Stock Lending Today - An Industry Under Siege!

Shuffling Securities Services Players Continues

I’ve mentioned before the dramatic leveling of the playing field in prime brokerage.  New entrants, new alliances and product combinations are all having an impact or may do so in the coming months.  Looking at the same issue from a different angle we can see increasing influence from a geographic perspective.  Canadian banks seem to have weathered the financial market turmoil better than banks in most countries.  Comments on these banks inevitably include positive endorsements on balance sheet, capital strength and counterparty strength.  I like to think that RBC and CIBC were both put into stronger positions as a result of my combined 7 years working for them in the 1980's.

The news last week that Bank of Montreal (BMO) had purchased Paloma Securities is just the latest example of the increasing footprint of the Canadian banks in the securities finance business.  This past year saw the six Canadian banks’ prime brokerage businesses all receive an increasing number of responses in the Global Custodian Prime Brokerage Survey.   Some are newer entrants to prime brokerage or at the smaller end (think National Bank and CIBC) whereas RBC, Scotia and TD have been part of the business for a longer period of time. BMO’s purchase will undoubtedly help improve some of their weaker scores in the securities lending space and aid their effort in growing the PB business.

CIBC Mellon and RBC Dexia are both long established global custodian banks, although both represent evolutionary developments from predecessor businesses.  A few months ago, Scotiabank dove into the Wachovia organisation and scooped up six senior executives to help it create an agency lending product.  In the repo space, TD has been a new entrant into the space in New York this year, filling an obvious gap in their product range.

Compare the Canadian experience with the latest corporate news from Australia in the securities space.  Yesterday ANZ announced the sale of its custody business to JP Morgan.  This follows a horrific period in ANZ’s recent corporate history with their experience in securities lending with the Opes Prime debacle.  They obviously decided it was best to cut its exposure to securities services and focus instead on its recent purchase of ING’s Australian wealth management and insurance business. 

Australia remains one of the less hospitable places for short selling and securities lending.  One of the key requirements placed on traders is that short sales must be disclosed when the order is placed and the exchange releases daily statistics on short sales.  I always wonder what this type of information is meant to convey.  I maintain that information without context is meaningless.  Lets look at the Aussie data by clicking here for an example.  This report is from trading on November 19th and shows 313 stocks where some short selling was reported. The report is a text file rather than a spreadsheet, so I have manually tabulated some figures and I admit there may be a certain degree of error which is mine alone. 

Of the 313 stocks, 59 of them reported short sales of 20% or more of total turnover. Thirteen of the stocks had short sale turnover in excess of 40%.  Of the 13 stocks where short sales were over 40%, 3 of the stocks had price increases on the day, one was essentially flat, 8 stocks fell between 0 and 2% on the day, and only one moved more than 2%, with a dramatic 6.89% drop.  Cumulative short sale positions are also shown, and despite this high daily activity which is pretty consistent, the largest aggregated position represented only 0.37% of issued share capital.  Effectively this is a negligible. 

So what do the numbers tell us?  Truth is, I don’t really know.  Is the short selling volume primarily intraday trading that is covered by the end of day?  Are the trading volumes low in my sample, thus showing short sale activity as disproportionately large?  Are the stocks and the report from the day not representative of the market as a whole?  I don’t really know the answers and I think it is likely that there are a large number of investors in Australian stocks that would also struggle to respond to those questions.  Rules meant to protect investors that can’t actually be used by them represent unnecessary regulatory interference. 

Weekend Wrap: Naked Shorts, Emerging Markets and Podolsky

Did Naked Short selling bring down Lehman?  Bloomberg ran a long story earlier this week.  Market information from last year suggested that the utilisation of available stock to borrow never really exceeded 60%.  While that is certainly an extremely high number, other companies are often above that and survive.  Sears Holdings is above 80%.  Sears has long claimed abusive short selling yet remains in business.  What do you think?  Be sure to vote in the following survey:

I have always had a particular personal interest in emerging markets.  Check out this article showing a colourful chart produced by Lazard Asset Management and displayed at Seeking Alpha.  The best performing emerging market in the MSCI Emerging Market index?  Morocco – it was only down 11.08% last year.  That’s right, the best performing market lost over a tenth of its value.

