Section 2 - FTSE

THE SECURITIES LENDING ROUNDTABLE
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others at extracting value from this product- I’d call that
Alpha. It is not just about what your collateral mandate is
and what the size and composition of your portfolio is. It
is also about the expertise and capability of the people
doing the business.
MF: Broadly, to go back to the point about the collateralised
nature of the markets, right now most people’s fixed income
business is going like gangbusters. To put some numbers
around this, there is $3trn to $4trn a day being generated as
cash collateral (mainly in the US dollar) looking for a home.
Typically some of it is out there on the yield curve, some of it
is nearer the front end. Today, it is nearly all at the front end.
One of the biggest challenges for the re-investors of such
large pools of cash is finding a home for the money on a daily
basis. The supply of commercial paper has dried up and the
risk appetite of the re-investment agents and their
underlying principal clients has dramatically reduced. The
scale of this daily activity and its importance to the global
money markets is quite stunning. The sub prime crisis is very
different than say the LTCM crisis. This time, things are
different because the risk has effectively been syndicated
through hundreds of hedge funds, funds and broker dealers.
In the LTCM crisis the risk was concentrated in the hands of
about ten to 12 significant known counterparts. People do
not know who owns the risk positions today and it is only
going to be as we go through the results season that we will
begin to see where the damage lies. However, the importance
of the securities lending markets to the cash markets is
enormous. Without it, it is almost difficult to see how they
would efficiently function.This is the time when the old stock
lending cliché “that it is the liquidity that helps the global
machine of capitalism function”comes to the fore. It happens
to be true. It is the oil that keeps the machine going.
RS: With quarter end coming up as well that will exercise
everybody’s minds.
FC: Is the securities lending industry very skittish then?
JP: Unfortunately only a few people really understand all
the reasons why people borrow securities and most
borrowing is perceived as being done by a bunch of guys
who want to take a punt on Stock A going down 20% in
the next month, so what we don’t want to see is a blow up
which causes lending to be at the forefront of the client’s
mind, when really they ought to have other things to
challenge them than our lending programme.
THE USE & ABUSE OF VOTING RIGHTS
DR: There is a risk to the industry of unintended
consequences if regulators intervene to try to prevent
borrowing to vote. It is important that the industry presents
its case well to prevent that, but also that the industry
keeps its own house in order so that we don’t get abuses of
people borrowing securities in order to vote. I do think
though that this whole issue is going to get more
complicated with the introduction of long: short funds
alongside long-only funds in fund management houses.
And what we talked about earlier of an index fund lending
to another fund in the group that has a short position, who
decides how they vote? It is quite tricky and it is not
primarily a stock lending issue. Rather it is an inherent
issue of shorting becoming a more normal part of
investment management, which effectively separates out
the two functions of taking a position in a share and
owning a company. People are going to have to wrestle
with how those things are combined.
FC: What role is ISLA playing in encouraging good practice?
DR: ISLA can only go so far. I don’t think that ISLA can set
standards for how fund management houses should
manage themselves.
MC: A lot of equity borrowing is driven by dividend trading
strategies, and that confuses the issue from a corporate
governance perspective when you have a dividend and a
vote happening at the same time.
MF: It makes the charts look very spiky.
MC: Is there not merit in maybe decoupling those two and
having the dividends paid at a different time in the
calendar from the votes? Wouldn’t that make it easier to
spot voting or other corporate governance abuses?
DR: Yes, and we have said that that is more desirable. But
that is really down to the individual companies and again
it may not be at the top of their list of priorities.
MF: A contentious vote is obviously also a trading or arbitrage
opportunity for a trader. A vote for something that is
contentious is most likely to take the company in one direction
or another – positive or negative.That is a good opportunity for
a trader to take a position - be it long or short. So again, if it
really is a hot issue, you may get a lot of borrowing around that
time, not to actually secure a cheap vote, but to actually take
advantage of a market trading opportunity to the short side.
So it is very unfair of people that look at corporate governance
in a vacuum to say,“Another big spike around a vote! Surely,
another abuse of lending” These people would do well to
remember that there are dividends and there is legitimate
trading and the facts simply do not support the fiction on the
alleged charges in corporate governance. One of the best
industry responses to this wrong-headed attack is the detailed
data based research that ISLA and the London Business
School Hedge Fund Studies Group are doing with Data
Explorers. The objective is to get some independent research
concluded and facts established. To date the debate has been
hijacked by people who do not understand securities lending
and want to sensationalise it for their own benefit. I believe
that the facts will set the record straight.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS