GSL 008
Transcript of GSL 008
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Annual MembeGBP 249USD 379EUR 286
Plus: Asia - opening up?ERC Meeting round-up
MARKETS
Brazil, Russia
INDUSTRY INSIGHT
Euroclear, Northern Trust
PROFILE
Tony Venditti, Ashley Wilson
GlobalSecuritiesLending|
tll ndeege?
New regulatoy
mnefields
SL ISSUE 08 Q2 2010
www..tv
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2 | Global Securities LendingMagazine | 2010
Qick Qrr Vi
Lend an earIn my last letter I discussed
regulators research into short
selling and securities lending
and I was optimistic that much
of the resulting output was
positive news for the industry.
I also dubbed 2010 The Year of
Collateral, but now it seems that
The Year of Regulation deserves
equal billing. GSL has so far
hosted four summits in 2010, and
regulation has been an increasinglyhot topic among panellists and
audience members alike.
We have seen a wave of new short
selling restrictions in developed
markets, new guidance for benecial
owners from the UK Pensions
Regulator and even repo entered the
mainstream medias parlance with the
publication of a damning report on
the Lehman Brothers bankruptcy.
In this issue GSL looks behind
the Repo 105 headlines and
takes an in-depth look at the
new US short selling restrictions
as well as discussing how the
industry can ght back.
But if developed market news
has been less than rosy since our
last issue, various reports from Asia
have caused many to be optimistic.
We look at the short selling and
margin trading trials being set up
in China and provide a detailedoverview of some of the liberalising
developments in the Indian market.
Additionally, some of the
panellists at the recent PASLA
conference provide their summary
on what was deemed by many
attendees to be a great event.
Moving to the southern
hemisphere, we provide a prole
of the Australian market and
look into some exciting new
developments taking place in Brazil.
Our increasing focus on repo,
collateral management and liquidity
continues as Godfried de Vidts
provides us with a review of the
recent European Repo Council
meeting. This is a follow up to
Godfrieds excellent industry
summary which appeared in the last
issue of Investor Services Journal.
Finally, the magazine features
two executive proles, with TonyVenditti of BMO Capital Markets
talking about his career in securities
lending and his outlook for the
future, and Ashley Wilson of
Barclays Capital outlining his plans
for growing the prime services
division at the British bank.
Z
Roy Zimmerhansl, Editor-in-Chief
Asian promise
Godfried de Vidts
Tony Venditti
Chris Poikonenon Brazil
Repo 105
Ashley WilsonIgor Marichon Russian repo
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4 | Global Securities LendingMagazine | 2010
cNN
Editor-in-Chief
Roy Zimmerhansl
Deputy Editor
Craig McGlashan
Contributors
Anthony Harrington
Cherry ReynardLeanne Wang
Business Development Manager
Richard Marshall
Front Cover
Morgan Miller
2i UK, 16-17 Little Portland Street,
London W1W 8BP, UKT: +44 (0) 20 7299 7700
F: +44 (0) 20 7636 6044
2i USA, 410 Park Avenue,
15th Floor, New York, NY 10022
T: +1 212 231 8421
F: +1 212 231 8121
2010 2i Media
All rights reserved.
No part of this publication may be
reproduced, in whole or in part,
without prior written permission from
the publishers.
ISSN 1759-0728 Printed in the UK
Contents
6 | News
Top industry stories.
10 | xeutve pofile
Tony Venditti,
BMO Capital Markets
12 | cong up shot
US short selling restrictions
16 | in ehan's tes
Investigation into Repo 105
18 | fghtng ba
The industry's response
22 | eung the utue
Ashley Wilson,
Barclays Capital
26 | azl shapes up
The Brazilian market
32 | estng te n chna
Margin trading, short selling
trials in China
34 | indan outlne
Description of the Indian
market
36 | & rm
Panel summaries from the
conference
News
eople
asten ose
tll nde ege
It's like stopping a soldier fromshooting when the general has giventhe command to go to war. Theregulators are reacting to the publicperception, but this did not happenbecause people were shorting stocks"
Who said this?
Find out, page 13
futue Vew
copanes/nsttuons
eatued n
alays captal 22,24
m captal maets 10,11
cental nvesty o fnane &
onos (chna) 33
cleastea 56,57
avs ol & adwell 12,13
eutshe an 26,28
eeendng 28,30
uex repo 57uolea 48
uopean repo counl 44-46
uota Juna 33
katten muhn rosenan
consh 13,14
aven atnes 13,14
mic 50,52
Natonal to xhange
(inda) 34,35
Nc (russa) 50,52
New ppoah r 20
Nothen ust 64
36-44
rm 18,20
noln eutes 32
unad 18
ncedt 57
c mashall hool o
usness 14
nast 33
GlobalSecuritiesLending|
Head of Sales
Patricia De La Grange
Account Managers
Cicely Lewis
Eradat Munshi
Chief Technology Ofcer
Peter Ainsworth
Operations Manager
Nicolette Whittaker
Managing Director
Jon Hewson
CEO
Mark Latham
GSL is part of
2Media
44 | ost-rc eetng
with Godfried de Vidts,
ERC chairman
48 | Natual ollateal
with Olivier Grimonpont,
director, head of collateral
services at Euroclear
50 | russan epoluton
The post-crisis Russian
repo environment
54 | uts
report on the GSL Nordic
and London Summits
56 | lobal eutes
fnanng ut
58 | enefial wnes
intenatonal eutes
endng & repo ut
60 | etoy
64 | Nothen ust
repo & collateal
coneenes
etoy
ende pofile
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6 | Global Securities LendingMagazine | 2010
SunGard appointed Chris
Clark as European senior
vice president for its
Astec Analytics business
unit, which specialises in
trading, perfomrmance and
programme management
for the global securities
nancing industry.
eSecLending, the securitieslending agent, appointed
Ross Bowman as senior
vice president of client
relationship management,
servicing the rms UK
and European based
clients.
Bowman moved from
BNY Mellon, where he
was responsible for the
management of existing
client relationships and
business development
for the securities lending
business across theEuropean, Middle Eastern
and African regions.
Pat Cestaro leftJ.P.
Morgan, following a
30-year career in the
securities lending business.
Cestaro was responsible
for building up the prime
brokerage business at Bear
Stearns before the rm was
bought up by J.P. Morganin 2008.
Hector Sants, CEO of UK
regulator the Financial
Services Authority (FSA),
is to leave his post in the
summer after three years in
charge of the organisation.
The European Central
Bank (ECB) made a new
appointment as it seeks todeal with system risk in
the nancial sector, with
Mauro Grande taking up
the role of director general
of the Directorate General
Financial Stability.
Sun Microsystems
veteran Masood Jabbar
has become the fth
independent director
appointed to the board
ofCalypso Technology, a
provider of trading, risk
and processing platforms.
Jabbar spent 16 years
at Sun Microsystems,
reaching the level of
executive vice president
of global sales operations
before leaving the rm in
2002.
The Risk Management
Association (RMA)
appointed Christopher
R Kunkle to the role ofdirector for securities
lending and market risk,
replacing the retiring
Curtis Knight.
