An area set to grow and grow
The securities lending market is on the up, as no doubt are the fortunes of the organisers of this year’s securities lending conference in Rome*, which attracted a record 600 delegates. Mark Hutchings from AIG Global Investment opened with an upbeat assessment of the market. Despite the trouncing equities have taken in the past 18 months, the lending market is prospering. “Pension funds are looking at alternatives and in particular hedge funds as a means of diversifying and this is fuelling the demand for securities lending,” he said.
Although measuring the magnitude of the securities lending market is tricky due to double counting and so on, Hutchings said that the market continues to grow. Partly responsible for this are hedge funds, a subject covered in one of the roundtable discussions. Although estimating the size of the hedge fund market is, like lending, hardly an exact science, the panel estimated the global hedge fund industry as worth $250bn (e265bn) back in 1996 and $450bn by last year.
Over the same period the number of hedge funds has grown from 2,700 to 3,700 with a particular proliferation in Europe. As an illustration, there was a hedge fund launched daily during the two weeks either side of Easter and the panel estimated that growth in hedge funds would continue unabated at 30–40% for the next few years. With this, obviously, comes an increase in shorting balances and Tamara Hughes at Goldman Sachs Asset Management said the obvious conclusion to draw was that demand for securities to borrow will rise.
Clive Barnett, head of marketing at Quaestor Investment Management said he expects the interest in alternatives to continue even if the markets maintain their downward trajectory. This is important to lenders as one of the most popular alternative strategies at present is equity market neutral and securities lending is crucial to shorting. “Access to securities lending is vital as it produces liquidity for half the overall portfolio,” he said.
Angela West at Deutsche Asset Management, spoke from the supply side and said that when a hedge funds approaches a prime broker it’s interested in the kind of stocks available, the risk of recall and whether the stock is available for the duration. The first point is somewhat salient as there is a finite number of securities available for lending. “We’re seeing more and more demand from clients to borrow securities and with more hedge funds setting up, so the general availability of stocks certainly becomes more of a question,” she said.
On recalls, West agreed that it’s the responsibility of the securities lending desk in a prime brokerage division. As did Kathleen O’Donoghue at ABC Arbitrage who said: “recalls are inevitable but it’s part of the prime broker’s role to try and manage the stocks. You can’t ensure against recall unless you get a guaranteed loan and of course you pay a premium for this.”
Another widely discussed topic was the risk associated with securities lending. Leading the way was Mark Faulkner, a director at Securities Finance Systems, who spoke about his firm’s recent survey of the 50 largest UK pension funds and their attitudes towards securities lending. About half lend securities in some way or another but of those that don’t, most are apparently very dissatisfied by the risk analysis and risk management provided by suppliers. “By and large the common response by those who don’t lend securities is that it’s not worth the risk,” he said.
“There’s a perception that this business is too much hassle and too risky. In fact there isn’t much risk to securities lending if it’s done properly.” Despite the fact that a well configured programme can be run efficiently and easily and produce a very attractive risk-adjusted return, the message is not getting through, he said.
Andrew Barrie, co-founder of Barrie & Hibbert, a company that produces amongst other things risk management solutions, said that that often risk analysis is oversimplified. “It’s this dependence on a single number and not realising how this number is reached. Risk management is not a science,” he said. Barrie predicted that within the next two to three years risk management will be bog standard with beneficial lenders.
There’s one complaint though just to spoil the party. According to Faulkner, the industry is tied up in red tape. With the GSTPA predicting annual growth of 45% in cross-border transactions, this is something the industry needs to confront.
* Organised by the International Securities Lenders Association and RMA