Q &
Ten questions with Jane Milner
Market Specialist, SunGard Securities Finance |
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Jane, what's happening out in stock lending/borrowing markets?
As with so many areas of the markets at the moment there is a sense of retrenchment - and a keener focus on the type of business that people want to be doing, and who they want to do it with. The potential need for further controls is top-of-mind. People are doing their housekeeping, looking more carefully at counterparties, their risk profiles and also looking to ensure that their systems are performing optimally. One of the many drivers for this is to glean whatever cost savings can be found. It's a somewhat cautious, pragmatic time, there's a distinct element of 'wait and see'.
With all of the recent adverse press regarding short selling is there any sense that securities finance business line is under threat?
No, I do not believe this to be the case. Securities financing itself is not short selling, however, stock borrowing is commonly used to cover short positions. It also provides an important yield enhancement and financing tool for investment managers, and is key in bringing liquidity to the markets. Securities financingThis is an industry that has been around for decades now, and it is used to continually reinventing/re-shaping itself due to market events. It is true to say that the bans on short-selling have affected the demand side to a degree, but the shorting of financial stocks is only one of the reasons why people borrow securities. In volatile markets traders need to look at the relative value of multiple stocks rather than outright trading. This helps traders buy oversold stock against other stock. Stock borrowing is a major tool in this stabilizing area.
You mentioned the recent bans that impacted stock lending demands - what's the market feeling about them now?
Some parts of the media painted short-sellers as the villains of the entire financial crisis. To anyone who understand how financial markets work, that's a gross caricature. Short-selling, far from threatening markets, is designed to make them more efficient - and there have been many academic studies that show that it does so. It also creates the possibility of hedging against risk and reducing losses from declining markets - most people would agree that these are good things. There was an idea around that it was somehow 'easier' to make money of out short selling than by following long-only strategies. Perhaps the Porsche/VW experience changed some minds there. Now that most of the bans have ended, and there has been time to carry out analysis after the storm, it is generally agreed that, if anything, the bans further exacerbated difficult market conditions by having a further negative impact on liquidity.
Are you seeing volumes of stock lending shrink?
Without question volumes are down as there are different pressures on both the supply and demand side. On the supply side we have heard that a few funds have pulled out of stock lending altogether, and others have held back some of their portfolios as part of a wider caution stalking the markets. Nevertheless supply is still there, especially in liquid stocks. Demand was to a large degree driven by hedge funds, which are facing a kind of perfect storm created by evaporating liquidity and redemptions. It must be extremely frustrating for managers who can see, in the wild volatility, perfectly good profitable strategies but can't execute them because of the squeeze on liquidity. Yet many funds have lock-up periods and most have positions they need to cover: some will deliver good returns and emerge stronger.
And what about lenders - how are they approaching the new realities?
Beneficial owners and fund managers are asking themselves whether this is the kind of business they want to be in and (if the answer's 'yes') what is the appropriate price. Hard to find stocks have always commanded a premium but there is potentially a new risk premium that needs to be factored into the lending rate. "Risk adjusted returns" are the new buzz words. Revenues, costs and risks are all being closely watched, but we shouldn't forget that, in challenging environment, securities finance can be an opportunity for relatively low-risk income - and there's not a lot of that about at the moment.
Has the perception of risk and reward changed?
For sure, investors are taking far greater interest in the risk, as well as the reward, associated with this type of business. Counterparty default and the need for quality collateral has always been there but it has never been so prominent. I would say there has been a flight to quality - if anybody knows what quality is anymore. The AIG situation is forcing lenders to look very closely at their cash re-investment guidelines. In the old days securities lending collateral guidelines might specify 'cash' and managers would pass the money over to the cash desk and that would be that. With the added concerns over the risks, re-investment of cash collateral has become a much more sensitive task, demanding greater control from the stock loan desk. Recent losses on cash re-investments have shaken the "cash is king" perception that prevailed in the US markets, and the use of non-cash collateral is now receiving greater consideration as an attractive alternative.
What do you see on the regulation horizon?
There's a clear sense in the market that there will be increased regulation, but this has not yet crystallized into what this will mean to the securities finance world. You have got to start thinking about additional reporting and implementation of greater standardization of regulations globally. In some jurisdictions additional short sale reporting was temporarily brought into play, and it is likely that this will be around to stay. An interesting development may involve ways of linking a short position to the associated borrow, offering proof that a short is not a naked short. Regulators also certainly welcome industry moves towards greater transparency, for example, through the introduction of a central counterparty and other services to expose 'benchmark' market price and activity data. There were moves toward some of these things before the crisis, and clearly things may change following recent events, but at the same time nobody wants to throw the baby out with the bathwater. There's a lot that works very well in securities finance.
Is the old focus on STP less pronounced?