Merlin Securities co-
founder Andy Lando has
returned to the rm in a
senior partner role which
will see him head up
the rms new securities
lending group. Lando, aformer managing director
and global head of
securities lending at Banc
of America Securities, was
one of the ve founding
members of prime
brokerage services and
technology provider Merlin
in 2004.
LCH.Clearnet Group
appointed a new non-
executive chairman,
Jacques Aigrain. Aigrain
replaces Chris Tupker, who
announced his intention
to step down in September
2009.
Brown Brothers Harriman
(BBH) upped its presence
in Asia following the
appointment ofRobert
Lees and Richard Meek
respectively as head of
securities lending trading
and head of securities
lending relationship
management for the Asia
Pacic region. Both men
will move to BBHs Hong
Kong ofce, with Lees
reporting to Jeff ONeill,
global head of securities
lending trading, and Meek
to Elizabeth Seidel, global
head of securities lending
relationship management,
business development
strategy and marketing.
Business and IT
consultancy Rule Financial
appointed Dr Chris Potts
as CEO, a move which the
rm said was part of its
plan for global expansion.
Potts moves from 3i
Infotech, where he was
president and CEO of the
rms Western Europe
division. He has also heldhigh-level roles at Cap
Gemini, Cap Consulting
and Misys Asset
Management.
Amaces appointed former
State Street and Aegon
Asset Management client
managerTom Robertson
as a director. Robertsons
most recent role was
at Legal and General
Investment Management,
where he was a client
account manager.
Joe Cassidy will take up
the role of head of prime
brokerage and derivatives
clearing for global rates at
Deutsche Bank in May.
He will report to Fredrik
Gentzel, head of credit
portfolio management and
prime brokerage for global
rates and commodities.
Cassidy moves from
Nomura where he has
held a number of roles,
including global co-head
of prime services, global
COO of prime services,
head of equity strategy
and head of European
corporate strategy
N
News Round-up Top industry stories at deadline.For daily updates go to www.gsl.tv
People Moves
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8 | Global Securities LendingMagazine | 2010
Richard Newman will join
Deutsche Bank as a senior
risk manager for global
prime nance within the
global markets division,
the bank announced
today. Formerly head of
European prime brokeragerisk management at J.P.
Morgan, Newman who
takes up his new role
on 4th May will be
responsible for providing
risk management solutions
to hedge fund clients with
a European focus.
The Chinese regulatorapproved a short selling
and margin trading trial.
British MP Frank Field
criticised custodians over
their securities lending
programmes, after a
pension fund told him
it had been entered into
a programme without
permission.
At the same time, the UK
Pensions Regulator issued
guidance for benecial
owners.
ISLA approved
amendments to the Global
Master Securities Lending
Agreement 2009.
A Bank of England deputy
governor called securities
lending "absolutely vital"but called for reforms.
German regulator BaFin
lifted its uncovered short
selling ban.
Northern Trust was sued
by the Public School
Teachers Pension &
Retirement Fund of
Chicago and the City
of Atlanta Fireghters
Pension Plan, over claims
that the bank broke its cash
collateral reinvestment
pledges.
The National Stock
Exchange of India (NSE)
held a special live tradingsession on 6th February
2010 for its securities
lending and borrowing
scheme.
The US Securities and
Exchange Commission
introduced new short
selling restrictions.
Former Morgan Stanley
and Banc of America
stock loan trader Salvatore
Zangari was charged by
the US Securities and
Exchange Commission
(SEC) over alleged
kickbacks from Clinton
Management, a Brooklyn-
based loan nder.
State Street succeeded in
dismissing a complaint
from a law rm over
an alleged breach of
prudence and loyalty
within its securities lending
programme.
The City of St Petersburg
suedWachovia Global
Securities Lending,
claiming that the bank
broke the terms of its
securities lending contract
by investing cash collateral
in Lehman Brothers bondsand failed to act when
the now-defunct bank
appeared to be in trouble.
Citigroup was ned
USD650,000 by the
US Financial Industry
Regulatory Authority
(FINRA) for violations in
its Direct Borrow Program
(DBP).
The Investment Industry
Association of Canada
(IIAC) selected the
Canadian Derivatives
Clearing Corporation
(CDCC) to develop acentral counterparty for
the Canadian repo market,
in a move welcomed by
the countrys central bank.
Bank of Canada governor
Mark Carney described
the move as a critical rst
step and cited the effect
of an efcient repo market
in helping the countrys
core markets function
continuously.
A loophole in the UK
Corporation Tax Act 2009
which could allow rms
to avoid paying tax on
manufactured payments
in repo transactions
was closed by the UK
government.
The long-awaited
report into the collapse
ofLehman Brothers
has criticised senior
executives at the rm and
highlighted the large role
of an accounting practice
known at the bank as
Repo 105. The report,
written by lawyer Anton
Valukas, outlined how the
bank used Repo 105 to
give its balance sheet a far
healthier appearance than
it warranted, in the run up
to its bankruptcy in 2008.
There was a strong
recovery in the European
repo market, the latest
survey from the European
Repo Council (ERC) of
the International Capital
Market Association
found, although the study
included pessimistic news
for the UK economy.
Investment bank BOCI,
a subsidiary ofBank of
China, implemented
SunGards Global One
securities nance solution
to help boost its recently
launched securities lending
business. BOCI will use
the Global One Lender
module to support its
lending business, which
lends Hong Kong and
Chinese stocks listed on
the Hong Kong Stock
Exchange.
Syncova and RiskMetrics
Group announced plans to
launch a risk-based margin
management solution via
the OPTIMA platform for
hedge funds and prime
brokers. The integrated
solution will include
features such as VaR
and client-specic stress
scenario based margining,
what-if scenarios and
combined risk and margin
rule-based portfolio alerts.
LocateStocks real-time
stock locate platform
Matador was launched on
ConvergEx Groups order
management system, the
Eze OMSTM.
BNY Mellon enhancedits Workbench reporting
platform with a new
securities lending
dashboard, aimed at asset
owners and managers.
Clients will now be able
to access data including
earnings, loan values and
credit quality from both
an executive summary and
detailed view point. Z
N
Repo
Securities Lending
Technology
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LCH.Clearnet: the essential link in the chain
In the event of member default, LCH.Clearnet guarantees the management of positions thereby protecting thenancial community against the risk of contagion.
LCH.Clearnet is the leading independent central counterparty group (CCP) in Europe, serving major internationaexchanges and platforms. It clears a broad range of asset classes including: securities, exchange traded deriva-tives, energy, freight, interbank interest rate swaps and euro and sterling denominated bonds and repos.
www.lchclearnet.com
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10 | Global Securities LendingMagazine | 2010
ciV rfi
The beginning to Tony Vendittis
securities lending career may
have been a case of right place,
right time, but his rise through
the industry was anything but. A
securities lending operations position
opened up when he was applying for
a job at Mabon Nugent Securities
and, despite having never heard of
the business before, he thoroughly
enjoyed his new position.
He explains: Six months later I
approached one of the partners at
the rm about a front ofce move.
He said, Id much rather youd be
a bond sales assistant, youll have a
great career this stock loan thing
will be automated in two years and
everyone will be out of a job. That
was 1985.
Rolling on 25 years, manual
securities lending is still here and
so is Venditti, by way of two stints at
Paloma Securities, with a number of
years at Nomura in between. Now he
is at BMO Capital Markets, after the
bank took over Paloma Securities in
November 2009.
