Stock Lending Today - An Industry Under Siege!

Letter from Australia

Australia was one of the first countries to go nuclear over short selling, and you have to agree it must be a tough place to be part of the securities lending industry this year.  I am fortunate to receive a lot of comments from readers of Stock Lending Today around the world  The Feejit map in the sidebar shows where recent readers are based.  One person has regularly sent me comments and I recently felt compelled to ask for a view from the home market.  Here is the commentary with no changes from me, other than the connection to Daniel Liptak.  The author is not Daniel, who by the way has made considerable contributions to the Securities Lending Traders Network group on LinkedIn in his short time as a member.  Enjoy the read and if you have comments, I will pass them to the author.

" When I first arrived in Australia - many years ago now - my impression was that the country was rather like a teenager. Still in awe of the 'adults', and unsure of its place in the world, but willing to learn, hard working and full of promise. Today, the country has turned into a student; keen on all the latest politically correct causes (and more than happy to lecture everyone else about them), living on dad's credit card (AKA commodities) rather than working for a living, and with not much idea of quite what it's going to do when dad turns the credit off.

And too fond of sport.

OK, that's unfair. On students....and Australia. But dad has turned the credit card off, and the 'powers that be' really don't know what to do.

The first reaction has been to pretend it hasn't happened; "Our economy is sound, and we have the best regulated banks in the world" intoned the Prime Minister, "this is an American problem", etc.

Before, at 4.00pm on a Sunday afternoon, banning all short selling.
"Well, The Australian Securities & Investment Commission ("ASIC") thought it might be a good idea". Over the Sunday barbie, it would appear, with 'Sunday afternoon thought' to the consequences. Come Monday morning, the stock market couldn't open; nobody knew what ASIC meant, and neither did they, it rapidly became apparent. Could CFD writers sell short contracts? What about Exchange Traded Options? Arbitrageurs? In the end so many exceptions were allowed, it takes about a day to read through them. Except for long/short funds, and for almost anybody else trying to hedge risk away in the physical market. Because real Australians don't insure their downside risk, perhaps?

As Daniel Liptak reported in the Hedge Fund Group forum on LinkedIn: " A recent study by Plato Investment Management on the effect of short selling in Australia highlight marked market liquidity decreases. The effect has been to reduce the daily volume of trading in Australia by around half of the impact of a NSW Labour Day Holiday. The authors of the report also found the intra-day volatility and idiosyncratic intra-day volatility have also increased. In summary the effect has been to slow the price discovery process and increased the cost of trading and thus making efficient trading difficult.

In addition many Australian hedge fund managers have reported that the regulatory changes has created other opportunities for establishing similar economic outcomes as short selling. In other words, the illusion for the public is that short selling is banned, whilst in reality other methods to achieve the same outcome are now being employed and the longer short selling bans remain the more that these alternative methods will become the norm."

That worked well then.

Next. Let me ask you a question. You have a commodity based currency, high interest rates compared to the rest of the world giving rise to a massive carry trade exposure, you have highish, and climbing, inflation and you run a large current account deficit. However, on the plus side, your government runs a budget surplus. Do you put interest rates up or down? Bite the bullet and respond with a fiscal stimulus, or adopt the Italian solution, and try to devalue your way out of the problem?

Well, yes, I know these are not normal times, but the impact of the - again unexpectedly -  large cut of 1% in interest rates was about as predictable as Paris Hilton's next home movie. The South Pacific Peso is trading at all time lows against the Yen, and inflation was unexpectedly high in September. Double digit inflation by Christmas?

Then, despite the lack of pressure on the retail deposit base of any Australian bank (just try moving a bank account in Australia, let alone try moving money offshore; the experience is about as easy as filling in your tax returns, and viewed as somehow slightly 'un-Australian', which is about the worst insult in the local lexicon) and despite the fact the country has done quite well with no deposit insurance, why, lo and behold, unlimited deposit insurance on all bank accounts! Paris Hilton time again. The entirely rational response of Australians has been to cash in their fixed income managed funds - particularly the mortgage funds that supplied a sizable chunk of the country's mortgage funding - and pile into bank deposits. Frozen managed funds all round, retirees unable to get to the money they live on, and pressure on a mortgage industry that hadn't experienced serious funding problems. Just as well the housing market is also doing led balloon impressions.....

Anonymous. The author holds no shares in anything going upwards, wishes he had a bank deposit worth the guarantee and lives in a box.  "

ENJOY YOUR WEEKEND!

Sorry ...

I was at a funeral yesterday so didn't get to post.  I have lots of stuff on today and tomorrow so I don't have time to do anything today or tomorrow.  Come back Monday.  Please.  All will be revealed. 

I have a guest blog that is being written at the moment and I hope to include some feedback from a couple of hedge fund managers on the impact of the changed environment.  I really think it will be worth the wait for you.

No post from me today

Our thoughts are with my good friend Hugh and his family.  You'll be missed.

It's the Prime Brokers Now!

I have included below an excerpt from Peston’s Picks, the blog written by Robert Peston of the BBC.