I would say that if anything there is now an even greater focus on STP as a way of driving down costs. Though the securities finance related back-office activities typically have a reasonably high degree of STP with other systems, there has been less uptake from a front office perspective. A fairly optimistic estimate would be that less than 20% of lending activity is created through automated systems today. One of the ways of increasing profitability for some organizations would be to get the simple, plain vanilla lending flowing automatically, allowing them to concentrate more on strategy and negotiations, identifying trends and hot stocks and pricing lending accordingly. Much of the work is still done bilaterally and face-to-face (or rather ear-to-ear). Despite the sophistication and power of the systems, securities finance is one of the great relationships businesses in financial services - everybody knows everybody else. It's interesting to see some commentators calling for the wider financial sector to return to this way of doing business.
Doesn't this bilateral way of working result in transparency issues?
It depends what you mean by transparency. Clearly when dealing bi-laterally you are aware of who you counterparty is, however, the complexities inherent in securities lending transactions, and the lack of an exchange, lead to a lack of transparency in terms of pricing and volumes. Knowledge is power: the more you know about what is happening in the stock loan market, the better. Market data, such as the data analytics provided by our Astec services, are a key tool here. They provide visibility into the daily 'price' (i.e. loan rate) of a security and the activity and usage of specific issues, both at the present time and over a period, allowing trends to be identified. The lack of transparency could, for certain players, be considered something of a golden goose, and moves to increase automation and transparency are slow.
How are you working with SunGard clients just now?
Our customers', like everyone elses, are looking to reduce costs as a way of increasing profitability. They are also looking to extend controls in order to mitigate risk. A way of achieving these goals is to get more out of their existing solutions. It's our job to help our customers unleash the full power of their systems. Typically, there may be aspects of system that a customer did not use originally/was not aware of, that may bring extra controls and efficiencies. Also, new functionality added over the years may not have been reviewed or applied. In today's cost/efficiency conscious world, where there is a little more time in a less volume intensive environment, people are taking stock, dusting things down, and looking at how to move forward in a more effective way. We are working closely with customers to help them address the new market realities.
Has the perception of risk and reward changed?
For sure, investors are taking far greater interest in the risk, as well as the reward, associated with this type of business. Counterparty default and the need for quality collateral has always been there but it has never been so prominent. I would say there has been a flight to quality - if anybody knows what quality is anymore. The AIG situation is forcing lenders to look very closely at their cash re-investment guidelines. In the old days securities lending collateral guidelines might specify 'cash' and managers would pass the money over to the cash desk and that would be that. With the added concerns over the risks, re-investment of cash collateral has become a much more sensitive task, demanding greater control from the stock loan desk.
What do you see on the regulation horizon?
There's no clear sense in the market as to what regulations may be on the horizon but you have got to start thinking about centralized reporting or certainly agreed standards between counterparties. In some jurisdictions additional short sale reporting was temporarily brought into play, and it is likely that this will be around to stay. An interesting development may involve ways of linking a short position to the associated borrow, offering proof that a short is not a naked short. There were moves toward some of these things before the crisis, and clearly things may change following recent events, but at the same time nobody wants to throw the baby out with the bathwater. There's a lot that works very well in securities finance.
Is the old focus on STP less pronounced?
Less than 20% of lending now flows directly through automated systems. One of the ways of increasing profitability for some organizations would be to get the simple, plain vanilla lending flowing automatically, allowing them to concentrate more on strategy and negotiations, identifying trends and hot stocks and pricing lending accordingly. Much of the work is still done bilaterally and face-to-face (or rather ear-to-ear). Despite the sophistication and power of the systems, securities finance is one of the great relationships businesses in financial services - everybody knows everybody else. It's interesting to see some commentators calling for the wider financial sector to return to this way of doing business.
Doesn't this bilateral way of working result in transparency issues?
For sure, the complexities inherent in securities lending transactions, and the lack of an exchange, lead to a lack of transparency. Knowledge is power: the more you know about what is happening in the stock loan market, the better. Market data, such as the data and analytics provided by our Astec services, are a key tool here. They provide visibility into the daily 'price'(i.e. loan rate) of a security and the activity and usage of specific issues, both at the present time and over a period, allowing trends to be identified. The lack of transparency could, for certain players, be considered something of a golden goose, and moves to increase automation and transparency are slow.
How are you working with SunGard clients just now?
Our customers', like everyone else, are looking to reduce costs as a way of increasing profitability. They are also looking to extend controls in order to mitigate risk. A way of achieving these goals is to get more out of their existing solutions. It's our job to help our customers unleash the full power of their systems. Typically, there may be aspects of system that a customer did not use originally/was not aware of, that may bring extra controls and efficiencies. Also, new functionality added over the years may not have been reviewed or applied. In today's cost/efficiency conscious world, where there is a little more time in a less volume intensive environment, people are taking stock, dusting things down, and looking at how to move forward in a more effective way. We are working closely with customers to help them address the new market realities.