The worlds’ Governments and regulators immediate response since the collapse of Lehmans was to temporarily ban and restrict short selling of financial related companies (the range of action taken varied by market), but the publicity and the connection between Stock Lenders and Short Sellers came into the mainstream media and the attention of politicians, news presenters and even the religious community!
The markets and financial companies in particular are still affected by falling share prices which has proved that the short-selling protection is not working; a re-think of the rules and restrictions is required in order to let the markets function as they should. The various bail-out agreements and toxic asset relief and insurance programs are intended to resolve the banking world’s liquidity issues which in-turn will restore investors’ confidence and correct the slump in share values.
Any further negative implications for the SBL industry will trigger a decrease in supply of securities to the SBL business as mutual funds, pension funds, government authorities and fund managers suspend new lending activity and possibly withdraw from existing positions due to the amount of negative publicity that short selling and securities lending have received. A small number of large institutions have already halted lending activity, it is not known if the decisions are permanent or temporary. Any reduction in securities that are made available for lending will decrease liquidity and subsequently lead to even more volatility in the markets.
In the light of short selling strategies related to companies at risk, lenders will demand that a greater level of disclosure and transparency is required of the SBL participants. This may give an increased level of confidence to companies, employees and union members that their pension and retirement funds are being invested wisely and within a set of new enforced ethical guidelines.
The various worldwide SBL trade associations joined together to issue a statement on short selling and SBL practices in regards to the market panic, further cooperation will be required to foster closer ties with the major regulatory institutions. A revised SBL ‘code of conduct’ may have to become a set of regulations in order to participate in the new world of financial markets that is evolving.
With the reduction in the numbers of investment banks – Bear & Lehman no longer trade, Merrill are now part of BoA and the new structure of Goldman Sachs and Morgan Stanley along with the reduction in the numbers of Hedge Funds, the impact to the demand for Securities Lending will take some time to settle in the aftermath of this financial crisis. Everyone is tightening their margins and increasing collateral haircuts, some of the smaller players have either been shut out or have withdrawn as the earnings no longer justify the risks.
A range of new restrictions from lenders will emerge once the situation has stabilised and as performances come up for review. There will be more counterparty, sector, company and collateral restrictions in place. Terms and types of collateral will disappear; cash collateral and cash re-investment funds have proved to be not so secure in a falling market, the quality demanded for non-cash collateral will rise and collateral margins will increase. The emergence of exclusive agreements over the last few years will now start to disappear due to counterparty risk measures. Tri-party collateral providers will be the winners as the Borrowers and Lenders try to come to terms with the ever more complex set of requirements that make it difficult for single lending agents to provide a comprehensive reduced risk service.
One area where there are a few new developments will be a move towards the use of Central Clearing Counterparty Services for Securities Lending. The aim of a Central Counterparty Service is to eliminate bi-lateral credit risk between lender and borrower and reduce the capital required to support securities lending transactions. This in turn is expected to lead to increased market volumes as participants access more markets and new counterparties.
Exchange and Clearing led developments are emerging but it will be down to ease of use, access to a wide range of counterparties, transparency and above all profitability while producing the promised reduced risk and capital usage for all participants. More to come as developments unfold....
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