So what has changed during his
time in the industry?
When I started, it
was interesting how
many people said
securities lending was
hard to understand I
thought it was one
of those things that
if you understood
stocks, pricing and
interest rates, it all
made sense, so I
was fascinated how
the smartest people
would always say, I
dont understand that
part of the business.
Back in the 1980s it
probably was true,
but now when you look at pricing
and liquidity, it shows probably
the biggest change of the past 25
years - how integral it is to so many
platforms and companies.
Venditti is keen to talk about this
history of the industry in terms of
phases, marked by major events.
I think the Asian crisis, where
liquidity really dried up, was the
rst elevation of the business, with
securities lending and repo being
used to protect liquidity. It was no
longer just an operational business
but a funding business. I also think
that, with the growth of hedge funds
in the 1990s, stable access to supply
and pricing became much more
important.
Now were into the transparency
phase. I think the credit crisis of
last year will bring much more
transparency what people are
doing, how they are doing it, how
they book it. However, Ive never
been one to say that the business
is that opaque, its like any other
market, its about how active you
are.
Venditti counts his achievements
during his second stint at Paloma as
among his best. When I went back
to Paloma it had just lost a lot of its
front ofce employees. My challenge
was to take a strong securities
lending platform, with a fair amount
of counterparties, and expand the
business.
We used the existing counterparty
base, the existing operations and
brought in strong front ofce people
not only focused on securities
lending, but also nance, delta one
trading and later government bond
repo. We turned it from just a global
Tony Venditti,
BMO Capital MarketsCraig McGlashan talks to themanaging director of BMO CapitalMarket's securities lending team,about his past and future
"Our securities lendingbusiness was really ableto self nance itself and
it proved that securitieslending can helpproprietary trading andindex arbitrage"
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2010 | Global Securities LendingMagazine | 11
ciV rfi
We felt, given the relative strength of theCanadianbanks through the crisis period, that we had
an opportunity to look for growth and the ability to
expand. It gave us an opportunity to consider areas
where credit rating, stability and so on were important
for businesses and their success.
The securities lending business is one where we
saw an opportunity to look for growth and the ability
to expand. So thats what led us to spend time with
Paloma and investigate the opportunities around the
acquisition.
At this point we are focusing on operating in all
the jurisdictions thatPaloma was operating in before we expand into any new
jurisdictions. We are three months into the acquisition
now and from our perspective things are going very
well, its been a very smooth integration process, and
we are very impressed and very happy with how the
business had been run and continues to be run.
That said we constantly keep an eye on where
market growth is occurring and are always interested in
extending core businesses and as opportunities present
themselves we make sure that we are in a position to
take advantage of them.Z
securities lending shop to trading
nance repo. Our business really
grew in the three years I was there,
we had a great run and that led us to
BMO.
He says his time at Nomura
helped pave a lot of my success.
Specically, during the Asiannancial crisis when the bank
was downgraded, our securities
lending business was really able
to self nance itself and it really
proved that securities lending can
help proprietary trading and index
arbitrage.
But the move to Paloma allowed
Venditti freedom to take what he had
learned and use it in an environment
where he was able to exert greater
change.I touched a lot of businesses at
Nomura. Nomura was very equity-
nance driven and we used all our
collateral quite effectively, and at a
smaller player like Paloma that model
tted perfectly, he says. Also, at
Nomura, I was only on the equity
side so I couldnt intertwine with
xed-income products or repo, but
when youre at a smaller shop you
have more control so its easier to
bring on businesses not really byproduct but how you can integrate
them with your client base and
infrastructure.
So now
that Paloma
is operating
under the BMO
name and
stable, what are
Vendittis plans
for the business?Paloma was
never a rated
counterparty
even though we
had the benet
of long-term relationships and
transparency in our nancials, and
a credit department that discussed
our structure and capital effectively -
because of this we were lucky enough
to have many counterparties treat us
as an investment-grade counterparty.That being said we always were
looking to do more business - in turn
eventually we needed more credit
which led us to BMO. BMO has a
very sound name. The institution has
been around for a long time and has
a solid reputation. We look forward to
using BMO as our credit instead of
Paloma as a hedge fund in hopes of
continuing to expand our business.
However, Venditti feels that the
acquisition will also boost BMOsother offerings. The one thing that
were really hoping is that our global
platforms could help propel some
of BMOs existing sales and trading
businesses, he says.
So aside from Vendittis plans for
BMO, what of the industry as a
whole? I think the industry has a lot
more room to grow and the market
making side of securities lending -
where its much more active - willbecome more electronic, he says. I
think one of the stumbling blocks as
always is about where the credit will
go CCP will have a role, Im not
sure how it will play out, but I think
you will see change there.
Venditti bet against
automation at the beginning of his
career and it proved fruitful if he
is right this time, it certainly proves
how much the industry has moved on
since 1985. Z
Luke Seabrook, executive managing director &head of nancial products at BMO Capital Markets,outlines the reasons behind the Paloma purchaseand BMO's current plans for the business
Factle: BMO Capital Markets
Employees: 2,200
Clients: Nearly 8 million
Total Assets: USD373 billion
2009 Revenue: USD9.6 billion
Tier 1 Capital Ratio: 12.24%
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12 | Global Securities LendingMagazine | 2010
tll nde ege?2010 has seen oe egulatons, lawsuts andnegatve pess o the seutes lendng ndusty
n the next ew
pages we exploe
soe o the ajo
developents and
how the ndusty
an fight ba
Coming up shortNew US rules on short selling have been poorly thought out - and couldspread across the Atlantic, ndsCherry Reynard
The Securities and Exchange
Commission (SEC) has been under
pressure to introduce new rules
on short-selling for some time.
Approximately 4,400 companies
have petitioned the SEC to clamp
down, with industry heavyweights
such as John Mack, chairman of
Morgan Stanley, blaming short-sellers for perilously driving down
company share prices in 2008. The
new rules have nally emerged. What
impact are they likely to have?
The SECs new rules aim to
promote market stability and
preserve investor condence by
placing restrictions on selling stock
short if a company is experiencing
signicant downward price pressure
on their share price. The alternative
uptick rule will restrict short-sellers
from driving down the price of a
stock that has dropped more than
10% in one day. Once this circuit
breaker is triggered, holders of the
stock will be rst in line and can sell
their shares before any short sellers.
Once the circuit breaker has
been triggered, the rule applies toshort sale orders for the remainder
of the days trading, plus that of
the following day. It applies to
all equities listed on a national
securities exchange, whether they
are traded on an exchange or over-
the-counter. Importantly, it offers
no exemption for market-makers.
Also, companies will be required to
have written procedures in place to
prevent the execution or display of
prohibited short-selling transactions.
Robert Colby, deputy director of
trading and markets division at law
rm Davis Polk and Wardwell says:
It is not a complete prohibition.
It means that a short-seller cant
execute at the bid price. This means
they cant chip away at the price
people are willing to buy. If, forexample, a stock is trading at 105-110
and a trader was trying to short-sell
and it triggered the circuit breaker,
they could no longer sell at 105.
They could only say that they were
willing to sell at 106 up to 110 and
wait for people to come to them.
