Stock Lending Today - An Industry Under Siege!

"Best Price" in Securities Lending

I got into a discussion with someone last week regarding the “best price” concept as it applies to securities lending.  It would seem to be an obvious and straightforward one, but never has been.  Unlike a straightforward trade execution where the measurement is an absolute price in the context of the day’s trading range, securities lending pricing has other factors that influence the assessment.

While there are overriding risk issues such as legal, tax and operation that apply to stock loans, these are germane to the business and don’t have an influence on individual trade prices for comparative purposes.  Counterparty risk and collateral management are two transaction-specific issues that have a direct impact on the assessment of whether “best price” has been achieved.

Counterparty Risk

Each market participant makes its own decision on the counterparties with which it will trade.  There is no centralised or commonly agreed rating or ranking on counterparties, so it is an individual selection based on the credit analysis and judgement of its trading partners. 

For example, Lender “A” may have a different view than Lender “B” as to the creditworthiness of Borrower “C”.  Except with hindsight, there is no way to determine whether either or both views are correct.

Collateral Management

What is the purpose of collateral in stock loan transactions?  It seems there are two broad approaches. 

One is that collateral is to be used as a safety net in the event of a borrower default.  The collateral is then liquidated and used to repurchase the stocks and bonds that were loaned out to the borrower.  This approach suggests that securities are taken as collateral against securities on loan.   Even here there are differing views.  Some look at “AAA” rated government bonds as the best type of collateral.  To the extent that they are unlikely to default, and are typically very liquid, there is merit to the argument.  The other view is that in line with normal investment criteria, the key is correlation.  That is to say that in order to replace a wide range of securities that are loaned to a given counterparty, the best collateral is to take a diversified portfolio that broadly resembles the securities on loan.  In other words, a portfolio of international equities and bonds is best collateralised by another basket of international equities and bonds.  The values of the portfolio on loan and the collateral portfolio should move in similar directions in terms of total value.

The second approach carries the same underlying purpose of asset replacement protection, but adds in the potential for enhanced returns.  This extra performance is achieved by taking cash collateral which is in turn used to buy money market instruments. In essence, the purchase of additional securities adds an element of leverage to the portfolio and adds incremental risk to the transaction.  Hopefully it also adds additional income.  Since this entails an actual investment transaction, the caveat that prices go up as well as down, and that historical performance is not necessarily a guide to the future is appropriate.  Making this decision requires investigation and analysis to ensure that one understands the pitfalls. 

Summary

Best price is not something that can practically be achieved in the context of a mulit-layer risk transaction like securities lending.  The best anyone can hope for is a meaningful discussion and analysis of revenue attribution and the risks pertain while achieving the income.

Sorry, I wish there was a more straightforward answer.  Do you agree/disagree?  Let me have your comments on this issue.

P.S. 
The Dutch regulator AFM has announced that the short selling ban on financial stocks, including insurers will expire on 1 June.

Free to follow your shorts

We are coming to the end of a number of the temporary short selling bans that regulators around the world put in place amidst the market panic last summer and autumn. Many of the bans were extended beyond their initial expiry date by the authorities. In the past week Greece, South Korea and Australia have all announced the lifting of bans. Australia was the surprise here as they removed the restriction on financials a week early. Several more are due to drop at the end of May or June.

The timing seems to fit quite nicely with the upcoming 34th Annual IOSCO conference that starts 8 June in Tel Aviv. In the closed-door sessions they will be following up on their Report on the Regulation of Short Selling. An IOSCO representative recently told me that once their report is finalised in early June, the non-private comments they received would be up on their site. The World Federation of Exchanges will have their Regulation Committee meeting concurrent with the IOSCO meeting. WFE recently came out with its response that was supportive of the IOSCO recommendations.

I was speaking with a lender earlier today and we were considering where the markets and the securities lending business is going for the rest of the year. We came to the conclusion that the second quarter has been surprisingly solid with the seasonal strength buttressed by a handful of specials, most notably Citibank shares. The rest of the year remains less than clear as credit markets seem to be stabilising, and net hedge fund assets under management still declining, albeit at the slowest level for many months.

The one positive outcome I feel strongly about is that there will be a better environment for short selling. I use the word “better” advisedly. It is meant in the context of clarity and definition rather than necessarily being to the benefit of traders. We saw last year that rules imposed without consideration or discussion can have unintended consequences. The arguments will no doubt continue for some time about up-tick rules, disclosure levels and timeframes and to whom the disclosure should be made. However, it must surely be to the benefit of traders to have a clearly defined set of rules through which they can execute or adjust their strategies.

Securities Lending Changes Ahead!

It’s been quite a week for news with respect to securities lending, so let’s look at a few of the issues.  I will be keeping an eye on each of these developments.

BGI

Last month CVC Capital announced a deal with BGI whereby it would purchase the iShares ETF business.  As I predicted when Barclays first declared it was interested in selling iShares, the deal did not include the securities lending business.  The terms of the deal were another example of Barclays’ excellent management team.  The same firm that refused to up the price when RBS stepped in to outbid them and then walked away from Lehman on the fateful September weekend only to jump back days later to buy the Lehman US business on the cheap, managed to secure a sweet deal with CVC.  The terms of the £3 bn transaction allowed Barclays to continue to search for a higher bidder for iShares for 45 days.  It now seems that there is considerable interest in the larger BGI business that press reports suggest could net as much as $12 billion.  Perhaps the biggest driver in the valuation leading to this huge price increase is the BGI securities lending business.  I'm sure it's gratifying for  BGI securities lending staffers to see their contribution making such a massive difference!

