Stock Lending Today - An Industry Under Siege!

Some sense & some rubbish - Must be Silly Season!

ETFs Hit the Mainstream

As all my regular readers know, I love ETFs.  They are the obvious tool for building an investment portfolio.  Punters like me can't possibly know which stocks to buy, but we can have views on which markets, sectors or regions are likely to do well.  The launch of the self-branded ETFs by HSBC marks another important step in the evolution of ETFs.  HSBC has been working on this project for some time and I know several people that were involved in the process.  There was a lot of debate, discussion and disagreement, but in any case, it is now the real thing! Needless to say HSBC Securities Services will be pleased with the additional supply and no doubt the Global Markets group (that has recently announced plans to enter into the Prime Brokerage business) will have played their part in the development of the business at HSBC.  

There is an interview with Farley Thomas of HSBC by Paul Amery of IndexUniverse.com that you can read here.  Also, read Paul’s follow-up comments here.  I won’t reiterate Paul’s observations, but I have a couple of my own.  The fact that one of Paul’s first questions was about securities lending shows how closely intertwined the two activities have become.  The second is that the readers of IndexUniverse.com are not typically knowledgeable about securities lending, but are more exposed to the subject than ever before.  This can only be a good thing in the crusade to build secondary market liquidity through the expansion of both the supply and demand side of securities lending for ETFs.  

Myners Voting Madness  

I couldn’t believe when I read recently that Lord Myners was promoting the idea of shareholders selling voting rights.  I guess the idea is that if a shareholder isn’t interested in actively participating in the management of a company by exercising its vote, it should sell that vote to someone who is interested.  I think this is one of those things that sounds good over a couple of glasses of port in the evening, but in the cold light of day is rather bizarre.  It particularly strikes me as odd given the furore (unnecessary in my view as it rarely happens) over the idea of hedge funds and other firms borrowing shares with the sole objective of obtaining voting rights.  Regulators, politicians and CEO’s have all railed against such actions.  And now one of that group talks about selling the rights?  I assume the idea was floated in August so that most people would be on holiday and not notice.  

Tut-tut on the Tobin Tax, Mr Turner  

While on the subject of silly season commentary, I can’t believe that a former banker has suggested a transaction tax on banks.  Yet Adair Turner, Chairman of the FSA has proposed a “Tobin Tax” on banking deals.  The idea is to assess an additional tax on banking transactions and in so doing, limit profits of the banks and thereby stopping mega bonuses.  Are you kidding me?  If I hadn’t already used the word “bizarre” in the blog already, I would be using it now.  (Oh, I DID use it again.  Bad editing.)  Most of the trading activities that would be looked at are incredibly easily transferred to another jurisdiction and would just leave our fine British soil.  Along with all those who are already planning on leaving with the upcoming 50% tax rate and the emergency preparations being made by some hedgies to flee proposed EU Alternatives regulations.  At least the traffic coming in to the City will be reduced.

Have a great weekend - especially those of you having Monday as a holiday as well!

Thoughts on the new Prime Brokers

Someone raised a question on twitter the other day about the spate of new entrants to the prime brokerage space. (You can follow me on twitter by clicking here) Twitter is a great place for quick communication, but not so good for long answers.  For what it’s worth, here’s my view.  I’m interested in hearing from you if you disagree or if I’ve missed something important.

There are large number of firms that have announced new prime brokerage launches (HSBC, Nomura and Cantor Fitzgerald are amongst these); expanded product offerings (i.e. BTIG Fixed Income Prime Brokerage); changes to the structure of their businesses (MS launching a trust company); and expanded offices or increased staffing (too numerous to mention).  The annual Global Custodian Prime Brokerage survey confirmed that there were more prime brokers that passed the minimum response threshold than ever before in their 16 years of running the survey.  And that was before any of the recent launches.

There are many different reasons for these launches and expansions.  While the hedge fund space has always been a profitable one for investment banks and dealers, until 2008 there was a virtual lock on the PB business.  Morgan Stanley and Goldman Sachs were the dominant firms for global funds and in the US Bear Stearns was also a dominant provider.  Other providers looked to satisfy specific product niches or to be appointed as “the other PB” alongside one of the triumvirate at the top.

Then the unthinkable happened and the Bear was eaten by JP Morgan.  While that caused some concern, in and of itself it wasn’t enough to cause a major shift.  The credit and liquidity crisis carried on and the markets continued to fall.  Short selling restrictions and bans were imposed across some 30+ markets around the world.  Lehman ran into trouble and wasn’t bailed out or bought.  Panic ensued and there was a run on many firms including the two remaining PB market leaders.  2008 was a quiet uneventful year wasn’t it?

The result?  Here are a few thoughts.

A more level playing field amongst the prime brokers than has ever been the case. The psychological barrier to entry of not being able to compete with the “big boys was reduced – even if the cost elements remained the same.  This gave rise to opportunities for new entrants that could make a case for a niche product or be considered as a viable alternative to the mainstream providers.

Some PB’s chose to change margin levels, reduce the amount of leverage made available to clients across the board or on a fund-specific basis as well as increased pricing.  Further, some PB’s changed their preferences for type of client, leading in some cases to relationship terminations. This is best exemplified by recent comments from UBS CEO Oswald Grubel:  “we're aware it's balance-sheet intensive - and that's why we're becoming more selective on the clients we are offering prime brokerage".  This highlights their change in strategy looking for fewer, larger and more profitable clients.  According to Global Custodian hedge fund clients in the UBS PB business was once their fastest growing client base and this universe has shrank by a fifth!  This is one example, but by no means the only firm that changed their approach.   These fundamental remodeling of the business dynamics created a universe of disenfranchised or disenchanted clients ripe for the picking.