The SEC is clear in its intent. SEC
Chairman Mary L Schapiro says
that the ruling recognises that short-
selling can have both a benecial
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2010 | Global Securities LendingMagazine | 13
r iN
and a harmful impact on the market.
She continues: It is important for
the Commission and the markets
to have in place a measure that
creates certainty about how trading
restrictions will operate during
periods of stress and volatility.
There has been considerabledebate as to whether the new rule
will achieve its goal of greater
stability. The Securities Traders
Association issued a lengthy response
to the SECs regulations, suggesting
that they were based on inadequate
analysis, a lack of empirical data, and
questionable rationale by the SEC.
It also accuses the SEC of not
being consistent. It says in its letter
to the SEC: This inadequacy
was noted by SEC CommissionerParedes in his opening statement...
there is an insubstantial empirical
basis to support the commission in
adopting the rule, especially in light
of the rigorous economic analysis
that led the SEC to repeal the
original uptick rule in 2007 after
years of study. The commission bears
the burden to justify its rules. It has
not done so in this instance. The
regulations were voted through the
SEC on a paper-thin 3-2 majority.The STA suggests that the new
regulation will not resolve the issue
of manipulative short-selling that it
was designed to address. As such,
it cannot bring about the investor
trust as intended. It will also
have signicant implementation
costs. Many broker dealers, for
example, will need to upgrade
their computer systems to ensure
that they can distinguish between
short-sellers and those investorswho hold stock and wish to sell.
In particular, the STA requested
that the regulator make an exemption
for options market makers, saying:
The nature of the derivatives market
is such that market makers must
be able to hedge their positions
easily and cheaply to reduce trading
costs. Failure to do so would
cause a decoupling of prices in the
options markets from the prices
of the underlying instruments.
This would result in reduced
liquidity and wider spreads to the
detriment of individual investors.
The group believes that the
regulations may be counter-
productive, resulting in less liquidity,
greater volatility, and wider bid-ask spreads, none of which is
conducive to boosting investor
condence. Furthermore, a short
sale restriction that makes it more
costly for investors to manage their
risk by hedging can hinder the ability
of companies to raise capital.
With the two sides clearly
delineated, what do industry
participants believe will be the
likely outcome of the regulations?
Jerome Lussan, managing director
of hedge fund consultancy Laven
Partners, says: This will impact all
international hedgers operating in
US markets. It will limit their abilityto make prots in falling stocks.
That said, it doesnt kick in until
there has been a 10% drop, which is
relatively rare, but if you sell stock
with small volumes it could happen
a lot faster. Therefore mid and small
cap managers may nd themselves
disproportionately affected.
It has been suggested that
the decision could have a
disproportionate impact in the
equity options world, as market
makers will not be able to hedge
their risk without an exemption.
Lussan believes the market-maker
restrictions could result in a loss
of liquidity. Market-makers receive
no help in trying to hedge their
positions and will therefore be lessinclined to make a market in certain
stocks. Plus, a perfect hedge becomes
more difcult because it cannot be
predicted whether the stock will
be hit by the new regulations.
Edward Black, special counsel at
law rm Katten Muchin Rosenman
Cornish, explained that in the UK,
the disclosure obligations apply
to short sales whether of a stock
or a derivative on it. The new US
restrictions only apply to short salesof the actual security. The impact of
the restrictions will depend on the
nature of future market movements.
The SEC has said that its approach
establishes a narrowly-tailored rule
that will target only those securities
that are experiencing signicant
intra-day price declines and that
it believes that addressing short
selling in connection with such
declines in individual securities will
help address erosion of investorcondence in our markets generally.
There is still debate on the likely
impact of the new regulations on
trading. The SEC has suggested that
on an average day approximately 4%
of the market would be hit by the
circuit breaker. This gure would
rise during a more volatile period.
Colby says: It is difcult to predict
how it is going to affect trading. It
means some people are in some
cases - not going to be able to hedgeby selling short and it may be at a
time when they most want to hedge.
Overall, it is likely that if someone
thinks the market is falling, they
will have to act immediately. As
such, it will make hedging more
unpredictable. Lussan agrees that it
will become more difcult to predict
how a stock will fall, adding: It may
fall 5-6% and then fall very hard.
Larry Harris, professor of nance
It's like stopping asoldier from shootingwhen the general hasgiven the command togo to war. The regulatorsare reacting to the publicperception, but this did
not happen becausepeople were shortingstocks"
Jerome Lussan,Laven Partners
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r iN
something must be done mentality
in reimposing a new price-based test.
The European exchanges have
similar, though less onerous, trading
restrictions in place. The London
Stock Exchange, for example, has
an automatic suspension period in
place to provide a pause in trading
when stock prices move severely.It can suspend any stock at its own
discretion if it believes that market
manipulation is taking place.
However, Black says that for the
most part, the US and Europe are
pursuing different regulatory models.
CESR and the FSA are focusing on
public disclosure and the ability to
intervene in an emergency rather
than any generalised restrictions. In
the US FINRA regulated broker-
dealers are obliged to report toFINRA twice each month all short
interest positions in all customer
and proprietary accounts in NYSE
and other listed securities as well
as OTC securities. That reporting
is on a combined basis and only
global short positions in issuers are
published, not individual positions
held by any broker or customer.
The goal of strengthening public
condence is sufciently nebulous
to make any real judgement on thesuccess of the rules difcult. With a
relatively small majority in favour of
the new regulations at the SEC, there
may be room for a re-examination
of the rules on market-makers and
possibly for a full change of heart
if the rules are found to create
additional volatility. Lussan sums up
the view of many when he concludes:
This is the least bad alternative.
The market was expecting something
and was afraid it could be worse.Z
but the crash happened because
there was insufcient regulation of
banks. Its like stopping a soldier
from shooting when the general has
given the command to go to war. The
regulators are reacting to the public
perception, but this did not happen
because people were shorting stocks.It is difcult to see how the new
regulations will act to stop additional
market abuse. The SEC had already
introduced changes to tackle
manipulative and naked short selling.
In normal circumstances, if RBS
looks over-valued, the short-sellers
move in and create a temporary fall
in the share price, but then the shorts
go too far and the long investors
come in and scoop up value. Black
suggests that much of the criticismof short selling should properly
be directed at market abuse; for
example the spreading of negative
rumours to articially depress prices
accompanied by short selling.
There has often been a creep
in US legislation across to the
UK. Clearly the new regulations
will affect all European traders
operating in US markets, but could
its impact be more widespread than
that? Lussan says: The EuropeanCommission has recognised that
hedge funds are not responsible. But
it may creep in because everyone
trades in US markets. America likes
to be the worlds policeman and
tends to take a populist approach.
Black says: Different regulators
have come at regulating short selling
in different ways. Some regulators
appear to be more suspicious of the
potential for short-selling to be used
for market abuse, while others believeit is a legitimate technique. The FSA,
for example, takes the latter view. It
has said that while it reserves the right
to introduce emergency short-selling
rules if market conditions warrant
it, the focus of its regulation of short
selling is to require more disclosure
of short-selling positions. CESR
has similarly proposed enhanced
disclosure of short positions. The US
appears to have displayed more of a
at the USC Marshall School
of Business, has suggested that
the new rules may prevent the
efcient functioning of markets.
