Wayne Burlingham describes an extraordinary year for lenders
The UK market can be considered to be one of the most mature in the world, having been established for many decades. As a result of regulatory and other settlement system requirements, it is still possible to quantify with some accuracy the true value of all outstanding loan positions of UK Securities – currently ranging around £70-£80bn (e??bn). This figure does not of course touch upon the value of non-UK securities lent by UK entities which is unquantifiable.
As found globally, lenders in the UK tend to be any significant asset holders such as pension funds or insurance companies who typically lend either through custodian agents or to the market directly, depending on their size and in-house ability to manage the product. Although there are no published lists to identify all UK lenders, the largest players are household names and would certainly come as no surprise.
Following a relatively prolonged quiet spell, 1999 has been an extraordinary year for lenders of UK Government stock gilts with unprecedented demand seen for virtually any issues. Competition for ‘specials’ has been particularly fierce with fees having often run as high as 3-400 basis points, which compared to the normal general collateral (GC) rates of around 5-10 basis points, represents a significant leap. Numerous lenders with relatively flexible collateral
mandates and credit lines have reported being ‘all lent out’ and as
a result, will probably enjoy their
best year ever. Although the number of specials and overall activity has recently diminished, the value of all outstanding loans remains at around the £60-£70bn level. The strong repo market, despite its relatively recent inception compared to other markets globally, has been a strong driver of loan business.
Conversely, throughout the same period, the equity market has remained relatively subdued, producing comparatively few specials. Many of the previous sizable and profitable positions open in stocks such as Vodafone and BSkyB, have now unfortunately come to an end, contracting the overall market size to around £12bn from a high of approximately £15bn. An ongoing increase in wholesale market activity coupled with a further increase in overall market supply has, at a time when market activity can only be described as steady, squeezed rates down to levels not previously seen and this trend may possibly continue for a while yet. Contrary to the expectations and belief of many players, repo activity in UK equities has not taken off although there has been a notable increase in other activity types such as Swaps and CFDs.
An issue that continues to frustrate non-UK lenders of UK equity securities is that of stamp duty. In the UK, receivers of stock are obliged to pay UK Stamp Duty Reserve Tax (SDRT) at a rate of 50 basis points with a few specific exemptions being available. To avoid this tax in respect of stock loans, it is necessary to meet certain conditions. The most important criteria are:
o The trade must be identified in the CREST system as a stock loan trade (SLO). Technically, a market purchase that is in reality a stock loan return is stamp exempt but this does not avoid SDRT being deducted at source.
Attempts to bypass the stock loan mechanism such as this usually result in SDRT being deducted which the receiver can then attempt to reclaim from the UK Inland Revenue.
As the IR require irrefutable evidence to support any claim that the receipt was in fact an exempt loan return, a lender should be ready to explain why the SLO mechanism was not used and provide suitable proof of the transaction type. There always remains a risk of course that exemption will not be granted.
o All loans must be ‘on-exchange’. If the lender or borrower are not London Stock Exchange members (one party is sufficient), SDRT will still be deducted, even though the trade has been booked as an SLO. This naturally restricts the choice of counterparties available to a non-UK lender.
Previous UK governments have intimated that SDRT would be abolished but as this tax is one of the simplest to collect, worth over £1bn to Treasury coffers annually, it comes as no great surprise that it still remains in place and that no firm plans exist for its abolition. The frustration felt by overseas lenders therefore remains.
The very successful introduction of both the CREST and CGOII systems (for equities and gilts respectively) has resulted in highly efficient borrowing and lending markets with extremely impressive settlement rates.
From June 2000, both of these systems will be merged and two subtley different markets will be forced together for the first time. The impact of the merger will of course be restricted to operational aspects only with the underlying lending markets remaining distinctly separate.
Wayne Burlingham is head of stock lending, Global Investor Services, HSBC in London