Stock Lending Today - An Industry Under Siege!

Central Counterparty – Part One

I see more press releases about new central counterparty launches for securities lending than there are bank bailouts and re-bailouts, so I thought that it was about time I started to discuss the subject here.
I say “start” to discuss, because despite all the announcements it is still very early days.  At this point in time, there are no live central counterparties (“CCP”) for securities lending activity that I am aware of, but within the next six to nine months there could be a flurry of activity in the space.  There have been various combined announcements from (at least) SecFinex, LCH Clearnet, Euro CCP, SIX x-clear, Quadriserv, OCC, DTCC, LendEx (apologies for missing it the first time) Clearstream and Eurex Clearing.  Let me know if I’ve missed any. 
In this post, I just want to highlight what I believe the potential benefits to be, and will use this in future as a benchmark as to their success.  I will return over the course of the coming months as to how the various CCP arrangements measure up against these criteria. 

What benefits could a CCP provide?
•    Counterparty risk reduction
•    Capital charge reduction
•    Increased reach to a wider universe of counterparties
•    Administrative benefits

There are questions that remain and here are some of the key ones from my point of view.
•    What will the impact be on revenues?  There is potential for negative revenue impact due to a more level playing field and reduced cash reinvestments versus the substantial positive effect of reaching out to a much wider universe of counterparties
•    Will benefits accrue to all market participants?  Not all firms have capital constraints.  Additionally, some existing lending arrangements would need to be changed to accept delivery versus payment instead one day pre-pay.
•    Can the CCPs provide the functionality they promise?  Issues in cross-border trading such as dividend processing are critical to the equation.
•    Will the increased operational burden be offset by the potential efficiencies CCPs bring?  For the foreseeable future, only a portion of any firm’s business will be processed through CCPs.  This will mean an additional operational process for each CCP market.  Will the extra effort be offset by financial (capital reduction and collateral efficiency), risk (counterparty risk reduction) and other operational benefits?
•    What volume of business will be required before firms start to realise the advantages of CCPs?

The success of CCPs will be based on the answers to three questions:
1.    Do the CCPs deliver the promised functionality and benefits?
2.    Are the benefits substantial and wide-ranging enough to be attractive to a significant proportion of the market?
3.    Will the securities lending industry embrace change and actively support the development of CCPs?

I have a little sign over my desk that says the following:

“Coming up with new ideas isn’t the issue.  The challenge lies in letting go of the old ideas”.  

Watch for Central Counterparties Parts Two, Three, etc … in the coming weeks and months.  I’m really interested in your thoughts on this subject.

Have a great weekend, and I will be writing to you next from sunny Scottsdale at the IMN 15th Annual Beneficial Owners Securities Lending and Repo Summit.  DON'T MISS IT - I hope to see you there.  If you haven’t registered yet – there is still time, but don't delay.

The battle continues

Many apologies, as it has been almost two weeks since my last post.  I will do my best to avoid delays like this in the future. 

Banking problems are continuing.  Gordon Brown, having announced last year that he had “saved the world”, uhhh… “saved the UK banks” … had to save them again last week.  Well, at least those banks that wanted or needed his money.  Not all of them did, and a couple were pretty adamant about not taking his coin.

Today a number of prominent hedge fund managers will be appearing in front of a parliamentary panel to answer questions for MPs.  Chris Hohn of The Childrens Investment Fund (TCI) and Paul Marshall, chairman of Marshall Wace are amongst the “guests”.  Short selling is top of the agenda.  The committee is being chaired by John McFall, a Labour MP who doesn’t like short selling.  It will be interesting so see the fireworks.

Want to know why Mr McFall is concerned?  Check out this graphic on bank capital.  I saw it on the daily repo commentary from Jeff Kidwell of  AVM LP.  Jeff credited JP Morgan and Bloomberg for the chart.  I am speechless.

