance, equity market, Caisse de d茅p么t et placement du Qu茅bec, stated: 鈥淭wo major elements that helped support growth is technology and engagement of our support teams. Technology is an essential factor in achieving efficiency.鈥�
Boisjoli continued: 鈥淎utomation has always been an integral part of our business, and I believe that if something can be automated then it should be.鈥�
The panel agreed that the industry has come a long way since the financial crisis, and Boisjoli explained: 鈥淪ecurities lending used to be more of a 鈥榖ack office鈥� business and was done with no regard for the optimisation of the collateral and its composition, cross-asset trades, liquidity as well as balance sheet optimisation, legal and tax regulations, and the risk profiles of counterparties.鈥�
She added: 鈥淗owever, the 2008 financial crisis and the regulations that came after have changed the landscape of securities lending forever. This was complex and while it posed a lot of challenges it also poses a lot of opportunities. We have changed significantly over the years and thus developed our businesses as a result.鈥�
During the panel that gave a buy-side perspective on securities lending, one speaker suggested that shorting is more of an art than a science. The speaker suggested that shorting is more of a thesis. They said: 鈥淵our initial thesis might be blown, and so re-evaluating your thesis is very important.鈥�
The moderator asked: 鈥淲hen I think about shorting, it is incredibly difficult and there are lots of challenges to it, how do you establish a thesis around it and how do you execute it?鈥�
One speaker replied: 鈥淲e look for red flags鈥攆or example, bank statements鈥攁nd we take these and look deeper into them. A big part of what we look for on the short side is high yields.鈥�
The moderator then asked panellists if they had spoken to a management team with the preconceived notion that you want to short them.
One panellist replied: 鈥淚nterviewing the management teams is a key part of our process. Questions, for example, include 鈥榠f you could only sell through one product what would it be?鈥�.鈥�
They explained: 鈥淨uestions like this help to probe thinking better. You don鈥檛 become a CEO unless you鈥檙e an excellent sales person, people will tell you the most optimistic perspective on it. It is about getting them to tell the full story, such as a series of interviews.鈥�
Panellists at the conference discussed some of the foundations of Canada鈥檚 reputation: its experienced market participants, proven infrastructure and a prudential regulatory regime that works in collaboration with market participants, and the country鈥檚 interaction with the rest of the world.
The conference kicked off with a global economic update presentation by Benjamin Tal, managing director and deputy chief economist, CIBC, who indicated that the global economy is currently in a fog of uncertainty. Tal observed that 2017 saw a peak for the global economy, but it has dipped since then. This was partly down to political concerns, but the speaker said in 2017 there was 鈥渁 rush鈥� for 鈥渃heap money鈥�.
Despite the global economic slowdown, the US pushed against this trend. Tal said this was a 鈥渟hort-term gain鈥�, but could result in 鈥渓ong-term pain鈥� for the US.
Elaborating on this, he added: 鈥淯sually, governments stimulate their economy when it鈥檚 down鈥攏ot up鈥攂ut Trump provided an extra lift that it did not need when it was high.鈥�
Meanwhile, in a panel on regulation and funding, speakers suggested that positive change is happening in Canada after the Canadian government revealed it was to make changes to a variety of federal tax laws earlier this year. Discussing the tax laws, Christopher Steeves, Fasken Martineau DuMoulin LLP, said that 鈥渨ithholding tax rules applicable to certain cross-border share lending arrangements were amended in response to perceived withholding tax avoidance鈥�.
He commented: 鈥淐anadian non-resident withholding tax generally only applies where certain payments (including dividends interest) are made by a resident to a non-resident of Canada. Domestic rate of withholding tax is 25 percent. Rates may be reduced or payments may be exempt under an applicable tax treaty.鈥�
The panel also pointed out that under the Canada-US tax treaty, Article XXI exempts US pension funds from Canadian withholding tax on interest and dividends. According to a speaker, interest and dividends may also be an example of where the beneficial owner is entitled to claim sovereign immunity.
For securities lending arrangements completed prior to 19 March, Steeves explained that compensation payments in respect of loaned corporate shares paid by a Canadian resident borrower to a non-resident lender were characterised as interest for withholding tax purposes unless the loan was fully collateralised.
Steeves noted that fully collateralised means, that throughout the term of the securities lending arrangement, the borrower provided collateral with a value not less than 95 percent of the value of the loaned shares.
He stated: 鈥淪ecurities lending arrangements completed prior to 19 March, where a loan was fully collateralised, compensation payments in respect of loan corporate shares paid by a Canadian resident borrower to a non-resident lender, were characterised as dividends. Dividends would be subject to Canadian withholding tax. The new characterisation rule applies to compensation payments on or after 19 March unless the payments are pursuant to a written arrangement entered into before 19 March.鈥�
In that case, the new rule will apply to compensation payments beginning in October 2019, Steeves added.
The moderator asked panellists if the supply-side is sufficient right now. Speakers confirmed that a number of firms have indicated that there is a significant amount of supply and it could have a significant impact on pricing.
