A bit short on shorts

If you remember the early days of the financial crisis, the term “short-selling” was making headlines as hedge funds took a great deal of heat for short-selling bank stocks.

Since then, securities lending – the process of pension funds, etc, lending stocks and bonds to the likes of hedge funds who would sell them and buy them back at a lower price – has bounced back.

The lending industry has worked hard to convince pension funds to increase securities lending as an extra stream or revenue. After all, securities are not ‘leant’, they are hired out.

Anyway, the Lens was speaking to securities lending specialists last week and found put a few facts about the industry in 2019.

The standout activity has been the high demand for ‘special’ or ‘hard-to-borrow’ equities linked with recent IPOs in North America.

Beyond Meat, a manufacturer of meat-alternative products, attracted particularly high borrowing fees in late July, and IPOs for (mini-cab firms) Uber and Lyft also delivered strong revenues for asset owners that held these securities and agreed to lend them.

But beyond the high profile ‘specials’ activity, it has been rather a bleak 2019 for the lender community. Global securities lending revenues for the first nine months of 2019 stood at US$7.6bn, slightly down on 2018.

Cost pressures among asset owners – known as ‘beneficial owners’ in securities lending terminology – means they are reluctant to miss out on the attractive source of relatively low-risk revenue that securities lending can provide. But there are problems on the demand side. Risk appetite is currently dialled down at many hedge funds and prime brokerage firms – who have traditionally been major borrowers of securities to close out short-selling positions, to drive arbitrage strategies and for a range of other uses.

Proprietary trading desks at investment banks – traditionally also heavy users of securities lending – have had their activities reined in by post-2008 restrictions on banks’ in-house trading activities (see the ‘Volcker Rule’).

And for hedge funds operating quantitative strategies, it is currently a complex task to factor in the impact of Brexit deliberations or the market impact of the Trump twitter feed into their mathematical modelling.

Further, under Basel III reforms – designed to provide extra resilience to the banking sector after 2008 – banks have been required to hold buffers of high-quality liquid assets (HQLA) sufficient to withstand a “significant stress scenario”. Banks have often used securities lending markets to meet this demand for HQLA – and also to provide HQLA that can be used as collateral to access funding from central banks.

But as their needs in this area have tailed off, so too has appetite through securities lending desks for the ‘HQLA trade’.

This is where securities lending agents earn their corn. Finding new sources of demand to meet this shortfall.

Meanwhile, as market data improves, and as performance attribution and risk metrics become more sophisticated, the Lens is told asset owners are better placed to evaluate where their lending revenue is being generated and where the associated risks may lie.