Stock Lending Today - An Industry Under Siege!

Learning About Securities Lending

There are no doubt several aspects to learning about securities lending.  Two of the key issues are Training and Discussion/Debate.  Taken together, the market will move forward for the benefit of all participants.  Today's blog will comment on both, starting with the latter item.

Discussion/Debate

I am in the final stages of preparing for the GSL.tv conference in Amsterdam on Thursday.  This should be a fascinating event with a wide range of market participants on the panels and in the audience.  We have also constructed the panels to take into account differing views, including a Beneficial Owner that stopped lending in the post Lehman environment.  The Dutch Beneficial Owner community is more sophisticated than investors from many other countries.  And as I know from my days at Rabobank, the Dutch aren’t hesitant in sharing their views!

It’s a half day event that starts with a market overview including an update from a panellist at last week’s SEC Roundtable in Washington.  We will also have an academic view on short selling before moving on to two market participant panels – one focussed on Beneficial Owners generally and the second one is Securities Lending Risk specifically. 

It should be an interesting and challenging afternoon.  It’s free to invited guests and subscribers, so if you are interested in attending, register now.  http://gsl.tv/event/149/dutch-securities-lending-summit-oct-2009

Training

As many of you will know, I purchased FinTuition about 6 weeks ago.  FinTuition is a specialist Securities Finance and Hedge Fund training company.  Although we have offered courses since my purchase, I haven't taught one myself yet.  That is about to change.  On 19 & 20 October I will be conducted the International Securities Lending course at our offices in Mayfair. 

I am excited about that, and I will be bringing some other market professionals to give their comments and views.  I really enjoy the educational aspect of my work and am looking forward to the session.  If you or your colleagues are interested in joining me, you can see more about the course by clicking here. 

I hope to see you in Amsterdam or on my course!  Maybe both ...

News from the Securities Lending World

ISF Awards Evening
Tonight sees the ISF awards event rolling around again.  In my blog last year I commented:
“I think next year’s results will be more interesting than this year’s based on the timing of the survey responses.” “... as far as the borrower rankings go, I am not certain tonight’s results will give any guidance to lenders on their business partners in the next twelve months.” 
With the exception of Bear Stearns, the majority of the industry reshaping happened long after last year’s votes were cast.  This year’s vote will be much more revealing.  Has the unquestioned levelling of the prime brokerage playing field actually translated into repositioning of the borrowers in the rankings?  Have lenders actually experienced a demonstrable change in their business flows over the past year.  If so, what has the impact been on the service standards and relationship side of the business?  I am also curious whether the borrowers’ view of the lenders has changed.
Prime Brokerage
I wrote some time ago that in addition to the new entrants into the PB world, that other firms were scrambling to come up with new products to meet the challenge of changing hedge fund expectations.  The announcement of the new Prime Custody Solutions product offering by JP Morgan is just the latest example of the increasing range of choices for hedge funds.  I have never believed that an unadulterated standard custody product would satisfy the service expectations of the majority of hedgies.  Now that we are a year down the road from the Lehman cataclysm, some of those that changed providers in a rush may be having second thoughts.  Others weren’t given a choice.
Lehman Brothers
Yesterday was the anniversary of the Lehman default, a seminal moment for the securities finance business as a subset of the wider financial turmoil the world has experienced.  Aside from the hedge fund clients that still have assets frozen by the liquidators, the whole prime brokerage community was impacted.  Segregation of cash and securities held by prime brokers, rehypothecation of assets and the general creditworthiness of the prime brokers all became issues that the vast majority of hedgies needed to consider, and hadn’t previously. 

Lehman has re-emerged, but now carries a couple of different names – augmenting the businesses at BarCap and Nomura - as well as some new ventures launched by former Lehman employees.  So the talent hasn’t been lost, just redistributed and is most definitely having an impact across the various successor firms.

Capital Raising in 2009 and Beyond

I attended a very interesting event yesterday that was hosted by Bloomberg Tradebook.  DealReporter and DataExplorers gave a joint presentation that attempted to bring together capital raising and securities lending.  I plan on taking a section of that presentation and using it as another example in the series of trades involving stock borrowing.  Watch for that in the coming days.  An excellent presentation and a great venue!

Stock Lending - Takeover/Merger

I probably will need to apologise to the majority of the readers for the simplicity of a couple of the recent posts.  The thing is, the readership is growing and more people are asking me to address some of the basics.  One of the concepts that some have difficulty with is making money from short positions that don’t have to go down.  As we know all too well, the media only mention shorting in the context of profiting when a company drops – and the more it drops, the bigger the profit.  That is a meaty story for them, especially if one of those fat cat hedge funds drives a company into oblivion.  People in the industry know the majority of short selling is for arbitrage or hedge purposes that suggests an offsetting long position somewhere.

