Having ranted beforeon securities lending and how it adds to the systemic risk of the financial system and how the division of the spoils appears to shortchange retail investors, there is a modicum of satisfaction in seeing the U.S. Securities Exchange Commission (SEC) commence an investigationinto the practice. Yet the industry continues to gather steam and take on the characteristics of an unstoppable train.
Securities lending occurs when mutual funds, exchange-traded funds (ETFs) and other institutional investors lend out securities in their portfolios to parties, mainly hedge funds, for short selling. Despite the body blow delivered by the financial crisis of 2008, it remains big business: $400 billion (U.S.) for stock lending on a global basis as of June 30 (down from the peak of $850 billion in 2007). The chart below (source: SunGard Astec Analytics as obtained from a Standard and Poors white paper) shows the trend (which, it will be noticed, is beginning to turn up again).
Among the SECs concerns and those of panelists at a Sept. 29 public roundtable are opacity and imprudent investing of the cash collateral put up by borrowers. A lack of transparency means regulators are hampered in discerning system-destabilizing risks. And the unfettered investing of cash collateral could lead to more collapses of the kind several lenders experienced in their lending programs during the past 12 months.
For example, a loss of over $600 million (U.S.) during the 12 months to March 30 was reported by California Public Employees’ Retirement System (Calpers). The pension fund was cutting out the middlemen and doing its own investing of the cash put up by hedge funds borrowing shares. They were, in fact, investing with borrowed moneyand when the hedge funds closed out their positions and demanded their collateral back, Calpers was compelled to sell positions to raise capital to return their cash.
But despite the hiatus of the financial crisis of 2008, the securities-lending train continues to gather momentum. Here are some recent developments:
A global surveypublished Sept. 21 by RBC Dexia shows the practice of securities lending is still thriving despite the market volatility of recent months only 17% of survey respondents (institutional investors) said they had dropped their securities-lending program (60% made no changes at all and the remainder tightened risk controls)
Standard & Poor’s recently announcedit has developed an index to track the cost of borrowing U.S. stocks from securities lenders at the wholesale level (which S&P hope will be used as a tool to give market participants the flexibility to develop a variety of products used in hedging and speculation.)