One speaker predicted that there is a big plumbing change coming to the industry. The speaker explained that the changes involve the futures having a liquid market, making sure that the swap conventions are consistent as well.
Meanwhile, during a panel that had a regulatory focus, panellists discussed the European Securities and Markets Authority鈥檚 (ESMA) Securities Financing Transactions Regulation (SFTR) Level III consultation paper and warned that this could present the last opportunity to make changes.
Following ESMA鈥檚 deliverance of its Level III guidance on 27 May, Tamela Merriweather, senior vice president, assistant general counsel, Northern Trust, said: 鈥淪FTR is coming and this consultation paper probably presents the last opportunity to make changes, if any. The consultation paper asks for comment on a number of things and seeks feedback. It also clarifies what is in scope and out of scope for SFTR.鈥�
Merriweather noted that one of the hurdles for non-EU participants will be the need to obtain a legal entity identifier (LEI).
She continued: 鈥淓SMA expects to see reporting on all securities financial transactions whether or not they鈥檙e settled, and it was disappointing to see they took this broad view of the scope of transactions to be reported.鈥�
鈥淚n terms of key risks, I would say that it will be interesting to see what sort of access non-EU beneficial owners will want to have or continue to have to the EU markets. For so many years we have been on a path toward globalisation, will we now see trends toward domestic portfolios or will beneficial owners accept the increased regulatory demands of cross-border activity?鈥�
Glenn Horner, managing director, State Street, cited: 鈥淒ifferent regulators go down different paths in terms of getting the information they want. The US thought the European regulators were going well overboard. We also have the other issue with Brexit. I鈥檓 not sure SFTR is going to offer any stability to the market. And it鈥檚 a huge financial resource for the technology to deal with it.鈥�
Later in the panel, the moderator asked panellists if they thought SFTR is driving technology opportunities.
In response, Michael Norwood, associate director, EquiLend, said: 鈥淭he industry has to become more efficient and precise. Operational processes and reconciliations have to be done in a more timely manner because of the upcoming SFTR and Central Securities Depositories Regulation rules.鈥�
鈥淎s a result, you have to take advantage of tools today, whether it be automation or reconciliation tools. The more you take advantage of the technology, the easier it is going to be to comply with the regulatory regime that is coming.鈥�
Technology, challenges, and opportunities became topics of discussion during one panel entitled 鈥業ndustry leaders鈥攖he current and future state of securities lending鈥�, and Robert Goobie of Healthcare of Ontario Pension Plans, explained that challenges 鈥渆ncourage us to think differently, and to think differently means coming up with new solutions鈥�.
Goobie cited: 鈥淪olutions such as changes to the legal doc combining master repurchase agreement (MRA) and global MRA since all these functions are been centralised. We should consider other forms of credit rating not the standard S&P etc.鈥�
Some of the challenges the panel discussed included trading in different time zones. To help overcome this challenge, one panellist stated that they leverage operational groups and technology, understanding the trading rules for each market, and communicating trading requirements is very important.
On the topic of technology, France Boisjoli, head of securities finance, equity market, Caisse de d茅p么t et placement du Qu茅bec, stated: 鈥淭wo major elements that helped support growth is technology and engagement of our support teams. Technology is an essential factor in achieving efficiency.鈥�
Boisjoli continued: 鈥淎utomation has always been an integral part of our business, and I believe that if something can be automated then it should be.鈥�
The panel agreed that the industry has come a long way since the financial crisis, and Boisjoli explained: 鈥淪ecurities lending used to be more of a 鈥榖ack office鈥� business and was done with no regard for the optimisation of the collateral and its composition, cross-asset trades, liquidity as well as balance sheet optimisation, legal and tax regulations, and the risk profiles of counterparties.鈥�
She added: 鈥淗owever, the 2008 financial crisis and the regulations that came after have changed the landscape of securities lending forever. This was complex and while it posed a lot of challenges it also poses a lot of opportunities. We have changed significantly over the years and thus developed our businesses as a result.鈥�
During the panel that gave a buy-side perspective on securities lending, one speaker suggested that shorting is more of an art than a science. The speaker suggested that shorting is more of a thesis. They said: 鈥淵our initial thesis might be blown, and so re-evaluating your thesis is very important.鈥�
The moderator asked: 鈥淲hen I think about shorting, it is incredibly difficult and there are lots of challenges to it, how do you establish a thesis around it and how do you execute it?鈥�
One speaker replied: 鈥淲e look for red flags鈥攆or example, bank statements鈥攁nd we take these and look deeper into them. A big part of what we look for on the short side is high yields.鈥�
The moderator then asked panellists if they had spoken to a management team with the preconceived notion that you want to short them.
One panellist replied: 鈥淚nterviewing the management teams is a key part of our process. Questions, for example, include 鈥榠f you could only sell through one product what would it be?鈥�.鈥�
They explained: 鈥淨uestions like this help to probe thinking better. You don鈥檛 become a CEO unless you鈥檙e an excellent sales person, people will tell you the most optimistic perspective on it. It is about getting them to tell the full story, such as a series of interviews.鈥�
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