Securities Lending - The bear case
With revolution in the air in Tunisia and Egypt, it is a good time to pose the question of whether or not securities lending needs to stage its own reform. The final panel discussion at our London Forum on the 16th March will investigate whether “Securities Financing is still in the dark ages”? Following my prior optimistic outlook for our industry, today we will look at the less rose tinted view.
First up, hot off the press is a new study by Oliver Wyman (using Data Explorers data) showing how investors are responding to proposed EU short selling public disclosure proposals. The paper re-validates the significant negative impact on liquidity and market efficiency these proposals could give rise to. Many Prime Brokers fear a reduction in client short balances if the rules are passed in their current form.
The study also flags up other unintended consequences such as choosing to invest away from Europe potentially taking employment with it. The paper does a concise job of presenting the industry view with evidence where possible. The suggestion to the EU is to mirror the US and Hong Kong’s approach by using one of three better alternative approaches: anonymous disclosure aggregated disclosure or raised thresholds. To see evidence as to why the current disclosure proposal is so harmful go to the full report: http://bit.ly/f1CJsj
The central tenet to my optimistic case was the likely rise in interest rates due to the widespread inflation of core goods (oil, food, water, gas and steel etc) with over USD 1 trillion of cash collateral ready to benefit. This was slightly de-railed last week when the UK economy was shown to be flat lining in Q4 (if you dismiss the impact of weather). However, the main reason not to expect interest rate rises is the lack of inflation in the US, which reports only 1.5% price inflation. I am inclined to agree with certain economists who think this can’t be true! Look at Proctor & Gamble’s (NYSE:PG) recent results. Its quarterly profit was down 28% due, in part, to raw material cost inflation where stock on loan is low. Either way, the world’s emergence from recession is too slow to make cash-reinvestment-friendly rate rises a near term certainty.
Another hot topic set to be openly aired at the London Forum is which part of the securities financing chain is witnessing the most pressure due to smaller balances being borrowed and few specials. In fact, our (mint fresh) Quarterly Review of the final quarter of 2010 shows that 69% of the 5,500 US equities on loan are sourced for less than 50bps. We hear that Agent Lenders are squeezing every pip out of the intrinsic lending fee to the extent that Hedge Funds are not putting on short trades to the prohibitive cost of carry. Or is it that Prime Broker margins are as thin as they have ever been and can only be going one way?
On the subject of hard to borrow securities, the process by which securities are transferred by the originating broker to the client account at their main Prime Broker remains inconsistent. So called, “put throughs” are still bones of contention with some Prime Brokers charging and some not. The buy side doesn’t enjoy paying a “parking” fee for the transfer of a security that the warehousing Prime Brokers failed to find themselves.
I could cover many more points, but wanted to sum up by noting that I am yet to sense that the Beneficial Owners, key figures in this business are keen for a central counterpart structure, despite the fact that every other market has moved this way and that regulators strongly desire this. Stand by for CNBC’s Steve Sedgwick to probe strongly in this area!
For more information about the London Forum, including the full agenda and registration details, please visit www.dataexplorers.com/london.
