Ongoing volatility and rising interest rates have given U.S. exchange-traded products the opportunity to prove themselves useful in remote corners of the financial markets.
After a surge in 2021, securities-lending revenue for ETPs has continued to climb, according to S&P Global Market Intelligence, even as headline flows have abated. Additionally, short-term Treasury exchange-traded funds are also being used as collateral in both the securities finance market and meeting margin requirements.
"The increasing interest-rate environment has provided numerous opportunities for borrowers, as both bond and equity prices have declined over the year," said Matt Chessum, director, securities finance at S&P Global Market Intelligence in London.
"Sourcing either long or short exposure via ETFs through the securities finance markets is definitely a growing trend. On-loan balances, lending fees and lender revenues continue to grow year on year."
Revenue is up 41% year over year, according to S&P. Meanwhile, net inflows to ETFs has slowed down, totaling $565 billion through the first week of December, compared with $900 billion for the full calendar year 2021, according to ETF.com Through October, ETFs have generated $736 million in revenue for lenders, with $631 million, or 86%, linked to Americas ETFs (primarily U.S.), according to S&P.
"Interest in ETFs increased substantially throughout 2022," Mr. Chessum said. Borrowing activity is up 23% this year, with monthly on-loan balances averaging $113 billion. "The size of the lending market is usually a function of the ETF market generally, but borrowing activity has increased at a time when market valuations have fallen significantly," Mr. Chessum said.
The $18.8 billion iShares iBoxx High Yield Corporate Bond ETF generated $99 million in revenue for lenders through October, followed by $30 million for the $37.7 billion iShares iBoxx Investment Grade Corporate Bond ETF and $28 million for the $4.1 billion Invesco Senior Loan ETF. The heavily traded SPDR S&P 500 ETF generated $26.5 million, while the high-conviction Ark Innovation ETF brought in $26 million, according to S&P data.
"Over the last six months, we're seeing a lot more specials in the ETF market," said Keith Wright, managing director and head of equity finance at Mirae Asset Securities (USA) Inc. in New York. "One stock can pull an ETF from general collateral to special."
"Specials" indicate harder-to-borrow securities that can generate a higher fee for the lender — and cost the borrower more.
Usually few ETFs earn that designation due to the usual ease and low cost of creating and lending new shares of an ETF to meet demand. Rising interest rates, however, has made balance sheet financing more expensive for ETF traders and market makers, pushing them into the loan market when they may have previously considered a creation transaction.
For ETF managers themselves, more expensive dealer balance sheets can offer opportunity, according to Bryce Doty, senior vice president and senior portfolio manager at Sit Investment Associates Inc., in Minneapolis.
"As their cost to finance goes up, it drops dealers out of the competition to bid against me," said Mr. Doty, who manages the $124 million ETFMG Sit Ultra Short ETF.
