Securities Lending Today

OK ... I'm sorry!

I took a day off yesterday, so spent some time in front of the TV and so my brain is a bit softer today than it was on Tuesday.  On reflection, I think this is revealed below.

I spent a lot of the day watching the testimony of several bank CEOs testifying in front of Parliament in the UK and Congress in the US.  The majority of the British politicians looked like rude buffoons.  One of them alleged that RBS and Lloyds had swindled the Chancellor - Alistair Darling. It’s nice to know that he thinks so highly of his fellow Labour party member.  

The questions from the Congressional Committee involved a lot of raising and lowering of hands, some wishes for everyone to work together to make things better, and a couple of monologues admonishing the banks and wishing them dire legal problems in the future.  At one point, a Congressman asked a question and I am pretty certain the CEO's didn't have any idea what it meant.  I replayed the question three times and I couldnt figure out what he was asking.  It was funny.  Well, funny for me because I didn't have to answer.  It seems the questionners all wanted apologies from the banks and only a very few on either side of the water were looking for lessons on how to avoid similar issues in the future.  Just a small note that the CEO of Abbey National (a UK subsidiary of Banco Santander) Mr.Antonio Horta-Osorio gave a couple of really interesting insights into Spanish banking regulations that bear further investigation. 

So, from my point of view it was a complete PR exercise and a waste of time for most, if not everyone involved.  Hands up anyone who agrees. And the media love bashing the banks.  I don’t get how everyone keeps lumping the performance of all banks together as if they are all the same.  If you want to see how a small issue can get blown out of all proportion as it becomes more public, check out this video (the word "porno" is used a few times.  No porn is shown.).

One of Gordo-the-World-Saver’s pets had to resign from the Vice-Chair of the FSA due to the allegation that he sacked the guy who told him HBOS was expanding too rapidly.  During my time at Nomura I worked for a period under Nick the Greek.  One of the things Nick made us do was to periodically shut down a major part of our book in order to demonstrate that we were able to do that without disrupting our funding.  Further, he also limited our ability to borrow stock from one of our clients who would lend to us for a low fee on an uncollateralised basis.  Essentially we could borrow from this client for normal shorting, but also borrow and raise cash.  A really, really nice arrangement and we were a tad upset when Nick artificially capped it.  OK, more than a tad.  However, it also meant we weren’t reliant on external sources to keep our bank running.  He was right and if he had been running the funding for HBOS and Northern Crock, they wouldn’t have been in that situation.  Nick, you are missed (by some more than others).

According to a couple of articles last week, Deutsche Bank at the time of writing was the most heavily shorted European bank stock.  That’s just wrong.  Shorting is evil.  Where is BaFin, the FSA, SEC, IOSCO?  Shorting bank stocks is a particularly heinous crime.  OK, shorting  Deutsche specifically is bad … and dumb.  Buy Deutsche.  Now.  (Disclosure:  the author has REUs that are coming due later in the year, but I am not letting this influence my recommendation here.  What’s an REU?  Don’t ask.  Apparently investments can go down as well as up.  That's not fair either.)

Four Guidelines for the Future

I am pleased to include the presentation that Mark Faulkner of DataExplorers gave at the IMN Conference last week.  After moderating the Industry Leaders panel, Mark gave quite a performance, storming through this PowerPoint: "The Future of Our Industry" at rapid-fire pace.  It set an excellent framework for the conference and I just wanted to reinforce and comment on some of his summary slides.  You can access the presentation here: Download MCF IMN

It's not the end of the world as we know it
However, it is a signal that some things need to change.  Beneficial Owners last week were crying out for more education.  Many felt that they didn't understand the risks in the business as well as they should have, and wanted/needed to know more.  It's up to the industry at all levels to improve that process.  In addition to the obvious cash reinvestment discussions, education must include indemnifications: what they cover and how they vary by provider.  Honest cash versus non-cash collateral discussions are essential.  I recently coined the phrase "Cash is King, but Correlation is Critical" in a recent videocast for Global Custodian Magazine.  I, along with others in Europe have been pushing non-cash collateral as an important feature for lenders in attracting borrowing demand and as a critical risk management tool for them.  It has never been more obvious or more important.  I gave a presentation to the Department of Labor in Washington more than a decade ago at the invitation of the RMA that covered non-cash as part of that. 

Don't bury your head in the sand
Demand explanations, be challenging to your providers and market counterparties and search out alternatives.  Understand where you are and where you want to be.  My feeling is that a lot of people last week are crossing their fingers and hoping they can ride it out and with a bit of luck avoid problems. That isn't a strategy for long-term success.

You are not prisoners
I had a number of conversations with people (including other consultants) before going to Arizona, then at the conference and since the event.  Many people feel they are trapped in their programs and are forced to carry on as before.  While it may not be simple or straightforward to make changes, and it may not be possible for most or all your program, there are things you can do to alter your profile and risk.  Again, talk to your providers first, and think outside the box.