There has been amazing volatility in UK bank stocks in January so far, and of course the short selling ban expired on 16 January.  Unsurprisingly, short activity has risen in virtually all the bank shares, but check out the share price performance of the banks since the 16th.  I’ll let you look up the charts yourself to make it interesting for you.

Fortunately many politicians and bankers will have time for skiing discussion this week at the World Economic Forum in Davos Switzerland.  Don't worry, they'll work everything out and it will be fine next week when everyone is back.

IMN Arizona Conference

I am thrilled that I will be attending the IMN Beneficial Owners Securities Lending and Repo Summit next week.  The European version was held in Edinburgh last year not long after Lehman, It was a great opportunity to meet with people in the midst of the post-default clean-up operation.

Arizona will be even better.  I expect it to be the highlight of the conference calendar this year.  I think it is safe to say that this is a critical juncture in the credit cycle.  Never before has there been a securities lending gathering at a time of such system stress and confluence of important events.  There will be some people that have experienced losses, many who are concerned about potential losses and numerous providers that have done their best to manage the inherent risks in the business.  If I was only going to one conference this year, this would be the one.

I am covering the event for Global Custodian Magazine and am interested in meeting anyone that has an opinion or concern and wants to share it with me.  Either on the record or off the record.  I’ll be there from Sunday to Wednesday.   Drop me an  email and I’d be happy to meet.

Videocasts

Today I am taping the third of my weekly broadcasts about Securities Lending for Global Custodian Magazine.  Today I will be covering some of the issues surrounding being a winner in securities lending in 2009.   Remember that the objective is not to teach securities lending market professionals about the business, but to reach out to beneficial owners and those not directly involved on a daily basis.  Look for it at the end of the week.  (I am getting better at it – I hope!) 

The End of the Beginning?

I’ve stolen the title of today’s post from the GSL Summit that was held yesterday.  The timing of yesterday’s conference was meant to coincide with the expiry of the ban on short selling UK financial stocks. Before Christmas there was huge pressure from some politicians for the FSA to extend the UK ban, and I am pretty certain that when a number of European countries announced extensions to their own 31 December expiry dates, the people at GSL must have been more than a little bit nervous. 

However, in the end, the FSA held their nerve and stood up to the clearly unwarranted hype and the restrictions in the UK do indeed expire tonight.  Interestingly, the Swiss announced yesterday that they too are following suit and lifting their ban tonight.  Still, there is little consistency amongst regulators as the Dutch AFM announced yesterday they will be extending their restrictions until the end of February.  That puts the Dutch in the same camp as France, Germany and some others.

Why do I say unwarranted hype?  All the evidence shows that short selling UK financials has more to do with the fundamentals of the bank stocks and market environment than it does with short selling.  Click on the chart of the FTSE 350 Bank sector and it will open a new tab.  Looks like the ban worked!  NOT.

GSL Summit
Getting back to the GSL Summit – what a turnout!  It looks like there were about 170 attendees there yesterday.  I think there was some interesting and valuable discussion, but as can often be the case, the real value is in the networking and private conversation before and after the event and during the coffee breaks.  Hopefully similar events will follow.

It was a really meaningful event, hats off to GSL.  They taped the event and I have asked for more information on when and how the video will be released.  I’ll keep you posted.

Global Custodian Multimedia
While we are on the subject of video … this week marks the first in a series of videocasts that I am doing in conjunction with Global Custodian Magazine.  I have known Dominic Hobson, the Executive Editor for many years and in my opinion it is the finest magazine of its kind.  They have been expanding their reach into multimedia for some time and I jumped at the opportunity to help this growth.  I jumped until I realised that video is a different medium than I am accustomed to.

If you are not familiar with the magazine, please take a few minutes to look at the Global Custodian website and then if you want to laugh at an amateur, please watch my video by clicking here.  Look for it weekly!  They say that blogs are all about content.  I would ask that you judge the video on content, not my impersonation of a news reader!  Be kind.  Or not as the case of a number of you who have already contacted me!  LOL

Have a great weekend.