Without short sellers, prices of
deteriorating stocks may be kept
articially high, leaving investors
potentially paying too high a price.The SECs focus on equities leaves
a huge amount of hedge fund trading
out of scope. Although there has
been pressure to limit the activities of
hedge funds in the market generally,
the SEC seems primarily concerned
with the proper functioning of equity
markets. This is also where much
of the pressure has been coming
from USA plc has put pressure
on the US government to stop it
shorting its stock. Other hedge fundactivities simply do not generate
the same amount of pressure.
This supports the view of Lussan
and others that the measure is
populist rather than necessarily to
ensure proper control of markets.
Erik Sirri, who ran the SECs
division of trading and markets
during the credit crisis that began
in 2007, has gone on record to
say that commissioners who voted
for curbs when a given stock falls
10% from the prior days closing
price did so without proof that
it would improve markets.
Lussan agrees: What are the rules
trying to achieve? The uptick rule
was rescinded in 2007 and is now
being reintroduced. The SEC has
said that its aim is to protect markets,
The US appears tohave displayed moreof a 'something mustbe done mentality' inreimposing a newprice-based test"
Edward Black,Katten Muchin
Rosenman Cornish
The commission bearsthe burden to justify itsrules. It has not done soin this instance"
Securities Traders'Association response tothe SEC
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Your ambition. Our purpose.
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In Lehman's terms
When is a repo not a repo? The answer, if you
are Lehman Brothers, is any time you provide 105%
more collateral by way of value than the cash you
are borrowing! Called a Repo 105 transaction, the
deal can legally be classied as a sale rather than as
a straightforward repo arrangement at least in the
opinion of law rm Linklaters, who advised Lehman.
But let us back up a few steps for the sake of any
readers out there who have not yet digested an article
or two on the subject of the Court Examiners 2,200
page report into the Lehman failure. It is important to
bear in mind that Anton Valukas, the Court Examiner,and chairman of the US law rm Jenner & Block, was
not asked to nd guilt, but to explore whether there
were colourable claims (actions that might constitute
grounds for litigation) against Lehman ofcers or
third parties. Whether or not those colourable
claims actually result in actions and in parties being
found guilty or liable is a matter for another day and
a different forum, as far as Valukas was concerned.
To the casual observer, which translates roughly
to anyone not involved in day-to-day repo activity,
the truly astonishing thing about this accounting
gimmick (the term used by some senior Lehman staffto describe the Repo 105 transactions), is the idea that
any serious minded person could simply pretend that
one half of a repo transaction isnt there. Consider
the following instance. I give you cash. You give me
collateral. I expect to get my cash back. You expect
to get your collateral back. This is not the same thing
as: I give you cash, you give me assets. In the latter
instance, we have a sale, in the former, a repo deal.
Linklaters has come under tremendous re for
being so obliging in its opinion. As Valukas pointed
out: Lehmans conducted its Repo 105 programme
under the aegis of an opinion letter the Linklaterslaw rm in London wrote for Lehman Brothers
in Europe, Lehmans European broker-dealer in
London, under English law. The UKs legal regulation
body, the Solicitors Regulation Authority (SRA) is
reported to be considering the Valukas Report and
Linklaters role, which of course, does not mean that
Linklaters was wrong. We are aware of the report
and we are currently reading it. After, we will decide
whether or not any regulatory action should be
taken, it said. (See http://www.cityam.com/news-
and-analysis/linklaters-put-alert-over-lehman-help).
The law rm itself has issued a statement to the
The fallout from the discovery of "Repo 105" transactions on the books ofLehman Brothers may have a long way to run, ndsAnthony Harrington
following effect: The Examiner who did not
contact the rm during his investigations does
not criticise those opinions or say or suggest that
they were wrong or improper. We have reviewed
the opinions and are not aware of any facts or
circumstances which would justify any criticism.
To understand Linklaters condence in this
matter, one needs a little inside knowledge of exactly
how Repo 105 has played on the street, as it were.
A securities lending source told GSL: Basically,
Im sick of all the blather over Repo 105. Everyone
post-Valukas pretends they didnt do it, but it wasa widespread and commonplace practice and it
had a benecial impact in that it enabled broker
dealers to address risk on their balance sheets
and to provide more liquidity to the market.
What Linklaters is probably relying on is the concept
of true sale as set out in FAS 140. In brief, a true
sale rather than a collateralised loan can be deemed
to have occurred where the borrower can be said to
have lost control of their collateral. The question
then is, what constitutes loss of control? The answer
comes down to the way in which normal collateralised
deals are marked to market. If you collateralise aloan in the normal way with 100% collateral, and the
value of your collateral shrinks or grows, the collateral
pool is adjusted to compensate for the movement.
In a Repo 105 transaction mark to market is
suspended until the market movement is violent
enough to move beyond some hurdle, such as 112%.
For the period where mark to market is suspended,
the collateral provider is deemed to have lost
control of their collateral, and this transaction in
jurisdictions that accept this rule can be deemed
a true sale. The other proviso is that it cannot be
an overnight loan. However, three days or more areconsidered safe. What was possibly unusual about
Lehmans case is simply the scale involved and the
fact that the transaction, in the words of some senior
Lehman nancial people, had no substantive basis
other than to shift debt off the balance sheet.
For the fourth quarter 2007, Lehman deployed
Repo 105 to shift USD38.6 billion of assets off its
books. In Q1 2008 it upped that to USD49.1 billion
and in Q2 2008 it upped it again to USD50.38
billion. In each instance it was good quality assets that
Lehman provided as collateral against the loan and
r 105
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fiiN ck
in each instance it treated this as a sale, increasing
the amount of cash on its books and decreasing its
leverage by 1.7 percentage points, 1.9 percentage
points and 1.8 percentage points respectively.
To put this in context, in its own internal risk
management, Lehman regarded a movement of 0.2%
of leverage as signicant. In other words, this was
window dressing on a grand scale, unless Lehmansnance team can show that the Repo 105 device actually
served some solid purpose other than to window
dress the quarterly accounts. So far, to my knowledge,
no such alternative purpose has materialised.
Of course, it is not only Linklaters who are under
scrutiny in the aftermath of this wheeze. Valukas also
agged up Lehman auditors Ernst & Young, and was
less than happy with the audit rms decision to allow
Lehmans use of the Repo 105 device to pass without
comment. However, Ernst & Young too, are taking the
view that they stand by their 2008 audit and since they
had not yet done the 2009 audit, wheres the problem?
One outcome from all of this, some way down
the line, is likely to be yet another blitz on window
dressing. However, looked at purely from the
standpoint of a potential case for the defence,both Linklaters and Ernst & Young would seem to
have quite a bit of solid ground to work with. Repo
105 was widely used and the securities lending rms
who provided it took detailed legal opinion - not
just from Linklaters - and they were relying on a
well-publicised Financial Accounting Standard. It
will be interesting to see how this one runs.Z
Fighting backCraig McGlashan gauges opinion on what the industry can do to improve itsimage and help ensure regulators are on side
The hits that the securities
lending industry has taken and
continues to take since the onset of
the nancial crisis are too numerous
to list here few jurisdictions have
not felt some sort of pain. But what
can the industry do to ght back?
