I read a blog post tonight and was going to just comment on the blog, but instead I thought I would turn it into a post of my own. The author of "An old world for Stock Borrowing and Lending", Gary Wright is a securities industry veteran and I usually find his views interesting and thoughtful. This time however, I have to disagree with him.
In Gary's article he suggests that the ESMA regulations and short selling and securities lending "appear to me [Gary] to be an admission that the stock borrowing and lending structure in the UK circa 1985 actually worked extraordinarily well"
I draw a different conclusion from the ESMA short selling regulations. They don’t harken back to the circa 1985 stock lending market, far from it.
I set up my first borrowing desk in London in 1987. I think it is fair to describe the activity in the market at that time as a small but profitable hobby for some with the regulations driven by the Bank of England’s desire to be able to monitor activity in gilts. The fact that equities were equally restricted was a by-product, which if not accidental, certainly wasn’t a priority and while they could have chosen to view which companies had the largest short positions as Gary suggests, typically they were more concerned with gilts and the money markets.
I also have to adamantly challenge the assertion that stock borrowing has “opened the floodgates for market abuse”. Market abuse regulations have been in existence for many years and are continually tightened by regulators. Market abuse can be perpetrated in many forms, but other than the Maxwell fraud – and I do say fraud rather than securities lending - I am unaware that the ability to freely borrow securities as having been the cause of any market abuse. I should also mention that today's day-traders that flatten positions by the end of the day would have loved the market environment Gary refers to - fortnightly settlement gave rise to all kinds of interesting intra-settlement-period trading Gary doesn't discuss.
As Gary correctly points out, the ability to borrow securities was restricted to jobbers and was gifted in order to support the liquidity of markets. This remains a key driver of borrowing demand today. Numerous academic studies point to the negative impact on liquidity that short selling restrictions imposed by regulators in 2008/2009 and again by a tiny handful of regulators last year caused in the marketplace.
Unfortunately what Gary doesn’t point out is that beyond market making activity, investors and traders require the ability to short sell to hedge, take advantage of arbitrage opportunities and yes, even take negative directional views on securities. Restrictions from the mid-80's would reduce the ability to manage risk for some (which probably isn’t Gary's intention) as well as reducing the ability for others to increase risk positions (which appears to be his preference). A market with the borrowing controls of the pre-Big Bang era would mean smaller markets for equities and fixed income as well as derivatives. Securities borrowing is never done for it's own sake, it is virtually always the result of another transaction in cash or derivative instrument.
ESMA recognises the valuable contribution that short selling makes to the marketplace. Their work questions how to ensure that short selling does not disrupt the market process. By enhancing the certainty with which short sellers can obtain and deliver securities – without the draconian controls of the 1985 era Gary refers to – ESMA rightly concentrates on the issues that could otherwise increase systemic risk.
Unfortunately I won’t be able to attend the short selling debate on 22 February as I will be teaching a securities lending course. Will Gary (or whomever) challenge Frank Field on his unsubstantiated comments from a few years ago regarding unauthorised securities lending allegedly being conducted by a custodian in the UK. I was editor at Global Securities Lending Magazine at the time and despite pestering from our end, Mr Field failed to add any more detail and the allegations withered in the wind.
"An old world for Stock Borrowing and Lending" - most certainly not.