UK Banks

To short or not to short - that is the question!

A little bit more on short selling financials in the UK.  One reader sent in this article from Investors Chronicle.   The point is made that the fundamentals of the banks lead to a continuing decline even (32% decline since the ban) without the ability for traders to short sell, so why would the reintroduction lead to a flood of short sales?

 

Sector or industry challenges and asset quality declines are two key considerations for fundamental short sellers. Clearly the financial sector still is an industry that is truly under siege and asset quality isn’t improving.  UK banks would seem to be good short candidates here.

Look next at the bank short data from Short Stories earlier in the week.   They examine the shares on loan for Barclays (3% of outstanding shares on loan), HBOS (4.47%) and Lloyds (1.19%).   These are all down significantly since the ban came into effect, so presumably there is room to add more shorts as there is substantial stock available for loan.

 Take all of these together and it looks like there will be scope for some shorts to get added.  I have no doubt that shorting will increase, but I believe the rise might be offset by the risk/reward scenario.  Continuing with the Barclays, HBOS and Lloyds examples, they currently trade at the following levels:  Barclays175.50p, HBOS 74.3p and Lloyds 126.60.  I’m not convinced there is a huge amount of long term potential in shorting these stocks, but no doubt people will jump when things open up again on Monday.

Dr Doom Returns

You really need to listen to the interview with Marc Faber on Bloomberg.  A really interesting guy who has been gloomy - and correct - for so long, that you need to hear his opinions.  And anyone that is completely against government intervention can't be all bad.

More short coverage

Short selling ban

Now that the FSA have announced plans to restore the UK to normal market status with the lifting of the short sale ban on financials, the commentary has begun.  Is it good or bad, does it add liquidity or is it morally questionable?

The Financial Times covers the subject as its main headline today:  "FSA to end shorting ban".  One very odd comment is attributed to Jonathan Weetman, an analyst at Royal Bank of Scotland.  He is quote as saying:

“[This is} bad news for bank share prices for those who believe our view that the domestic UK banks have further to fall”. 

RBS is saying that UK bank shares are likely to fall.  OK, that’s their view.  He doesn’t say that bank shares will fall because of short selling, just that they are likely to drop.  Let’s remember to point that out to the media when they blame short sellers for bank share price drops in the near future.  You know it will come, don’t you?   There is pent up demand building in anticipation of the expiry of the ban and shorts will follow.

The article doesn’t go into why the analyst thinks the removal of the ban is bad news.  Will the shares fall more quickly to get to RBS’ view of fair value?  Is that in itself bad?  Will the shares go through the level RBS thinks is correct?  What makes their number correct?  Why did the FT have this quote in a separately highlighted box in the middle of the page?  

On BBC Radio 4 this morning, Andrew Baker, deputy CEO of the Alternative Investment Management Association and Vince Cable the treasury spokesman for the Liberal Democrat party in the UK were interviewed about the short selling ban. Unsurprisingly Mr Cable is not keen on having the restrictions lifted.  He seems to think that traders will have free rein to gamble with the public’s money by recklessly short selling the bank shares.  First, RBS – part owned by the government - thinks the bank shares will go down as noted above.  Second, he refers to properly run companies that are unfairly targeted by short sellers.  He is a trained economist, so I’m quite surprised he can refer to the overleveraged and overextended banks that have needed bailouts as being properly run.   Third, he was the first politician to come out in favour of nationalising the banks.    Finally, the traders are gambling with their own money and if the investment community thinks they are wrong about the value of the banks, the traders will lose money.  If the market thinks the traders are right, it is manipulative for the regulators or politicians to intervene.  I haven’t heard of any bailout plans for hedge funds, but who knows, the year is early!

GSL Summit

I’m speaking at the GSL Event next week and we are doing the preparation work for the panel I am sitting on.  Our subject is “Risk”.  Fairly wide open with lots of scope for discussion.  If you have any suggestions on risk issues you would like me to raise, just email me roy@stocklendingtoday.com