Curtis Knight, former director for
securities lending and market risk at
the Risk Management Association
(RMA), believes that a global
industry needs global harmonisation
to deal with its problems and this
includes making sure that regulators
thinking is in tune with the industrys
needs.
Global harmonisation will be
extremely important in making sure
that the correct risk management
tools are being used, that regulators
are working together - and in
conjunction with industry players -
to make sure that the best possible
regulation is being enacted, he says.
I cant see another more
important issue right now. We can't
have situations where one rule in
one jurisdiction conicts with one in
another jurisdiction.
This potential disconnect between
the rules governing different regions
can perhaps be most felt by the many
businesses in the industry which run
a global offering, not least in terms of
the technology they deploy, he adds.
Jane Milner, a market specialist
at SunGard Securities Finance,
describes disparate regulations
as a challenge for the business.
She adds: The US is by far the
most regulated market, with 15c3-
3, RegSHO, Rule 402, Agency
Lending Disclosure and the more
recently introduced short sale circuit
breaker. In the rest of the world
the problem is in some ways more
complex in that regulations vary by
jurisdiction. The recent attempt by
CESR to set standard guidelines for
new post-crisis regulation seemed
somewhat undermined by the
German regulators variation from
the standards.
Interestingly, this problem can be
exacerbated by impacts from other
markets too. Integration issues
may occur when the regulatory
requirement is not exclusive to the
securities nance market, and data
from a securities nance solution
needs to be consolidated with data
from other systems, she says. To
handle this it is important that a
solution has the exibility to export
data on demand, in a user-denable
format with as little need for IT
development as possible.
Milner does feel that current
technology standards are able to
meet this challenge. Typically when
functionality is potentially re-usable,
it would be built in a exible way to
allow it to be adapted as necessary
to a similar, but somewhat different
requirement.
However, even if technology will
be able to meet the challenge, the
problem still exists for the industry
of rules being created on an ad hoc
basis, with each country causing
problems for another.
So what of Knights call for
harmonisation among the various
industry bodies? Chris Kunkle, who
took on Knights role at the RMA,
explains that this process is already
taking place.
My personal key effort just now
is two-fold; its to improve the global
coordination and communication of
the industry associations and their
sub operations, and by that I mean
working with the other bodies.
18 | Global Securities LendingMagazine | 2010
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20 | Global Securities LendingMagazine | 2010
fiiN ck
The regulators and IOSCO are
coordinating very well across borders
just now and before they make snap
decisions without a lot of expertise or
a view from the industry, I want us
all to be able to communicate both
the positive and the negative issues.
ISLA, PASLA and ASLA hadtheir rst joint operations meeting
last December and those things will
go a huge way to helping. RMA is
coming into that now.
Indeed, an Industry Leaders panel
took place at the recent PASLA
conference, featuring gures from
some of the major institutions (read
the summary on page 42).
However, this effort to work
together is only one half of the
puzzle, according to Kunkle: Wehave a major effort to improve
education for regulators, academics,
benecial owners and eventually
for the press. We are going through
a serious time and the RMA,
during my last executive committee
participation term, started meeting
with the Fed, the SEC and the OCC
on a periodic basis, and we have a
quarterly meeting with the Federal
Reserve Bank of New York.
The RMA has developed a series ofmodules to help with this education
process and Kunkle believes the
education policy can benet from the
harmonisation policy: What Id like
is to broaden our education modules
so other associations can use these
modules.
Knight concurs: An educated
lender is an important piece of the
puzzle. Education means that, going
forward, some of the situations that
have now developed into lawsuits canbe nipped in the bud early.
However, no one can doubt that
a lawsuit is always bad press for
any industry. But has the securities
lending industry been particularly
poor at presenting itself in the
mainstream media, especially during
the nancial crisis? Jessica Johnson,
managing director of New Approach
PR, a specialist communications
agency for the securities nance,
asset management and hedge fund
industry, believes so.
She says: The error was that
there was no real PR whatsoever!
We are now nearly two years down
the line and just starting to realise
that this industry really needs to
promote what it does and implementa proper defence mechanism that can
promote proper understanding. For
this reason it would be wrong to say
that the industry was too reactive
because it did not really react.
So how would Johnson combat the
negative press that the industry has
received? I want to implement a PR
effort that represents and defends all
aspects of the industry so that the
wider world sees it in a more positive
light. Regulation is also a key aspect
of anything to do with nancialinstitutions, and it is also on the
agenda of every nancial journalists
mind this year. I think the securities
nance world does want to work
within a regulated environment, both
at individual and corporate level. If I
am so permitted, Id like to ensure all
relevant bodies are effectively covered
with regards to how regulatory stories
are handled in the press. I think
that everyone in the industry has a
common goal; to project the businesspositively and as a professional and
well regulated environment. I hope
my company can help do that.
However, Knight is unsure about
how such an operation would work
in practice. How do we manage
PR? Do we need a face, if you will,
for securities lending? I havent
developed a conscious decision on
it either way. You have the RMA,
ISLA, PASLA and so on my
concern has always been over who
the industry spokesperson takes
the lead from. And how does that
directive get translated to this single
rm or individual so they are saying
something that most people in the
industry will agree with?
Individually, at times theinstitutions involved in the product
have not wanted to promote their
product when things were going
good, because its just something they
do as an organisation.
But then when some negativity
hits, someone feels that there is
a need to manage that ow of
information to the various sources
and thats where you get this
concern. I personally dont think
the industry needs a face, and if itdoes choose a face then it has to be
pretty well set up as to how that rm
or person gets their cues. If Im the
RMA, I would want to make sure
that our committee has a strong voice
in whatever edicts come out; my
concern is that if I dont agree, does
that mean the RMA has to put out a
counter piece?
Instead, Knight believes good
PR begins at home. Internally,
the industry players need to makesure that they have good robust risk
management systems, and for the
most part they do. They need to
make sure that theyre being adhered
to and on the agent lender side
that their clients are educated and
understand the product.
While various suggestions will
continue to be put forward and
different opinions raised, the need to
work together seems to be the one
area that most participants agree on.The next opportunity to do that will
be the ISLA conference in Berlin on
22nd to 24th June. GSL will see you
there. Z
Watch Jessica Johnson debate with
Richard Thompson of ISLA and
Northern Trust at the Februarys
GSL London Summit at www.gsl.tv/
videos/1052/gsl-london-summit-10-pr-
debate
It would be wrong tosay that the industry wastoo reactive - because itdid not really react."
Jessica Johnson,New Approach PR
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22 | Global Securities LendingMagazine | 2010
criN fr
Barclays Capital has had perhaps
more good headlines than most of its
peers of late, with its acquisition of
Lehman Brothers US business and
its move into the European equities
space. Another headline has been
the appointment of Ashley Wilson as
head of prime services for EMEA.Did all the positive news around
Barclays attract Wilson to the job?
Right now there is a huge amount
of energy, growth and focus within
BarCap. There is a lot of talent
joining the rm, especially because
of the Equity division growth across
EMEA and Asia Pacic and in prime
services. To give you an example the
equity division has hired 750 people
front to-back, across EMEA and Asia
Pacic, over the last 12 to 18 months.BarCap is attractive to our clients
- it is a very high credit quality
bank, a UK-centred bank with a
full prime services offering that did
not take any direct bailout funds.
