Stock Lending Today - An Industry Under Siege!

Stock Lending Today - Happy Anniversary!

Today marks the first anniversary of the launch of Stock Lending Today.  I started the blog last year in response to what I viewed as ill-informed coverage of short selling and securities lending.  If you think back to last summer, the SEC in the US had implemented a short-selling ban on financial stocks, but at the time, it was the only country to do so.  The second reason I launched the blog was my feeling that the industry was at a critical point in the maturation process and there didn't seem to be an independent outlet for views to be expressed and challenged.

Within a month of launching SLT, Lehman had defaulted, AIG needed rescuing and there were major concerns raised about a number of other leading securities lending market participants.  There was a veritable media frenzy and I think the subtitle of the blog - "An Industry Under Siege" was well-earned.  Subsequently over 30 other markets implemented short selling bans or restrictions.  A number of high profile lenders withdrew from the market either in whole or in part. 

Politicians and regulators around the world struggled with the often conflicting challenges of protecting the integrity of the markets while striving to ensure that that companies and economies weren't unfairly targeted and attacked.  Often, the need to be seen to be taking action was as important as the actions themselves.  The confluence of events and circumstances in 2008 were unprecedented and as a result, no blueprint was available for reference.  The former SEC chair, Christopher Cox would subsequently reflect that the imposition of the short selling bans was the biggest mistake of his career.  Indeed, all the academic evidence suggests that investors were disadvantaged by the actions of regulators hoping to stabilise markets through restricted short selling rules.

The silver lining from those dark days is that the subjects of short selling and securities lending (now forever linked in the popular imagination) has survived the world's scrutiny and emerged with the recognition of the vital roles they play in the capital markets.  While there are still outstanding issues, inquiries and discussions going on in many markets, they are with the clear objective of restricting inappropriate activities and embracing legitimate short selling ans securities lending.

The competitive landscape amongst industry participants has changed more in the past 18 months than ever before.  The true winners and losers will not be known for perhaps another year at least, but there is undoubtedly more of a level playing field than ever before.  

Market infrastructure is at an important crossroads with the future uncertain for electronic trading, central counterparties, integrated product structures and the technological changes that will drive the way forward.

All business activity is a function of supply and demand.  Many of the institutional investors that make their securities available for loan are in a state of flux.  Some have pulled out in whole or in part.  Others had exited and later returned.  The majority of lenders stayed the course and deserve considerable thanks from the agents, prime brokers and traders.  (Although some would argue they had no choice but to stay in the game and may yet exit in future when their fortunes change.) The demand side of the market - the hedge funds and proprietary trading firms - have seen improved performances this year and all will be watching for whether this upturn is sustained.

So one year on, the business has survived the greatest onslaught it has ever experienced and emerged a little battle scarred and smaller than its peak levels of a couple of years ago - but still huge compared to where it was a decade ago. 

I would argue securities lending is still under siege, but "siege" is now with a lower case "s" as opposed to the capital "S".

I'd like to thank all of my readers, contributors, commentators and survey/poll respondents over the past year for your time and comments, and I look forward to even more engagement in the year to come!

Lender Supply Poll Results

A couple of weeks ago I posted a poll asking for your views on the supply side of the business.  The poll was prompted by a couple of reports from US based consultants that suggested a considerable pullback amongst Beneficial Owners participating in securities lending programmes.  I asked readers to indicate whether supply had increased, decreased or stayed the same over the past year.  There were 35 respondents to the poll, so not that much smaller than either of the research pieces.  Obviously the difference is that this was an open and anonymous poll and the respondents haven't been validated or questioned.  In any case, the objective of running these polls isn't for scientific accuracy, but rather to elicit a common sense, gut -feel reaction from the people in the industry

I am writing this while away from the office, so I won't be able to add the graphic representations for a couple of days.  The results of this survey are as follows:

Location and number of respondent:
UK - 13
US - 12
Unidentified - 3
France -2
Switzerland - 2
Israel - 1
Ireland - 1
Holland - 1

Change in supply over the past year:
Reduced by less than 25% - 51%
Reduced by 25% or more - 23%
Stayed the same - 11%
Increased by up to 10% - 9%
Increased by more than 10% - 6%

The UK and US are the only markets where there were enough responses to look for trends.

UK - 7 of 13 respondents said the supply has reduced by 10% or less.  3 replied that things were pretty much the same.  Two had the view that supply had dropped by more than 25% and one noted that supply had actually increased by up to 10%.

US - A wide variation here, but decidedly bearish overall.  Five respondents showed a supply drop of up to 10%, followed by four respondents indicating a drop of over 25%.  Looked at another way, 75% of US based respondents showed a drop and a third of these were by more than 25%.  There were two people that thought the supply had gone up by up to 10% and one lucky soul indicated a supply increase of over 10%.

A decidedly more negative view came from the US, so confirming the validity of the commentary from the consultants.  Of course there is potential for further Beneficial Owners to drop out, but at the same time, others could return. 

I maintain that if there are significant departures from the lending community that the impact is likely to be concentrated within certain markets or sectors.  Most at risk would be the US with small and mid-cap stocks as well as some fixed income supply being more reliant on US based institutions being active lenders.  For other markets a departure by some represents additional opportunities for others.

Thanks to everyone that took the time to participate.

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 …

Securities Lending Conferences Survey Results

Last week I posted a survey on the subject of securities lending conferences.  I wanted to get a feel for peoples thoughts, views and experiences.   I have summarised the results below.  There were 28 people that took the time to complete the survey, so while it is not scientifically accurate, I think it is representative of the comments I hear directly from people.  Thanks to everyone that took part.