This is serious not fatal
Sure, changes need to be made, and there are definitely casualties - with no doubt more to come.  Yet the industry has survived because it is a critical part of the capital markets.  Short selling goes back hundreds of years and (unsuccessful) regulatory short selling bans stretch back almost as far.  Despite the temporary actions of regulators and hysteria of the uninformed scare-mongerers and media hounds, the markets need securities lending and it seems that proper deliberations are replacing the knee-jerk responses of the past nine months.

However, the capital markets don't necessarily need a securities lending business that looks exactly as it did in 2006.  The time for change is now, and it is most likely to come in small changes in practice and procedure and the industry will be changed in aggregate in a way that won't necessarily be clear until we look back in future. 

Many pundits who were predicting an upswing in the stock markets for the second half of 2009 are now pushing that back into 2010.  It will be interesting to see how things stand from a securities lending point of view when we look back from the IMN 2010 conference. 

Initial comments on IMN Conference

I got back from Arizona mid-day yesterday, just in time to shower, change and head to an event entitled "The future of short selling and stock lending".  Today I am spending the day on some personal matters so have snuck out of my lawyer's offices for a few minutes so can't go into anything in great detail, but I wanted to give you some initial thoughts on the conference.

The attendance was fantastic, and I was really surprised.  It's estimated that there were somewhere in the region of 375 attendee which is amazing in the current environment.  That deserves an A+ rating!

Closed-door Beneficial Owners only sessions are a feature of this event.  Being closed-door, I couldn't get in.  That's too bad because that is where the real issues were raised.  More comfortable for the industry participants, but I think that's not so good for the industry.  If, at the time of the greatest turmoil this business has seen, we can't openly debate with, and challenge each other at an industry event, then we have lost a golden opportunity to move things forward.  The questions may have been relayed to the session moderators, but the emotion and context can never be replicated.  The IMN Edinburgh conference delivered more open debate as did the recent GSL event in London.  Still, I spoke with more than a few Beneficial Owners who felt they got real value from the closed-door sessions, and since it is billed as a Beneficial Owners' event, I guess that's the key benchmark.

The networking social side of any of these conferences is critical and I believe this event delivered on that front as well.  Great locations help and I love Scottsdale, although I didn't get a chance to experience it this time.

Key themes of the event that I will develop over the coming days in the blog are as follows:

• Back to Basics
• A focus on intrinsic value
• Cash collateral
• Education, Education, Education
• Indemnifications

The best question I heard a panel member ask their fellow panel members and the audience as a whole:
"If you all thought that Lehman was going downhill for a period of time, why did I still have exposure to them when they defaulted?"  Not surprisingly, no one answered ... Drexel unwound across the market, we unwound our business in the final spiral of Yamaichi, we cut down to virtually nothing with Barings .... Why was it different with Lehman?  The best private response I heard from someone was that it was a judgement call that Lehman would be bailed out.  That seems like an entirely reasonable bet to me, but in the end turned out wrong.  Whether it is the US government reconsidering it's decision to let it go, or market participants hoping it would be protected, I wonder who would be wishing they took a different view?

If you have any comments you want to make privately or pulbicly, just email me.

Have a great weekend and I'll post at you soon.  

Happy Groundhog Day!

Conference
This week I am at the IMN Beneficial Owners Securities Lending and Repo Summit in Arizona.  In addition to the amazing conference ahead of me, London is experiencing the worst snowfall in 20 years. A real picture from my garden this morning:

My day starts with a 6.30 breakfast meeting (good thing I couldn’t really sleep Sunday night).  I wanted to give you an idea of which panel session I am really looking forward to, but I can’t really say which one.  I am seriously interested in every session.  The day starts with the Industry Leaders’ Roundtable reviewing events in 2008.  Other Subjects in clued Counterparty Risk, Cash Collateral Reinvestment, Risk Management, Short Sales … See what I mean!

Central Counterparty (continued)
It seems like my Central Counterparty story was pretty timely.  Natasha de Teran has written an important article on the subject in today's Financial News. In it Natasha outlines the significant and growing stresses between clearing members and clearing houses.  In light of the likely first steps of the securities lending industry into this universe, it is surely important that we all become more familiar with the issues.  Natasha’s article is a great place to start.  If you are new to the clearing and central counterparty subject, this video interview with Alberto Pravettoni from LCH.Clearnet is a good starting point. Further, this weekend The Observer reported that my old stomping grounds ICAP was considering spearheading a consortium bid for LCH.Cleanet which itself is already under bid at the moment from DTCC. All this because I didn't mention their name in last week's article? (LOL)

Spitalfields Advisors - Securities Lending Yearbook
Securities Lending Yearbook  I haven’t had a chance to read it yet, but in addition to the country updates, there are a few Feature Articles that look very interesting.  And to top it all off – it’s FREE to download.  So go to the Spitalfields Advisors website and download it today!

That's it for today, but stay tuned over the coming days for a conference update.