Earlier this week I ran into Richard Greensted, a veteran commentator on the securities services industry.  It gave me the opportunity to talk to him about The Podolosky Diaries.   Richard describes it in the following way:  “A cautionary tale for our times: The fictional account of one hedge fund manager's decline and fall from grace”.  As I read it, I often find myself thinking: “I’ve been in that meeting” or “I’ve met that idiot”.  A darkly amusing diary that I highly recommend you read.

Plus ca change ...

As I have been saying for some time now, I expect next year to be more like 1996 than 2006.  This theme is explained in more detail in a Bloomberg story today quoting people who really know what they are talking about:

Paul Tudor Jones:   “Those of you who have visited recently have heard me refer to this return to our roots as back to the future,”
Brad Balter: “The industry lost its way, and this is a reset.”
Louis Bacon:  Bloomberg describes how he has concentrated his equity investments among a smaller number of in-house stock-pickers with proven records of generating a return when prices fall or rise.

The article also makes reference to new funds that are launching to take advantage of heavily price-distressed assets.  This reminds me of a former colleague in the early/mid  1990s who had experienced a great year with convertible bonds, only to be followed by a terrible year and he was sacked.  The negative price movement was a function of the markets, not his choices.  He was quickly picked up by a hedge fund, and his first action was to buy the really cheap CB’s from his former employer at knock-down prices.  Not surprisingly, his first year at the new firm was a very good one as well. 

The more things change, the more they stay the same.

The big news across all the markets today is the failure of the US Senate to agree a $14 billion short-term rescue plan for the big 3 American automakers.  I won’t go into it as you can read more on the story elsewhere.  However, it has set off another day of markets tumbling around the world.  Will the car companies go bankrupt?  Who knows, but we can see the doom and gloom that has returned to the markets today. 

I have been relatively sanguine about the IOSCO Task Force on short selling that is due to report in a couple of months.  However, there is also a regime change coming in the US when President-elect Obama and his team fully take over.   Roel Campos, a member  of the Obama transition team made a few comments earlier in the week that I find confusing and disturbing.   The article is from MarketWatch, and since I wasn’t there when Mr Campos made the remarks I can’t judge for myself what his intentions really are.

First he is quoted as saying: 

"We're looking for disclosure of positions, with a small delay, after a short sale is made,"

Then the article goes on to say:

“Campos is seeking to have the next SEC chairman introduce new rules requiring short sellers to publicly disclose their positions in a manner that is similar to how equity investors are required to reveal their equity stakes. "

The story reminds us that:

“For example, to comply with the SEC's 13F rule, investors with $100 million in capital or more are required to publicly disclose their positions 45 days after every calendar quarter.”

Then having said the rules should be similar, it carries on with: 

“But Campos argues that four-times-a-year public disclosure of short sell positions isn't enough.”

And closes with comments from Obama’s advisor as follows:  

“Campos said the delay in public disclosure is intended to protect some proprietary strategies, but that there should be some parity with equity disclosure requirements.”

Are the politicos looking for similarity, parity or different standards?  Your guess is as good as mine.  What did I say above about the more things change … ?

Have a great weekend!

To Underwrite or To Not Underwrite ?

The announcement by the UK regulators last week that firms won’t be able to protect against potential losses by shorting stocks underwriters and sub-underwriters is potentially a costly new restriction.  I understand the concern that firms are receiving underwriting fees to undertake the exercise and that there is a possibility of undermining the sale of the stock, but surely firms must be able to hedge against risk.   In fact, if firms can’t hedge their potential risk, why undertake the transaction in the first place?  A Bloomberg story on the subject carries the quote:

“Laying off risk through short-selling can push a stock price lower and can be damaging to the client,” said Tom Troubridge, head of the capital-markets group at PwC in London.  

Maybe there is a reason the stock price should be lower in the first place?  Nothing is free, and if there is a greater risk of loss when underwriting an issue, it will be reflected somewhere – higher fees or lower target prices or elsewhere.  I think this is another example, like the ban on short selling, that looks good on paper to the public, but practically has a negative impact on the markets overall.

