BNY Mellon’s Asia-Pacific collateral business has been built on the success of its global franchise and significant presence in Japan, but this year the firm has taken strides in developing its business in two of the region’s key emerging markets: China and Korea.
BNY Mellon became the first firm to provide investors the ability to use their Stock Connect Chinese A-shares, listed on the Shanghai and Shenzhen stock markets, as collateral in BNY Mellon tri-party transactions – widening the utility of A-shares from these key markets. That facility came just as MSCI included some large-cap China A-shares in its emerging markets index on June 1 escalating demand for China shares.
The June inclusion saw around 230 Chinese large-cap stocks, known as A-shares, added to MSCI’s emerging markets index, a benchmark tracked by $1.9 trillion in assets, with a 2.5% part inclusion factor. The second phase of the inclusion happened on September 3 and the MSCI entry is seen integrating the world’s second-biggest equity market, with a total stock market capitalisation of more than $8 trillion, into the global financial system.
Stock Connect is a collaboration between the Hong Kong, Shanghai and Shenzhen stock exchanges and allows international and mainland Chinese investors to trade securities in each other’s markets. First launched in November 2014, the scheme now covers more than 2,000 eligible equities in the three regions.
Just as the initiative faced challenges over the free flow of assets between China and Hong Kong given the differing trading conventions, the tri-party project too faced technical issues, which BNY Mellon overcame, according to Natalie Wallder, Asia-Pacific head of collateral management at BNY Mellon Markets.
“There are a number of challenging market infrastructure requirements that need to be satisfied to allow collateral to be allocated between clients on a transfer-of-title basis,” Wallder says. “In addition, Stock Connect assets are required to be held in a segregated custody account. To overcome this, we set up a pledge structure for Stock Connect tri-party programmes allowing the transfer of security interest, while respecting mainland Chinese regulations.”
There are a number of challenging market infrastructure requirements that need to be satisfied to allow collateral to be allocated between clients on a transfer-of-title basis
Natalie Wallder, BNY Mellon Markets
Two further areas were required to be addressed. Firstly, for northbound trading of Stock Connect assets, in the event of default in security interest arrangements, assets need to be sold in the name of the pledgor. Secondly, there is a requirement for pre-sale trade checks to be made before the selling broker can obtain the authority to sell.
BNY Mellon dealt with the presales check issue by setting up a segregated account custody arrangement with its sub-custodian, while an event-of-default solution was structured in conjunction with Pershing, a BNY Mellon company, as the execution entity in such situations.
“Pershing provides a bespoke execution service selling Stock Connect assets upon instruction. At which point, assets are sold in the market with the proceeds routed to BNY Mellon to be repatriated to the non-defaulting party. This allows for a seamless and efficient default scenario,” says Wallder.
MSCI started including A-shares in June. While volumes have been modest so far, Wallder is seeing strong market demand for the product and expects liquidity to grow quickly. “We are confident about the future direction of this market, particularly as the MSCI expands beyond large-cap stocks. In fact, we are already receiving great interest from market participants who are starting to learn about this new opportunity”.
While investors have been exiting emerging market equities, they have been pouring into Chinese stocks, thanks to the MSCI inclusion, according to a report by the Institute of International Finance in September.
Chinese stocks accounted for $5.8 billion of inflows or 82% of all equity inflows in August. So far this year, net flows to China have crossed $92 billion more than reversing the $53 billion outflow during the same period in 2017, the IIF said.
The last 12 months haven’t been solely about China; in February this year, we launched a foreign exchange trading room in Seoul, as part of a strategic move to grow our presence in east Asia, says Wallder.
To further develop its Korea offering, BNY Mellon also launched a Korean Record Date solution, allowing the allocation of Korean equity over record date for their transfer of title solution in Korea. This provides funding efficiencies for clients already using Korean securities as collateral and according to Wallder also makes the market more attractive for firms looking to make more of their existing Korean asset base.
Significantly developing the tri-party Korean product required discussions with the nation’s security depository, which has enabled BNY Mellon to operate tri-party transactions in a more standardised way.
Amid all these initiatives, BNY Mellon’s existing business has continued to grow. Its markets’ global triparty collateral management balances have increased from $730 billion in 2017 to close to $1 trillion of assets, today.