Deutsche buys Dresdner Agency Lending

The third party agency lending business of Dresdner Bank was purchased by Deutsche last week.  There has been a lot of speculation about this deal for a while and while the price has not been disclosed, it looks like a great deal for both sides.  From my conversations with people directly and indirectly involved, I know Deutsche has big plans for this solid veteran team that has successfully challenged other lenders while building their business. 

Does this Rally have Legs?

Not everyone thinks that the market has turned around and many remain sceptical.  Sharon Bell of Goldman Sachs noted last week that the amount of stock on loan in the UK and Ireland has fallen to a 5 year low.  I picked up the chart below from the FT and since they haven’t attributed it to anyone, I am assuming it is their chart.  During the rally the amount of stock borrowed has steadily and consistently declined.  This will mean that there will be little if any support for prices from short covering rallies.
 
Similar data comes from the US.  Short interest as at 30 April showed a continued drop, with NYSE reporting a 3% fall and Nasdaq 3.72% as compared to the previous period at mid-April. 

Greece lifts Short Selling Ban

From 1 June, Greece will allow short selling on the Athens Stock Exchange.  Traders must declare short positions and their broker must disclose and flag that the order is a short sale.  Further, shorts will be subject to an uptick rule that requires the order to be entered at a price higher than the last trade.  Further, short positions that exceed 0.10% of a company’s share float must be disclosed.  Once this threshold is reached, traders are required to report any subsequent changes to regulators.  The stock exchange will publish the short interest on a daily basis for each stock.  This is definitely a step forward, and better than a ban, but it will be interesting to see how traders adapt to the situation.  

P.S.  Final Countdown!

One month from today, the LCH.Clearnet CCP for SecFinex securities lending trades goes live.  I’ll revisit this in the coming days.

Education, Education, Education

The three "E's" seem to be pretty much in demand these days.  There are two upcoming events that you should consider attending.

GSL Summit -  Lending for Liquidity

The securities lending industry is slowly emerging from a sea of turmoil.  Having spent most of the past two years, the size of the business is somewhat smaller, but profitable and largely intact. 

Conference attendees will get a unique insight into a wide spectrum of issues informed by the perspective of many of the industry leading firms.  Commencing with a review of where we are today, speakers and panellists will focus on three key areas:  Short Selling, Beneficial Owner Issues and the Potential Changes Ahead.

Some consider that the pandemonium recently faced by the securities finance industry to be indicative of a business that is broken. Others counter that the industry has coped well with matters largely beyond the control of market participants. 

This is a half day event that is FREE OF CHARGE to registered attendees.

Listen to the speakers, challenge their views and use what you learn to apply in your own business decisions. You can get more information here.

P.S.  I forgot to mention that I am chairing the event and moderating the panel sessions.

Securities Lending and Borrowing Course

Many of the readers of Stock Lending Today are new to the industry and looking for more information.  Indeed, I often get asked about core securities lending training sessions.  I just thought I would let readers know that there is a Securities Lending and Borrowing Course coming up on Tuesday 19th May in London.  The course is provided by Investment Education plc, a leading provider of courses in securities and investments. You can read the course brochure here:

Download Securities Lending & Borrowing courses + Corporate Actions course.

Of course, such events are really dependent on the quality of the instructor.  Course participants will be happy to know the person leading the training session has many years of experience in the business, a wealth of knowledge to share, is kind, good looking, sincere and humble ... and if he can't make it, I guess I will step in.

ISLA / RMA Conference on International Securities Lending

It is now less than 50 days until the 18th Annual ISLA/RMA Conference on International Securities Lending gets started.  This is the key industry event in Europe and the value of attending is reinforced each year.  More importantly, this event comes at a critical time for the industry.  Helpfully, the conference has been moved to June to avoid conflicts with the heavy workloads associated with the month of May when it has historically been held.

The conference captures the big issues in the industry every year and looking at the agenda, it has done so again for this event.  An excellent programme has been arranged, chaired by David Hopton of Santander and including panels on central counterparty, regulation, the repo market, beneficial owners and the Spanish market.  We have panel participants from FSA and CNMV; Michel Stubbe from the European Central Bank will provide an update on its operations; Jim Reid, Credit Strategist at Deutsche, will give a macro look at risk assets and the economy; and Juan Andres Yanes, the Chief Risk Officer of Banco Santander, will give the keynote speech on risk management lessons from the crisis.  The conference will conclude with an industry leaders' panel, moderated by Mark Faulkner of Spitalfields Advisers and including senior executives from BNP Paribas, Citi, Credit Suisse, Deutsche Bank and JP Morgan.  You can see more details by clicking here.

In my view, Barcelona is an ideal location and ISLA/RMA are returning with good cause.  We can’t ignore the current market environment, and to their credit, ISLA/RMA have arranged for a further discount to the Hotel Arts room rates which are now down to €299.  In addition to the conference sessions, networking is an essential part of the event.   Barcelona is easily accessible and this always ensures a good turnout, with this year being no exception.  Despite tight budgets, it is undoubtedly cost effective and sensible to make this one trip to connect with all of your relationships rather than not meet or make individual trips. 

I hope to see you there.