EQUITIES COMMENTARY — Jul 19, 2023

Q2 Securities Finance Activity Review Webinar Slides

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Responses to the questions received that we didnt have time to cover during the presentation:

Q2 Securities Finance Activity Review Webinar Q&A - Responses provided by webinar guest James Clunie.

What can we expect from US - China relations going forward?

The two countries have been highly connected in terms of trade and money flows, especially from 2001-2018. The rhetoric between the two countries has deteriorated since around 2018, although it waxes and wanes depending on the situation. But if you examine actual events, the two countries are gradually increasing the barriers to trade, investment, flows of data and in some cases, movement of people. This looks like a developing trade war, and even cold war, based on geo-political rivalry, differing values and political expediency, amongst other things. It's possible that Western investors will be unable to hold on to Chinese investments in the medium-term (possibly as a result of US sanctions and restrictions).

Should we expect a big government stimulus in China?

The Chinese economy has disappointed in recent months. There has been minor stimulus, mostly to support distressed property developers (so that unfinished projects can be completed). Low inflation suggests scope for monetary easing, but given the level of government and SOE debt, and a legacy of malinvestment, I wouldn't expect anything on the scale seen around the time of the Global Financial Crisis.

In your experience do rising markets usually lead to more or fewer short positions?

It depends! In a speculatively-driven market, I'd expect shorts to get 'knocked out' as losses mount, and so short positions would fall. In a more rational, value-cognizant market, short positions should grow in cases where share prices rise too rapidly relative to long-term cash-flow prospects.

Are meme stocks here to stay?

In the long-run, if these are 'bad' investments, you'd think participants would eventually lose their money and the game would fizzle out. But two other important things matter: in the short run, the interaction of long and short position holders (the 'longs' can impose losses on the 'shorts' if they co-ordinate well); and in the medium-term, companies with over-priced shares can issue new shares 'cheaply' and thus gain a competitive advantage (low cost of capital), changing the course of the future if they invest the proceeds well. The game can continue!

Can the Fed pull off a soft landing?

Yes, but they'd be lucky! It's safest to assume this is 'possible', but not 'probable' if you're doing scenario analysis.

How does a weaking USD affect investors and how is it likely to affect the securities finance markets?

A weak Dollar effectively boosts liquidity for the rest of the world (RoW). It's good for RoW asset prices, and would mark a change from what we had before, and maybe also change in the securities finance markets (change is often good for trading and activity levels in markets). It should also boost US overseas corporate profits, while raising US import prices.

What is the future of ESG investing?

I think some investors got carried away with the notion that high-ESG level stocks could out-perform almost continuously as regulation, investor preferences and trends were on their side. In most studies, though, it is 'changes' in ESG scores/ratings that drive out-stock performance, rather than the 'level' of ESG-ness itself. And in theory, ESG investing should result in owning a subset of the total market, which means a slightly higher risk and so a lower risk-adjusted return. I think ESG investing has an important role to play, but it'll become much more nuanced than just buying into 'environmentally-friendly' firms.

Is disinflation transitory?

This is the big debate in markets. Clearly, headline inflation is still falling in most major economies, but I expect a regime of slightly higher and more volatile inflation after this disinflationary episode, based on the balance of medium-term inflationary/deflationary forces outlined in my slides. Let's see what happens.

Is there a risk of imminent financial crisis in any major world economy?

Where leverage is high and a regime of low and stable rates gives way to rapid interest rate rises, things can definitely break. In the past year, we've had a Chinese property developer crisis; then levered UK 'liability-driven investment' pension funds struggling to post collateral; and then the failure of some US regional banks with concentrated deposit bases. Could there be more? Sure (Swedish or South Korean housing; some corners of private equity or real estate; an entire country like Turkey?). What we've learned so far is that central banks and governments have no appetite for financial crisis, even being willing to pump in liquidity or pubic resources to stem the crisis, even as they're trying to defeat inflation. It's reasonable to expect more crises and more policy responses. And yet allowing things to fail surely makes the system stronger in the long-run?


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