I am writing this as I sit on the plane, on my way to the 18th Annual ISLA/RMA conference on securities lending. I think that I have been to 15 of the 18 events, and I can't recall a more important nexus for the industry.
Hedge funds remain the single most important driver for the growth of the business. Hedge fund data from May have finally shown a turnaround in fortunes for the alternatives industry. Performance is up virtually across the entire spectrum of funds, new investments have exceed redemptions for the first time this year and some sizable new fund launches are in the works. Yet one month's figures do not constitute a trend. In addition to the natural challenge for performance, regulations loom large and ominous for hedge funds around the world. Regulators and politicians in practically every region want more controls, restrictions and reporting. The impact of these forces is hard to predict at this time, but they will have an effect on the business.
On the morning of last year's ISF awards announcements in September, I suggested in my blog that the winners on the borrower side of the survey enjoy the celebrations but the lenders shouldn't take any notice of the rankings. My feeling at the time was that the past winners would perhaps for the first time not be a useful guide to future winners and that there would be a new order arising. I feel pretty good about that prediction. I don't think there is a prime brokerage firm out there that isn't grappling with the after shocks of the Lehman default last year. Numerous hedgies have changed and/or added PBs, and many of the switches involved moving their relationships into the US offices of their PB. The original move to providers based outside the US was to take advantage of more commercially oriented leverage arrangements from non-US offices of the prime brokers. However, given the very low degree of leverage this is no longer an issue, and many funds feel more comfortable dealing with future potential insolvencies in the US as opposed to other jurisdictions. PBs are having to re-examine their service and funding models, coming up with different and innovative solutions for their clients. Any provider that hasn't added any new services, arrangements or features over the past 9 months or isn't working on them now is likely to be left behind by the end of the year.
Agent lenders have been on the firing line for much of the past two years as a result of the credit and liquidity crisis that has hit the cash reinvestment side of the business. The core challenge for these agents has been less about the selection of investments and more about their ability to keep the pools funded in a shrinking market. Forced sales generally have unfortunate outcomes. Agents who predominantly lend against non-cash collateral have had a growth spurt in business as their clients haven't had cash reinvestment losses and the collateral profile is attractive to the majority of borrowers. The debate about the purpose of collateral - safety net or alpha generator - is surprisingly still in its infancy. Borrowing demand is down from peak levels a couple of years ago so lenders have to work harder just to stand still.
Beneficial Owners that participated in cash programmes ... Hmmm. Are they the victims in the cash reinvestment story or willing participants until the tide turned against them? Have they been ill-educated and uninformed by their service providers or were they only interested in the bottom line? "Securities lending in five minutes a month!" Which Ben Owner wants to admit to this approach these days? For those funds that took non-cash collateral, they missed the best of the returns generated by their cash-oriented brethren, and with market volumes down are no doubt well off their best revenue years. I suspect however that this is the group that feels least stressed (depending on how much business they did with Lehman and the type of business).
Further, the issue of electronic trading and central counterparty is finally real rather than an abstract idea for the future. The question here seems to be more an issue of those fighting for the status quo rather than considering whether CCP is a valuable part of the future of the business. Indeed, individual firms have their own best interests in mind in their actions. However, a number of the arguments made against CCPs don't bear up under scrutiny. Typically it is regulators that are tasked with determining what is best for the wider markets. I'm not sure this an issue the stock loan industry wants to leave solely in the control of the regulators.
Finally, the subject of short selling has never had so much focus as it has over the past twelve months. Securities regulators, politicians, church hierarchy, day traders, pensioners, corner shop owners and cab drivers have all been given time to air their views, happily accommodated by a media fueled by frenzy. We have almost emerged from the fog of fear and a more considered and thought-out regime will likely result over the coming months - although it is likely to be different on a country-by-country basis.
All in all, we see a securities lending business that is still huge, and recognised as a cornerstone of the capital markets. But we also see an industry that is dealing with important fundamental issues that will shape the market for years to come. What that final shape will look like however, is yet to be determined.
Should be an interesting conference.
(A long post - hope you made it to the end. See what happens when the flight is delayed and I have too much time on my hands.)
