Stock Lending Today - An Industry Under Siege!

World Federation of Exchanges - IOMA/IOCA Annual Conference

i am just back from covering the World Federation of Exchanges IOMA/IOCA Annual Conference in Frankfurt.  I was there for Global Custodian Magazine, and this was the first year that the press were allowed to attend. 

For those of you who don't know, the WFE is an association of 51 regulated exchanges from around the world.  IOMA is the International Options Market Association and is a sub-group of WFE that focuses on the derivative markets within the membership.  It was a fascinating event with some very senior people at the conference. You will be able to read about the event more when I put the articles together for GC Magazine.

Why did I go?  The session that captured my interest last week was a session on "Reworking the Principles behind Short-selling". Now you know why I wanted to go, and in addition there was a session on Lehman.  I have mentioned the WFE before, because one of their top three priorities for 2009 is:

"... to help the International Organization of Securities Commissions (IOSCO) set best practices for short selling and securities lending."

The good news is that these words are more than just a trite statement.  I was fortunate to have the opportunity to interview Mr William Brodsky, WFE Chairman and Mr Thomas Krantz, Secretary General of WFE.  I can tell you one thing for certain, these people recognise the fundamental importance of short selling in the marketplace and are doing everything they can to help regulators create sustainable, sensbile rules regarding short selling and securities lending. 

Watch this space and GC Mag for more in the future on WFE.

London Marathon Update

It's only a few days until the London Marathon takes place, and it looks like they will have some greeat weather (maybe even too hot!).  On the right sidebar you can go directly to the sponsorship sites for Bill Foley of JP Morgan and Charlotte Wall from DataExplorers.  "Step up" and support these people and others running the marathon.  Good luck Bill, Charlotte and the others that have contacted me privately and don't want to have their names listed!

One small step for man ... and a giant leap for [stock lending] mankind

I'm really excited about the potential for this announcement, so please stick with this rather long article ... Data Explorers have announced the launch of The Data Explorers Stock Lending Index (“DESLI”) You can access the Index page here http://www.dataexplorers.com/desli 

Maybe it’s not quite that important yet, but it will be.  The value of data is not in having it, but in using it to shape and inform your business.   The securities lending world has undergone a huge transformation from the mid 1990’s when the first tentative steps were taken towards improved transparency in the business.  Improved, who am I kidding – it wasn’t that long ago that transparency was non-existent.  The only information that was shared was done so in bars and at conferences, and possibly skewed by the information giver.  Even then, the best one could hope for was to gather a series of anecdotes and merge them into a wider market view.

Enter the Benchmarkers

For many years Beneficial Owners have required their fund managers to report to benchmarkers on investment performance and employed consultants to oversee and interpret results.  Why should securities lending be different?  The challenge was to convince people that the independent aggregation of data and analysis of their securities lending data would be of benefit to them, and worth the cost and effort.  The Data Explorers dataset covers $14 trillion of inventory in a market they estimate to be valued at roughly $20 trillion.  I guess the intellectual argument has been won then.

The Next Stage in Information Evolution …

for the securities lending business anyway.  Now that it is possible to view your own performance in the context of the wider universe of participants, where do you go from here?  It’s about the whole market stupid!  Whether making tactically or strategic decisions, there is obvious value in knowing what the market is doing and the extent to which that mirrors your own experience.  With the introduction of DESLI, it should now be possible for you to say “How does our business compare to the current trends and what are the implications of these trends for our business now and in future”.

It all sounds good in theory, but I put some questions to Jonathan Morris, COO of Data Explorers.

SLTN:  You estimate that your dataset currently captures approximately 70% of the securities lending market.  What data is missing from your universe?

JM:  We estimate that in addition to the $20 trillion of inventory there is an additional $2 trillion of availability in Exclusives.  This data will soon be available to our customers.  We are bringing on more contributors every day, including domestic lenders.  Broker to broker activity is on our roadmap for early next year.

SLTN:  The index constituents are the top 200 securities based upon the available quantities of each security.  That means that a change in contributors to your product will have an impact to the index itself.  New contributors, or beneficial owners entering or exiting the lending pools of your existing contributors all will have an impact on the data.  How will you deal with these changes?

JM:  New contributors that carry inventory or loans will be added to the programme, however, as these contributors will be relatively small and unlikely to significantly swing the index as it is designed for the largest volume securities.  In the instance that a new contributor does bring a significant volume to the index we will re-base the index back to the start date and let our customers know.

SLTN:  How frequently is the data collected and available?  Is back testing available?

JM:  The data is collected and compiled every day.  There are different options for reporting and we will work with customers to identify their needs.

If a customer is a securities lending or investment management professional they can have access to all of the underlying data as a product or data feed, including 6 years history and per-security data.

SLTN:  What information are you compiling?

JM:  There are two indices – total shares on loan and total inventory available. The constituents are weighted by the proportion of each security value available on the rebalancing date.  Crucially we capture both inventory and loans giving us a clear insight into securities lending as a proxy for short interest. 

SLTN:  What happens to the index in the event of a corporate event – takeover, merger or (gulp!) nationalisation of a stock occurs?

JM:  We will adjust the list of 200 and make a call on whether the security should be excluded from the 200 or replaced.  Again, we will notify our customers in this instance.

SLTN:  The index base is 1 September 2008.  When does rebalancing occur?

JM:   Rebalancing will be by calendar quarter.  We are likely to create a back-history index as well to cover before the 1st of September which work in progress.  We chose 1 September for the launch of the product as it captures some of the interesting movements generated by the recent short selling regulations around the world.

SLTN:  Where there is an index there is a tradable product.  Do you anticipate people launching synthetic products based on the index?

JM:  At this level of abstraction, these indices are more general sentiment indicators.  The underlying data, however, has been proven to be a fantastic opportunity for creating alpha – driven by its timeliness and comprehensiveness.  We are always open to exploratory conversations based on client feedback.

SLTN:  What are you expecting to happen when the SEC ban is removed later this week?

JM:  It will be very interesting to see how the Data Explorers Stock Lending Index behaves over the coming days. The DESLI index shows an increase in stock lending activity globally with a substantial spike in Asia since the recent legislations on short selling. Following the ban on short selling of financial stocks in the US, the volume of loans in the affected sectors dropped by more than 20%; as did the volume of inventory.  The drop in inventory reflects sales of stock by beneficial owners as well as specific decisions to stop lending these stocks.

So there you have it, straight from the vendor’s mouth (kind of).

The index will give the market the most accurate overall view and trend information that we have ever seen.  My experience with statistics is that first you need the data.  Then you have to analyse it, come up with various hypotheses and then test for a reality check.   Several questions will help decide the fate of the index over time.

Can you apply it to your business and can it help you make decisions?  Will this just reinforce what you already know? Is what is happening in the rest of the market relevant to you?   Can I turn this information into a profit?  Or a cost savings? Or a risk reduction?   Will this help you allocate your scarce resources more cleverly?  Is it tactical or strategic or subject to dramatic and immediate changes that it is interesting but not useful?

These questions and more will decide the future of the index.  It is obvious that the more lending activity that is in there, the better.  I think exclusives have an important impact on the market and believe that domestic to domestic activity is huge and relevant. 

Ten years ago, only the true believers and first movers would have expected to see this much securities lending data held in one place.  I can’t see why the other $6 trillion of “missing” assets isn’t being contributed, but I guess they have their reasons. 

And I cannot fathom how you can plan on the future of your business without having information that takes into account the world outside your office doors.