Hedge funds were suddenly made aware of existing risks involved with having a custodian of assets.  They hunted for alternatives and found at least three:  change of jurisdiction of the PB; switch to “safer” organisations, typically banks; diversification of assets across multiple PB providers.  I am not convinced that all the firms that won business as safe “bolt-holes” will keep their new clients.  Hedge fund service expectations aren’t the same as custody clients.  Additionally, some hedgies have realised why they didn’t select certain PBs the first time around and may have regrets about actions taken in the heat of the post-Lehman environment. 

In essence, many firms have seen an opportunity and have tried to jump on it. There will no doubt be further announcements of more firms joining the fray.  The existing top tier of firms won’t give up their business lightly to the newer entrants and will use their muscle to squeeze the competition.  Some of the newbies and niche providers will establish themselves as quality PBs, and this was demonstrated by the strong showing of Shoreline in the Global Custodian Survey.  Inevitably some of the announced launches won’t actually come to fruition and will fade away.  There is a history of firms trying to get into the space and quietly disappearing.

To sum up, I think that even after the inevitable fallout of some also-rans, the universe of firms offering Prime Brokerage will be larger than it was a year ago. There will be better choice and a more interesting range of products for hedgies to choose from. 

Now all we need is for the funds to continue the improved performance we have seen year-to-date and for investors to continue the green shoots of reinvestment into alternatives that have recently been sprouting …

ISLA Conference, Central Counterparty & Hedge Fund Performance

ISLA/RMA Conference Next Week
A week from today I will be writing this blog from Barcelona.  There are a number of critical issues for the industry at the moment and I am looking forward to being near the centre of debate and discussion at the conference.  Over 400 attendees from over 150 organisations have now registered, so the numbers are quite strong, and I think reflective of how important people believe the communication aspect of the conference will be.

If you want to set aside some time at the conference, drop me a line at roy@stocklendingtoday.com.  I hope to catch up with the "Three C's" - Colleagues, Customers and Counterparties. If you are there and I haven't met you, please introduce yourself to me - I'm interested in your views. 

Central Counterparty
This Friday LCH.Clearnet will launch a Central Counterparty for securities lending trades executed on SecFinex from this Friday, 19 June. 

You may have read a brief quote of mine in an article in Securities Industry News last week relating to the ISLA consultation document.  As only one sentence of my comments were used, it was difficult for readers to get a context for the quote.

The ISLA report (Download ISLA CCP may 27)is an inital indication of the wishlist from ISLA working group members on what they would like to see as part of a CCP.  As such, the document itself is part review of CCP and part checklist for key features.  While it serves a useful purpose in identifying the issues for the uninformed, it isn't an assessment of specific products that have been proposed by the different vendors or a document that puts CCP into any type of context.

When my kids were younger and put together their Christmas lists to send to Santa Claus, they didn't indicate which items were essential, others that would be "nice to haves" or some that were pie-in-the-sky.  In the same way, this report lists everything as if it was a pre-requisite to participation.  If all products required a similar all-encompassing list of functionality from Day 1 with all market participants being active, nothing new would ever launch.  Loanet didn’t start with 400 participants and it took a considerable amount of time before even the EquiLend owner-consortium was dealing across all the live markets between themselves.  Products grow and develop, they don’t begin fully formed.

While there is no guarantee of success for this central counterparty, or any of the pending offerings, I think the important point to remember is that this is the start of the journey rather than the final destination. 

(By the way, there has been an excellent discussion on the subject of CCP on the Securities Lending Traders Network group on LinkedIn.  If you are involved in the securities lending industry, why not join the group, and the debate?  Apply here.)

Hedge Fund Performance
The Eurekahedge Monthly newsletter came out today and carries quite a lot of positive news.  Most importantly from my point of view is that the industry had net inflows for the first time in ten months – a total of just over $11 billion for the month.  Critically linked to this inflow is the largest amount of capital appreciation from performance - $19 billion.  May was the best aggregate monthly performance in almost a decade and virtually every strategy was in positive territory.  Indeed, Eurekahedge report that 84% of the funds that reported their numbers were positive for May and 74% were up for 2009 YTD.

Securities Lending Weekend Update

A bit of a weekend wrap up of news.

I had a sneak preview of a new product launch from DataExplorers.  They have added some new features and functionality to the Transaction Explorer.  I am a bit of a data geek, so I have always loved it.  For some time I have believed that the real challenge for the product is to take it from being a valuable analytical product and transform it into a front-line trader’s tool.  These enhancements take it a long way down that path.  Have a look at the video and more importantly take a look at the product to get a more detailed idea of the functionality.

Men to Blame for Credit Crunch!

UNISON General Secretary, Dave Prentis, said at their Womens’ Conference yesterday.:
“The credit crunch is, without doubt, a man-made disaster.  But in the recession it is women who will suffer the most.”   Sky News carried on with a story this morning including three commentators who also blamed the macho male culture in the City of London for the current crisis.  Apparently women wouldn’t have taken the same risks and always bring a more balanced view.  What’s your view?  I can tell you that the overwhelming majority (95%+) of comments that I get as a result of this blog and through the two securities lending social networks that I run are from male readers.  A call to women:  Send me your views, comments and suggestions on securities finance topics you’d like me to cover.

Not Standard Practice

I never really comment on individuals in this column (other than Gordo Boom-Bust-Brown and his cadre of NuFooLabour) but I am going to make an exception today.   I read that Mark Harrison has rejoined the sell side of the business.  Mark has joined Citigroup in the role of Head of European Prime Finance.  Mark is an extremely knowledgeable and experienced professional and will make a great addition to Citi’s business.  I worked with Mark at Deutsche, and on top of everything else he is a nice guy.  Good news for Citi – for a change.