However, other aspects of the
Barclays offering helped to entice
Wilson. Historically Barclays was
very strong with xed-income hedge
funds, due to the xed-income
nature of the rm. Additionally,
we gained a lot of multi-strategyfunds and this was primarily due
to our cross-asset class margining
capabilities. We were also strong in
the quant space, where participants
look for low-latency direct market
access, i.e. using the banks pipes
to access directly to market.
These were the three areas that we
were always very strong in. Now with
the equity build-out we are seeing a
lot of growth in the equity business
and as a result
we are nancing
all asset classes.
This rare
situation is one
of the main
attractions for
Wilson. It is adifferent model,
you have xed-
income, futures
and equities all
within prime
brokerage, and
that is rare
because most
prime brokers
only concentrate
purely on
equities andmy background
has always
been equities,
so the move allowed me to gain
exposure to the other asset classes.
He continues: Our global repo
book is over USD500 billion so that
gives you substantial purchasing
power when speaking to agents
from whom you want to source
securities and so on. Of the 310
Eurex members active in interestrate derivatives, we are ranked
number 2 for traded volume.
We have a very strong xed-
income and futures activity, so we
are now very focused on the growth
of the equity platform. It was a
challenge to grow something again
but also to have this one balance
sheet where you have the chance
to control three different products
which I thought was unique.
Since moving to Barclays Capital
from Merrill Lynch in September
2009, Wilson has been quick tooutline his intentions, including
using his 11 years experience on
a Morgan Stanley trading desk to
introduce a more trading-focused
Ashley Wilson, the new head of
prime services for EMEA at BarclaysCapital, talks to Craig McGlashanabout his plans for growing thebusiness
This renewed focus on risk has meantthat we have had to develop different assetprotection models and as a result of that,the old adage that prime brokerage is a
commoditised business is denitely broken"
Securing the uture
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criN fr
approach to the British bank.
There is term specials trading
for instance, where you go long
stock and short futures to create
inventory because of the miss-
pricing between the future and the
stock-borrow value, he explains.
However, this is not the onlychange he hopes to instigate.
Id like to have a trading focus,
but I also think you need to build
out the product offering, he says.
Weve just introduced swap-
backed ETFs and we are on the
ETF exchange platform. We are
developing a GCM business.
Currently, our DMA pipes take a
lot of business from non-exchange
members but if we start looking
at clearing the exchange memberbusiness, we need to do GC.
Wilsons vision of change is
in keeping with a general trend
being seen in the prime brokerage
industry. Numerous reports have
surfaced of late suggesting that prime
brokerage clients are looking at risk
management and transparency at a
much greater level than in the past,
with terms like multi-prime being
used with increasing frequency.
Hedge funds are denitelylooking at multi-prime, they are
also assessing their current prime
provider in terms of credit quality
and the asset protection solutions
that are on offer, he says. This
renewed focus on risk has meant
that we have had to develop different
asset protection models and as a
result of that, the old adage that
prime brokerage is a commoditised
business is denitely broken.
For instance, at BarCap wehave introduced a US broker/
dealer so our clients can trade
international securities. There
is demand for this because US
investors want SIPC [Securities
Investor Protection Corporation]
protection, which they gain through
exposure to a US broker/dealer.
Additionally, we are launching
Bank Prime, which allows
clients to transact and face
Barclays Bank plc, so it is not an
international offshoot of a big US
parent you are facing the main
parent entity, the rated entity.
Other projects in the pipeline for
Barclays prime brokerage offering
include gaining a SAS 70 (an
independent audited statement on
the controls within the business)
and an asset sweep solution which
allows clients assets to be held
at a third-party custodian.In terms of sourcing securities
Barclays Capital has an extensive
network of exclusives. We have
eight centres where we have staff
dedicated to sourcing securities:
London, New York, Hong Kong,
Tokyo, Madrid, Paris, Frankfurt and
Milan, Wilson explains. We have
a very large exclusive pool of assets
that we go out and bid for. We go
to the underlying benecial owner
and enter into an exclusive securitieslending contract with them.
Despite BarCaps network of
exclusives sourcing centres, Wilson
does appreciate the importance of
agency lenders to the process.
It is critical. We pride ourselves
on not recalling hedge funds on a
hard-to-borrow name and to be
able to do that you need a wide
supply of securities and you need
to mix it up - you need to have
some exclusives and have verygood relationships with the agency
lenders. So securities lending is key
to the prime brokerage business.
Some commentators have
suggested that fewer assets have come
on to the market in the exclusives
model in the wake of the Lehman
default, citing a perceived higher risk
from a benecial owners point of
view, given the lack of diversication.
Is this a trend that Wilson has seen?
There are two models the
exclusive model, where you know
the counterparty you are dealing
with, you know its rating, so as an
AA-rated entity we are not seeing
an impact. Then there is the agency
lender route where you diversify
your pool of borrowers, where within
that pool you might have some AA-
rated counterparties but you might
have some single A or some BBB
companies. Its a securities lendingfunction, you are lending out equities
versus collateral, and if the borrower
goes into default the equities tend to
fall in value so you unwind the trade.
We are not seeing a lack of assets
coming due to credit constraints, I
think people pull out of the exclusive
arrangement when the returns are
not high enough and dividends
are being cancelled so they put
it through an agency lender.
However, what of the future forBarclays prime services offering?
We mentioned the strong hiring
plan in the equities division; we also
have a very aggressive hiring plan
for prime services in Europe. We
are seeing a lot of talent coming in
and a lot of big names are speaking
to us, explains Wilson. In the
European role there are about 150
under me, with around 20 people
hired across sales and traders since
I joined. There is probably aroundanother 10 people on route.
He continues: From the
beginning of the year to now our
European equity balances are up
just under 50%, we have aspirations
of continuing that so we end the
year more than double where we
started, so its all positive.
It seems that, if all goes to plan,
there may yet be more good headlines
for Barclays Capital this year. Z
"We are not seeing a lack of assets coming dueto credit constraints, I think people pull out of theexclusive arrangement when the returns are nothigh enough and dividends are being cancelled
so they put it through an agency lender"
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Brazil
shapesup
These have been strange times for Brazils broker dealers, traders and
securities lending specialists. The market has been on a tear for months and
at the time of writing was still climbing, but the volumes have been thinning
out. As Andre Suaid, managing director at Deutsche Banks New York ofce
explains, investors have grown accustomed to seeing a lot of volume and a
market that was gaining anything from one to three percentage points a day.
Now the upward movement has slowed to 30 to 50 basis points. While Iwouldnt classify volumes in Brazil as light they have normalized to lower
levels than what we saw at the peak, and it may be some time until we see
the hype and the continuous inows we enjoyed in recent years. In London,
dealers would shrug and say: Sell in May and go away, but there is no such
tradition in Brazil.
On the plus side, and it is a very big plus, Suaid points out that this is the
rst presidential election (set for October) where politics has not yet inspired
any real market volatility. One of President Lulas great achievements is that
his government has created a strong sense that after being spoken of for
decades as a coming country Brazil has now well and truly arrived on the
world stage, irrespective of the complexion of the next government. Even
the idea that Lulas nominated successor, Cabinet chief Dilma Rousseff - astrongly left-leaning candidate with a known penchant for interventionist
policies might win the elections is not overly distressing the market.
