Although the suspension of brokers’ willingness to commit capital to client trades can be traced to the collapse of Lehman Brothers last September, sell-side risk pricing appetite has flowed back at varying paces, depending on factors such as geography and instrument. In some cases, it has also assumed a slightly different character.
In Asia, for example, many global brokers operating in the region brought down the shutters very firmly in Q4 2008, often on instruction from head office in Europe or the US. Moreover, many sales traders were laid off, some of whom tried to resurrect buy-side relationships at ‘eat-what-you-kill’ agency brokerages.
But some transactions rely so heavily on broker facilitation that the window never fully closed. One example is over-the-counter American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) launched by brokers to allow trading of Asian firms’ non-domestic stock within Asian trading hours. Such instruments can be attractive to international buy-side institutions investing in Asia, in part because they avoid stamp duty in markets such as South Korea and Taiwan and can be traded without having to establish the necessary custodian relationships on behalf of global funds that trade only rarely in smaller Asian markets.
Trading the non-exchange ADRs and GDRs of Asian corporates almost by definition requires an element of facilitation by brokers. “Pre-Lehman, there were perhaps a dozen brokers that could facilitate on Asian ADRs and GDRs during Asian hours. Right after the crisis, a number of closed their facilitation books,” a buy-side trader observes.
Despite a general tightening, not all brokers walked away from the market. “Even in the crisis times, there were always some brokers there to offer facilitation,” recalls another buy-sider. “It didn’t disappear altogether but the spreads certainly widened out.” The spread on a very liquid ADR/GDR might have doubled in the months following the Lehman collapse, for example.
But the drought only lasted a month or two. Before the end of last year, all the same brokers were back in the game. And as the market recovered from the March lows, brokers had more appetite for risk. “Whereas they might have only done a $1 million deal on an ADR/GDR, now we can do $3-5 million,” a head of trading at an Asian trading desk comments. “We’re pretty much back in business, back to the peak.”
Aspects of the market have changed, however. In short, brokers are asking more for their risk. Before the events of last September, some brokers would be willing to offer facilitation with only a limited amount of protection for their own position. Now the spread between the discount from the market price offered to the client and the price at which the broker has underwritten the deal is much tighter. “We had got to a point where brokers were under-pricing the risk that they were taking on their own books,” a market participant said.
A further change is that hard underwriting – an absolute guarantee that the client gets the deal away at the agreed price – is less common than a couple of years ago. Nevertheless, despite more stringent risk management, brokers have adapted to ensure liquidity is still available to buy-side clients in this particular market.
To register your vote in our monthly poll on risk pricing, click here