The other day I showed a simple pairs trade.  Today I am going to latch on to the current news regarding the Kraft bid for Cadburys.  In a simplified stereotypical bid situation, the trader goes long the company being bid on, and short the company doing the bidding.  I have included a Bloomberg chart below that plots the relative prices for Cadburys, Kraft, Hershey and Nestle.  The latter two are mentioned as among potential bidders.  As you can see in the chart, the price of Cadbury has rocketed upwards relative to the other three.  Therefore at the headline level, it was a straightforward profit if you traded Long Cadbury, short Kraft.  Real life suggests other risks and costs and doesn’t take into account a number of factors that impact the true profitability.  The objective here is just to give you an idea of how it works.

A takeover is a bit different situation than the pairs trade in that it is often the case the acquiring company share price does indeed drop as the market considers whether a fair and affordable offer is made.  This is especially likely in the event a bidding war emerges.  Even so, the point is that the short doesn't have to go down to generate a profit for the trade.

P.S.  I’m really enjoying our new office location in Mayfair.  I have spent more than 20 years located in the City, so the West End is quite different for me and fun.  As I parked my car at 5.45 this morning, there was a man wearing a suit paying for his parking ticket.  Couldn’t be a hedgie, as he would be unlikely to be wearing a suit to trade Asian hours from London.  Unlikely to be a local resident as he wouldn’t be paying for parking on a daily basis.  An illicit tryst perhaps and the man skulking away in the early morning light?  Probably.  Then I saw the magazine in his arm:  Casino Life.  I pass about half a dozen casinos on my way to work and that is around closing time.  It’s definitely different around here.

Airline stocks and a Pairs Trade

I picked up an article on Seeking Alpha yesterday suggesting a "pairs" trade.  This type of trade typically looks at two securities within the same sector and takes a view on the expected performance of the two stocks relative to each other.  "Relative" is the important watchword as one of the attractive features of this kind of trade is that the effect of exogenous factors are in theory neutralised as they effect both securities equally.  For example a spike or a drop in oil prices should affect two airlines equally.  Clearly, it's not that simple as each company might have different fuel price hedging strategies, but that's not the point here.

In the article (you can read it here) the author looks at the relative trading between Continental Airlines and United Airlines.  He draws the conclusion that the relative value and recent trends between the two stock prices suggest a narrowing of the spread from the current approx 215% towards the 180% historical level.  The author's recommendation (not mine - I don't have a view) is to go long UAL and short Continental.

If the author is correct, it doesn't matter whether the stocks move up or down, the key factor in profitability is the relative price movement.  This isn't the most obvious example I have ever seen, but as a blogger, I have to take the bones thrown to me.  I have created a Bloomberg chart below and made some annotations showing movements for the past four months and the relative prices.  It also shows why stock loan trades need to be open trades as the trader doesn't know when the convergence will happen, if it all.  As an example, if you were expecting the relative movement to go to 180 and you put the trade on at 4 June, you might have closed out a month later at a loss.  The same trade put on a month later would continue to yield a profit even though it hasn't hit the target level yet.

As a side note, DataExplorers has issued a couple of research reports on airlines stock, and Continental has featured in the document you can read here.  It concludes that short interest in Continental has declined recently, which has coincided with a rise in the stock price.

 

Training and Education - HELP!

I wrote my first training course in 1983.  I was working for the Canadian Depository for Securities in Toronto.  CDS had just launched a new clearing process and I was asked to write a course that would qualify towards the achievement of an "Operations Specialist" certificate.  I wrote the course, and unbeknownst to the Certificate sponsor, I enrolled as the first student.  I didn't get 100% when I did the exam, so they were rather embarrassed when I told them they marked my results incorrectly.  Turns out they made an error in coding and I did indeed get 100%.

A lot has happened in the past 26 years!  Who would have thought that I would end up owning FinTuition, a specialist Securities Finance and Hedge Fund training company?

I need your help and input to make certain that FinTuition reflects the needs and objectives of the potential delegates.  Please take a few minutes to complete the following survey.  Anyone taking some of their valuable time to give me their views will receive a 25% discount on any FinTuition courses they book from Monday until the end of October. Click on the link below to take the survey.

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P.S. If you give us a suggestion that we turn into a new course, you and a colleague or friend will be eligible to attend free!