Of course, Brazil cant make the running on its own. Like any country it
needs a favourable global economy, particularly since commodity-related
stocks make up anything from 47% to 60% of the countrys index, depending
on how one measures such things. There have been so many hard-to-read
factors swirling around, including the latest bout of jitters over sovereign debt
fears in Europe, that the risk appetite of market participants is having a hard
time getting up a consistent head of steam. As Andre Suaid observes: If the
market can continue to rally there is a tremendous amount of money in the
money markets right now that would move across into global equities.
All of this makes for a tremendous desire in the market to engage insecurities lending. Suaid points out that there has been tremendous growth in
the last two years in the local hedge fund community and in the multi market
funds and long/short funds in Brazil. Plus, of course, the high frequency
algorithmic trading funds are now global in their outlook and they all want to
get involved in securities lending in Brazil.
However, and it is a big however, Brazil is a regulated market and all
securities lending has to go through the CBLC [Brazilian Clearing and
Depository Corporation]. The CBLC has been managing securities lending
for the last 10 to fteen years and it has a very sophisticated approach. They
look at underlying market risk from a total portfolio level. If you are using the
CBLC for different strategies they will cross margin the risk, but there is no
doubt that it is an approach that works for local players but not for offshoreborrowers, explains Paul Busby, also a managing director at Deutsche Bank.
For would-be offshore players the fact that the CBLC stands squarely in
the middle of the trade makes it extremely difcult to relate the Brazilian
securities lending model back to the familiar world of securities lending that
benecial owners and borrowers are comfortable with in Europe and the US.
Basically, to be active in securities lending in Brazil you need to be a broker
and a member of the CBLC. For a US benecial owner, for example, there is
just no easy way to lend stock in Brazil.
What you will nd is that right now a lot of the natural hedges and
proprietary assets are coming from the domestic market and not the broker
dealers themselves, Busby says.
Anthony Harringtoninvestigates thecomplexities andpeculiarities of the
Brazilian industryand nds a 'watchthis space' market
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28 | Global Securities LendingMagazine | 2010
ri
However, things are on the move. Busby points out that the CBLC has
acknowledged that it wants and needs more foreign participation in Brazils
equity markets. It also understands very clearly that a vibrant securities
lending environment would bring a substantial amount of very welcome
liquidity to the market. This is a culture and a climate that is looking
to adapt to change, and the CBLC is the hub that will shape the future
development of the market. It is far more ready to talk to market participantsand to listen to what is said to it than central depositories in almost all other
emerging markets, he says.
Suaid says that he was in a meeting recently with ofcials from the CBLC
where market participants told the CBLC about their concerns over high
exchange fees and high costs. As a result, at the time of writing, the exchange
(BVM &F) was holding a meeting to talk about lowering exchange fees for
high frequency trades. It is very clear that both the CBLC and the Brazilian
Exchange are willing to be more exible to attract foreign capital. They are
very responsive to the fact that we and others have a vast array of clients who
in some capacity or another are either actively trading Brazilian equities or
who are looking to get more exposure to Latin America in general and Brazil
in particular. And securities lending has a big role to play in this, he says.Chris Poikonen, executive managing director at eSecLending argues that
the role of the CBLC in securities lending in Brazil can be viewed either as
a tremendous risk mitigator, by offering a sophisticated centrally cleared
platform, or as a signicant hurdle to having offshore investors participate in
the market. The clear issue right now is the lack of offshore lending supply
in the Brazilian securities lending market. The activity that is currently taking
place is largely between local market participants, he says.
Brazil has the second largest exchange in the Americas, and that makes it a
very big market for overseas borrowers and benecial owners to nd difcult
to access. The CBLC is a wholly owned subsidiary of BOVESPA. It offers
cash, futures and options trading and has all the securities that are eligible for
securities lending transactions. Both BOVESPA and the CBLC are regulatedby the Brazilian Securities Exchange Commission (the CVM) and the
National Monetary Council (CMN).
They are responsible for setting the maximum limits for securities lending
open positions and they regulate the CBLC by ensuring that it is always
in a comfortable position with respect to any exposure it is taking on.
The regulators also dene the parameters for what constitutes acceptable
collateral for securities lending, typically FRB bonds, and Poikonen points
out that they have a fairly sophisticated algorithm which is used to determine
the creditworthiness of parties and limits maximum loan balances as a
percentage of the free oat in the system. Poikonen too, says that a robust
securities lending system that appeals to offshore participants will help
increase the overall liquidity in the market. BOVESPA has a deep marketand many offshore benecial owners have substantial allocations to the major
index constituents within their emerging markets portfolios. Having them
participate in lending will be key to further progression.
However, Poikonen argues that the central counterparty model should not
be viewed as a bad thing, in and of itself. If you look around the world there
are central counterparty (CCP) models in many markets, so the fact that
Brazil has a CCP model should be viewed positively, he says.
Of course, it is a different transaction, in securities lending terms, for a
benecial owner, since their exposure lies with an exchange, rather than with
a broker-dealer. This means that benecial owners have to get comfortable
with the exchange as counterparty, and they need to clearly understand how
The clear issueright now is thelack of offshore
lending supply in theBrazilian securitieslending market.The activity thatis currently takingplace is largelybetween localmarket participants"
Chris Poikonen,
eSecLending
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the exchange model works and what it offers in terms of security. Some
benecial owners are not yet that comfortable with taking exposure to an
exchange. However, we believe that the way to promote liquidity in this
market, at least in the short to medium term, is to educate the lenders in the
considerable merits offered by this model, he says. On the subject of CCPs,
when one looks around, there are considerable efforts going on to set up CCP
models in markets that are currently OTC and bi-lateral, the credit defaultswap (CDS) market being an obvious case in point. The whole derivatives
space is under tremendous pressure at present to shift across to a CCP
approach.
At the same time both in the US and in Europe there are initiatives
underway to set up CCP models for securities lending, at exactly the same
time as a number of parties are trying to persuade the Brazilian regulators and
the ofcials of the CBLC to initiate a more standard approach to securities
lending. It may well be the case that if the CCP approach to securities lending
got off the ground in Europe and the US, it would really help the growth of
securities lending in Brazil. The point, of course, is that there are very different
kinds of CCP models, with very different rules, and what is needed is a model
that will inspire the right degree of condence in benecial owners.The model in Brazil contrasts sharply with the model in Mexico, where
there is an active securities lending market run along US lines, and which
benecial owners can access via bilateral deals in the usual way. Latin America
is clearly an area of focus for many organisations right now, and Brazil is
undoubtedly the largest and the most interesting. However, it is very much
still a developing market and there is a real buzz in the air right now about
securities lending in Brazil.
One of the big concerns that offshore benecial owners have about the
Brazilian CCP model is their direct exposure and the fact that collateral is not
held in their own name within the CBLC, If either the CBLC or BOVESPA
went down, benecial owners need to understand what the unwind position
would be. This is a pretty obvious question for a benecial owner. They needclarity on the issue of how loan transactions would be unwound if the CBLC
was, for some reason, to become insolvent, Poikonen says.
However, common sense tells you that when you are talking about one
of the largest e