Respondent Locations
People from 11 different countries responded with UK and US each posting 9 answers, 2 from the Netherlands and 1 respondent each from 8 other countries.

How many conferences have you attended in the past two years? 
Most people fit into the one conference per annum category, and it seems that the majority will keep it at that level.  An equal number plan on attending more conferences in the future as there are people planning on going to fewer events.

Rank in order the reasons why you attend conferences.
People clearly attend conferences for the opportunity to meet and greet counterparties and prospective counterparties.   61% of the respondents looked at general networking opportunities as the top priority in attending conferences.  38% told us that centralised sales and relationship meetings were the main reason they attended.  Interestingly, content was important, but not the primary driver for showing up at conferences.  I’m not surprised. I’ve always said that you can always get more information about specific subjects directly from one on one meetings than you will find out about at a panel session.  However, I firmly believe that the events can be useful for identifying the key issues for the industry.  Properly constructed, they can highlight the important topics of the day.

One person made the comment that “filling the diary” is an issue.  The feeling is that too many people feel compelled to have a full schedule before getting to a conference and that this reduces the opportunity to have ad-hoc meetings and discussions.  I concur with this thought.  This conference was one of the best ISLA/RMA conferences I’ve been to, and it has certainly been the least structured for me.  The lesson: leave yourself some slots for unplanned meetings. 

Prioritise the issues conference organisers should focus on when putting together events.
Approximately 70% of respondents said that keeping abreast of industry trends was their top priority or an important reason for attending conferences.  It is therefore not surprising that 58% said that Subject Content was the most important issue for conference planners to think about.  Given the current economic environment it is also no shock that the Cost of Attendance was either the top or second most important factor for 76% of attendees, similar to the combined top and second priority score for Subject Content.

Other comments
Some interesting views came from the audience.  There was a consistent commentary that people wanted to see a wider range of topics and products covered, rather than updates on the “same old subjects”.  There were a couple of recommendations for fewer but more in depth sessions.  There is a feeling from these people that a combination of more detailed sessions with more open networking time would be a winner.  One of the reasons why some have asked for a different group of speakers is that the major players are often the leading conference contributors but aren’t necessarily representative of the industry as a whole.  Virtually everyone that left a comment was positive about the networking aspect of the ISLA/RMA conference with 92% saying that the conference was either Very Good or Satisfactory value for money. 

Thanks again to everyone that took the time to respond to the survey.  I will take your comments into account when I am contributing to future conferences.

Top Ten Prime Brokers for Securities Lending

The securities lending business was recently described to me as being like an hourglass.  At the top there are thousands of beneficial owners who supply the securities that support the trading needs of the thousands of investment banks (insofar as these still exist) and other proprietary traders, notably hedge funds.  In the skinny centre bit are the small number securities lending agent banks and prime brokers.  The liquidity of the market is entirely dependent on how efficiently the flow passes through the middle.

The annual Global Custodian Prime Brokerage Survey was released earlier this week.  It’s the 16th annual survey and comes at a seminal point for the hedge fund industry.  The survey is the definitive inquiry into hedge funds’ views on their prime brokerage providers and garners a huge amount of attention from both the hedgies and the PB’s themselves.

There were over 2,000 respondents to this year’s survey, down by about a quarter from 2008.  The topics for the survey cover ten service categories:  Client Service, Operations, Financing, Margining, Securities Lending, Reporting, Technology, Hedge Fund Business Consulting, Capital Introductions and Value.  More prime brokers received votes than ever before, and several firms passed the minimum threshold to qualify for commentary in the survey.  It looks like the PB section mid-hourglass has just widened.

I want to quickly examine the Securities Lending ranking.  You can’t simply take the final scores without putting them into the context of the overall report, but since that’s only available to subscribers, we shall have to make do without.  You also need to remember that the rankings are based on the perspective of what’s important to the hedgie, which might be different to what is important to an agent lender or beneficial owner.  The ratings also vary by region and by size of the respondent.  Still, I think it is interesting to look at the firms listed as the top ten. 

The following firms are shown in order from highest score through to number ten:  Shoreline Trading, Credit Suisse, Fidelity Prime, JP Morgan, Citi Prime Finance, Deutsche Bank, Barclays Capital, Merlin, Scotia Capital, Bank of America Merrill Lynch. 

Credit Suisse, Citi, Deutsche, Merlin were also top ten in last year’s ranking.   JP Morgan purchased Bear Stearns and its leading PB product.  Bank of America sold its PB business to BNP Paribas and then turned around and purchased Merrill Lynch and its PB biz.  Both of these combinations would have resulted in double top tens.  Shoreline, Fidelity and Scotia all make their first appearances on the list (With many congratulations from me).

What does all this really mean?  Obviously I have only looked at the securities lending ratings and not the overall score.  First, I think it shows that the universe of prime brokers that are taken seriously by the hedge fund community has widened.  Second, the purchase of some former market leaders hasn’t necessarily diminished their service to clients.  Third, the leaders of the past aren’t guaranteed to be the leaders of the future.  Spot the firms not on the top ten list – it shouldn’t take you long to come up with a few notable absences.  Lenders - take note.

More than ever before, there is no automatic entitlement to pre-eiminence in the sector.  Everyone will have to continue to work hard to achieve top rankings.  The top ten is a more fluid place and  some firms that have dropped out of the top ten might even fight their way back. 

"Like sands through the hourglass, so are the days of our (seclending) lives."