Read it and form your own opinion, but I think he is looking at a number of concurrent events and (mistakenly) trying to create direct cause and effect links that don’t exist.  Or am I reading it wrong?

Mr Peston suggests that the Ukraine and Hungary are victims of the current environment of deleveraging, a lack of credit availability, and plummeting share prices, that was caused “to a large extent, by an unprecedented shrinkage in the prime brokerage industry”.  

Two trends undoubtedly exist:

• Deleveraging across banks, fund of funds managers, hedge funds and yes, prime brokerage businesses is having a substantial impact on the markets;
• Credit seems to be only available to those that don’t need it, and even then is only grudgingly given, and at exorbitant prices;

The question arises as to how much of the deleveraging is being driven by the direct business contraction of the prime brokers as Mr Peston suggests and how much is due to other reasons?

The feedback I get is that while the investment banks clearly have been trying to reduce balance sheets for the past year, there are two more important factors.  First is simply a lack of trading opportunities that require leverage in the first instance.  This is evidenced by the huge pools of cash that many hedge funds have been sitting on for much of this year.  If you can’t spend your free cash, you don’t need leverage.  Second, many investors have been disappointed with the performance of their alternative investments.  Investors go into alternatives for two reasons:  one is for absolute returns and the second is to get returns that have low correlation with their traditional investment portfolios.  Despite the fact that hedge funds as a group have outperformed most, if not all, market indices, disappointment abounds.  Further, many judge that alternatives have also failed on the diversification issue as well.  Simply put, their traditional funds have gone down, and so have their hedge fund investments, so investors haven’t really gained any risk reduction by adding the alternatives.

I think that the contraction of the PB business is part of the overall credit crunch/liquidity crisis, but I think it is too much of a leap for Mr Peston to write that the current market environment is caused to a large extent by PB business shrinkage.

Where I do agree wholeheartedly is with his final paragraph.  Governments can't meddle in markets without causing unintended consquences.  That is why they should stay out.

Agree/Disagree – Tell me what you think!

" Ukraine and Hungary are trapped in the vice of the last phase of deleveraging, or the reduction in credit being provided by banks and other investors, and the decline in the real economy.

As for this most recent phase of the withdrawal of credit, which has caused financial crises for a series of emerging economies in eastern Europe, Asia and South America (see "Now there are runs on countries") and also global falls in share prices, it was in a way wholly foreseeable.

It was caused, to a large extent, by an exceptional and unprecedented shrinkage in the prime brokerage industry, which in turn led to a serious reduction in the volume of credit extended to hedge funds, which in turn forced hedge funds to sell assets, especially those perceived as higher risk.

This contraction in loans provide through prime brokers was the inevitable consequence of the collapse of Lehman, but also - far more importantly - of the recent conversion into banks of Morgan Stanley and Goldman Sachs.

Morgan Stanley and Goldman are - by far - the biggest prime brokers, with Morgan Stanley the number one.

But as banks, they're prevented by regulators from lending as much relative to their capital resources as they had been as securities firms.

So the US authorities should have known - and presumably did know - that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

Which, as if you needed telling, only goes to show that regulatory intervention carried out with the best of intentions can have consequences that - in the short term at least - can be very painful. "

Monday Markets - ugly, ugly, ugly

Japan hits its lowest level in more than a quarter of a century.  Europe is down across the board, hitting 5 1/2 year lows.  US futures are indicating a down market of around 2% in the US on opening.  On Friday though, futures trading was actually stopped for limit down trading.  In the actual event, it wasn't as bad as the futures showed. Whats a few percent between friends.   The real money has only been there in the opening hour and the last hour of trading in New York.  Check out these two charts from an article by Zubin Jelveh in Portfolio.com.  Shocking.  Click on the charts for a larger size pop up.  The both show just how volatile the opening and closing hours have become.  You really just need to wait until the closing hour and then run with the momentum.  Stay away for the rest of the day.  Or not.

So that shows the shocking volatility is the US.  What is happening to performance elsewhere in the world?  This is unbelievable, and I picked it up from Obsidian Wings. 

"Markets down more than 70%:

Vietnam (-70.5%),

Peru (-73.2%),

Ireland (-73.4%),

Russia Iceland (-88.7%). (-73.9%),

Markets down between 60% and 70%:

Hong Kong (-60.1%),

Poland (-62.6%),

China (-69.8%).

Markets down between 50% and 60%:

South Korea (-54.5%),

Italy (-55.2%),

Egypt (-56.9%),

Brazil (-57.2%),

Japan (-58.1%),

Singapore (-58.2%),

Turkey (-58.5%),

India (-58.3%)."

Despite the doom and gloom, there will always be someone who thinks there are opportunities and here is one that says the "Attractive Stock Valuations Being Created In This Bear Market".  Is this different from the person who said a couple of weeks ago that the risk was being underinvested in equities?

Brace yourself for another week.  I've run out of superlatives.  Hang on ...

I hope to have several items from other contributors this week and next, so watch this space.

P.S.  Go to the sidebar and Vote.  I want to know how you are feeling!  Are you bullish because we've hit the bottom, or are you thinking about careers outside the investment markets?

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