Securities Lending Today

Securities Lending - Last Word for 2010?

It's about noon GMT on Christmas Eve.  Based on the calls I've made this morning, and the emails I've sent out I may be the last person still at his desk in London.  I'm  calling it a day in a few minutes and will spend the afternoon eating some of the baked goodies my wife and kids have been making over the past couple of days.

The year started with high expectations for a demand recovery for the business.  Remember that with all of the Specials activity of 2009, it was actually a very good year for lender revenues, even though demand was severely curtailed.  So this time last year people were hoping for good things for core securities borrowing demand.  Unfortunately those hopes were dashed fairly early on as hedge funds continued to get net longer rather than shorter and proprietary trading for investment banks in the equity space was virtually non-existent.  Revenues were hammered across the board, and although inevitably some firms did well, I sense the feeling across the industry was one of disappointment.

Much progress was made in terms of education, information and communication and I think this sets the stage for a better future.  After all, revenues ebb and flow over the years, whereas informed market participants ensure a stable operating core for the business.  I have said that I believe that we are in the midst of a 5-7 year reshaping of the industry and I am hoping that the surprise, shock and revelations of the past three years of Liquidity Crisis, Reinvestment Losses and Lehman Default are Ghosts of the Past rather than Ghosts of the Future.

I recently ran a survey and haven't had time to share the results with you yet.  The most important statement asked for views on  Securities Lending itself.  "Securities Lending is a risky business that has generated substantial losses."  The results are shown in the chart below. 

Let me first acknolwedge that the survey is self-selecting to an extent.  People that follow the blog or have seen the survey displayed on LinkedIn or Twitter are by definition interested in securities lending and most, if not all have a vested interest in it continuing as is.  Yes, I get that, and accept the bias.  However, I also have a lot of people who follow me specifically because they HATE securities lending (or at least the short selling associated with securities lending).  They are usually pretty good at stirring up contrary feelings.

The results:

So you can see that people overwhelmingly believe the business to be low risk.  Is that correct, given the well publicised losses that a number of Beneficial Owners experienced?  In any investment prouct - which securities lending is - participants should recognise that there are "Up" years and "Down" years and it is the relative volatility and depths of losses that decide the degree of risk.  

The liquidity crisis and Lehman's default created a perfect storm which resulted in actions by hedge funds, prop traders and Beneficial Owners that triggered some losses and exacerbated what would otherwise have been small losses.  The actual degree of default in cash reinvestments remains low, and much of the negative performance was due to forced sales. 

Given the history of profitable annual returns in securities lending year after year, followed by turmoil for a significant, but small proportion of the overall lending community, it seems that the survey results are an accurate reflection of the return risk that securities lending presents.  Securities lending has generated consistently positive returns for investors year afer year.

Compare that with underlying portfolio losses during the same period which was pervasive across both the institutional and retail investment community and one can't help but reach the conclusion that overall this business is one that generates a useful return that cumulatively benefits portfolios over time.  Not without risk, but one that if properly understood by investors and professionally practiced by providers, securities lending is low risk and additive to fund performance.

I wish you all the best over the Holiday Season and hope you have a Happy, Healthy and Successful 2011.

 

IMN Securities Lending Conference

Monday and Tuesday of this week sees London hosting the 15th Annual IMN European Beneficial Owners' Conference on Securities Lending.  I'm moderating the closing panel session on Tuesday, focusing on the Central Counterparty white paper that Andrew Howieson and I have recently released.  You can register to receive a free copy of the white paper by completing the form below.

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Now to the Vote!

In any case, I am also curious as to which of the panel sessions you would be most interested in seeing if you could.  I'll be tweeting on Monday afternoon and Tuesday while I'm in the audience and I will see if I can get reports back to you on the key subjects after the conference.  

Vote Now!

 

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 …

New Securities Lending Twibe

In my on-going effort to try out every new form of media, I have created a "twibe". 

What is a twibe?
A twibe is a group of Twitter users interested in a common topic who would like to be able to communicate with each other.  It's a really easy way to create a central place for news and comments that all relate to the securities lending business - be it securities lending directly, hedge funds, prime brokerage, short selling ... you get the idea. 

How do I join?
If you are a member of twitter, all you need to do is tweet the URL: http://twibes.com/securitieslending and you will become a member.

How do I tweet to the twibe?
If your tweet is something that you think will be of interest to the securities lending community, then just add the acronym "sbl" somewhere in your tweet and it will be picked up automatically.  The twitter search rules mean that it wont necessarily show up immediately, but should be there within 24 hours - although in my experience, it has been only a matter of minutes.

The Bottom Line?
Over time, this should develop into a central repository for interesting news and updates that is available to everyone.   So please join and contribute interesting stuff!  And as always, pass this on to others - the more, the merrier, and more useful.

P.S.
Later this weekend I will be posting the results of the Conferences Survey I put up last week.