David Lewis | senior director, FIS
May 08, 2020
With the securities finance market busier than ever, it’s never been so important to stay informed. FIS compares today’s crisis with those from the recent past, discusses the similarities and differences, and tracks the effects on the market.
Contagion risk is a very real threat in the COVID crisis. Keeping your distance and staying at home is believed by many to be a significant weapon against the virus spreading, but the sudden ceasing of most economic activity brings a different cost and type of contagion.
In September last year, in pre-COVID times (remember them?), Reuters published an article indicating that millions of workers in the UK were just one month’s pay away from losing their homes. Just under half of working people in the UK live in privately rented accommodation, and fear that the loss of their job would quickly mean that they will not make their next rent payment. Apply this to businesses; their jobs have been lost too as there are fewer people spending any money.
Primark recently announced that they have gone from sales of £650 million a month to zero. Like the tens or even hundreds of thousands of employees fearing for their jobs and incomes, the corporations are already there, worrying that they won’t make their next rent payment either.
British Airways has announced potential job losses of around 12,000; Boeing, a major supplier to and dependent of the airline industry has announced it may shed 16,000 roles. These drastic measures represent levers that the company can pull; stopping paying wages is one thing, but they also need to pay their creditors. Corporate bonds are a major source of funding for these large corporations. Certain governments include buying corporate debt as part of their quantitative easing actions, but they cannot support every business. The chart shows a 60 percent increase in borrowing of European corporate bonds over the last 12 months. The significant rise in the last few months suggests that there are many investors betting against these bonds being paid off because no one is travelling or shopping.
Flying the unfriendly skies
The current COVID-19 crisis has had far-reaching effects on almost all aspects of the world economy. Few industries are exempt from some sort of impact, but the impact on some is perhaps more visible than for others. The skies above London are benefitting from unseasonably warm and sunny weather, but also from a near 100 percent drop in air travel.
As the travel restrictions came into force across the world, demand for air travel disappeared almost overnight; planes were mothballed and government support sought. Short sellers were quick to act, taking out substantial short positions against the major airlines. Flybe Group PLC, the UK operator, was the first to fail, although it had been close to the edge before the pandemic struck. Virgin Australia is the latest to fall, entering voluntary administration after failing to secure a lifeline from the Australian Government. Some analysts are suggesting that few airlines will survive in their current forms for any significant period beyond May.
The following graph shows the utilization (percentage of market supply actually borrowed) of shares borrowed for Norwegian Airlines, American Airlines, Delta and Virgin Australia over the last two years.
Norwegian has been facing significant headwinds through 2019 as the green plot signifies, but the significant rise in utilization for American and Virgin Airlines shows the soaring levels of short interest in these companies. Despite the share price falling by more than 60 percent over the last six months, Delta appears to have eluded short sellers’ attention by comparison. With short interest levels reaching these heights, it appears that many expect more turbulence to come.
The current market turmoil created by the global pandemic of COVID-19 has shown remarkable similarities with the financial crisis which started around 2007. The collapse of Lehman Brothers rattled global markets and sent investors rushing for safe haven assets (March saw an 11 percent shift from prime equity into government bond funds); short sellers were demonized as benefitting from falling markets seemed abhorrent to many investors who were losing money; some lenders withdrew their assets from lending programs while some regulators banned short selling in some manner and governments around the globe stepped in to shore up their economies.
The same responses are present in the COVID-19 pandemic. One major difference is the response from many regulators. The many new laws that had been put in place since the Lehman default to ensure bank liquidity and resilience in a crisis are now being relaxed. The implementation of new regulations – designed to increase transparency and settlement certainty across markets – are being delayed due to the crisis. Substantial quantitative easing programs in both Europe and the U.S. extend to trillions of USD and euros in support for industries and economies, buying up everything from government debt to municipals and junk bonds and bloating Central Bank balance sheets.
The graph shows the borrowing volume (not value) of U.S. Treasuries and their utilization. Utilization is a measure of the amount of market supply being used up. Both are at very high levels, with the risk that prolonged quantitative easing could restrict the supply of high-quality collateral vital for the safe and efficient working of the world’s financial markets. While many countries remain in the eye of the COVID storm, the financial and regulatory impact of this pandemic is yet to be determined.
Market volatility has been extreme in recent weeks as a direct response to the economic threat from COVID-19 and the unprecedented financial support from various governments around the world. Short interest in European equities jumped toward the end of February, adding some 110 percent by volume from February 1 to a peak on March 22. The last days have seen a significant reversal, as volume (not value) dropped by over 21 percent to March 30. This change in direction brings the importance of the timeliness of data into sharp relief. Intraday data, provided by the FIS Securities Finance Suite, brings transparency to the securities finance markets and as a proxy for short interest.
The world is getting shorter: The last two months have seen asset borrowing volumes rise fast. European equity volume is up 110 percent since February 1, with U.S. equities rising 20 percent to a peak last week, recording a net gain of 16 percent by volume now. Utilization has risen in line, hitting 7 percent for European equities. The correlation suggests that there has not been a significant change in the supply over that period, despite some funds elsewhere in the world reducing their lending activity and some short selling bans coming into effect more recently. Global data from the FIS Securities Finance Suite can provide you with intraday data wherever you trade; with markets moving as they are, yesterday’s data is not good enough.