I am up late every Sunday night into Monday morning so that I can get my fix of American football, so it’s not my favourite day for maths.  Hence I was perplexed when reading Guido Fawkes’ blog this morning that was looking for an explanation of the Bank Bail-Out in the UK.  Check out this article, and if you can explain how the government is expecting the numbers to work out, please let me know. 

Sorry to have my first post of the week predict bad news, but it can’t be helped.  My man Finbar Taggit is predicting worse news on the job front this week than we had last week.  

And let's share in the emotions of Bill Fleckenstein who is leaving the hedge fund world in words that were picked up by CalculatedRisk:

"on a personal note, I no longer want to run a short-only hedge fund, as it is very stressful, nerve-wracking and generally not very much fun." 

Good luck this week:  I’m a Stock Lender – Get me out of here!

Follow up on AllAboutAlpha.com Article

One of Stock Lending Today's avid readers passed on an article written by Christopher Holt of AllAboutAlpha.com entitled "Securities Lending starting to dry up a little?"  

Mr. Holt brings together a number of strands quite nicely in his article, and I wanted to expand on these points a little bit further.  I suggest you take a few minutes and read it, as I am making additional points and comments based on his article rather than starting this post from scratch.

He looks at a number of issues in securities lending at the moment:  Supply/demand, the Watson report and cash reinvestments.   I have taken a number of the comments made by the contributing reader and added some of my own.  Probably all the good comments are his and the ones you disagree with are mine.

In addition to the points raised, demand has also been impacted by a few other factors.  Hedge funds have been closing out both long and short positions for some time in order to fund redemptions.   As well as hedge funds, investment bank prop traders have been loathe to take on new positions and have been in "December lock-down" for some time now.  For many, 2008 was a write-off and they have not been keen on risking further losses, rather they are holding fire until we get into 2009.  I also continue with my assertion that as stock market prices continue to drop, the risk reward scenario for a directional short changes and becomes less attractive.

Regarding the reduction of supply, I have questions about the “quality” of the assets that have been pulled from lending programs by institutions.  I have yet to hear too many lamentations about the disappearance of liquid, widely available “general collateral” assets from the global lending pool.  Inevitably there has been a diminution of some assets that are in demand and can’t easily be replaced, but by and large the stocks that have gone have been substituted without too much concern.

The Watson Wyatt report?  Don't get me started.  Refer to my previous blog on the subject instead.

The Pensions & Investments article referred to quotes a corporate pension fund executive as saying he was surprised at how much long dated paper was held in the collateral pool for his loans.  Surely people check their investments from time to time and cash collateral re-investment should have been the same.

In any case, as the reader points out:

“This for many will no doubt be a contentious view point but ABS and MBS were seen as good investments for many years and by the size of the market issuance this view was held by others not just Securities Lenders. Risk managers and investment professionals believed they were appropriate investments as did rating agencies who rated them AAA.”

Time will tell just how many of these investments actually default.  Until then, the real losers will be the ones who bought at previous “normal” market prices and have been forced to crystallise losses that are simply a result of selling distressed assets in an illiquid market. The real winners will be those who do the buying and can fund them until maturity.  

Chris makes reference to the joint statement issued by ISLA and other lending associations in September.  The letter from the various lending institutions came at a time of significant stress in the markets stemming from the Lehman default.  Indeed, there were several well-publicised withdrawals from lending in whole or in part by a number of institutions.  However, this has levelled off recently and I believe that the joint statement was an important and valuable move in stemming the tide.

Chris suggests an almost inevitable increase in the cost of borrowing stock,  Given that the need to maintain liquidity in cash reinvestment pools is currently skewing lending fees, it is difficult to necessarily come to the conclusion that the reduction in supply will result in higher intrinsic fees charged to borrowers.  We all watch this point with interest.

However, as Mr. Holt points out oh-so-accurately there is an awful lot of peddling going on under the waterline to keep the motion of the securities lending business going.  The only disagreement I have with him is that I prefer to think of securities lending as a swan, rather than a duck.

P.S.  Thanks to the contributor of the article!