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Equilend : EquiLend 10th Anniversary
the neXt ten years equilend – 10 yeaRS of innovaTion 20 Anecdotal reports among UK and European securities lending respondents reveal that very few incurred a loss after non-cash collateral was liquidated following Lehman’s collapse and lent securities were repurchased. The majority actually ended up with a surplus. “Historically, cash collateral reinvestment is where lenders have lost money,” says McNulty. Lenders that were burnt by reinvesting a portion of their cash collateral into mortgage-backed-securities during the last crisis are now considering taking non-cash collateral – typically government bonds or equities – in order to avoid reinvestment risk. “In general, collateral flexibility can always benefit the lenders and the primes: it is always better to have a choice,” says Nadd-Aubert. “Over the next decade, I think lenders will make informed decisions to widen the range of collateral acceptable and this will make a significant difference to volumes,” says McNulty. A shift is certainly possible. Canada has reduced its reliance on cash collateral by about a half over the past three years, according to some estimates; Holland by almost a third. But US regulators are notoriously cautious. The Department of Labour (DOL) is responsible for ERISA assets, comprising two thirds of US pension money. It has kept well behind the risk management controls and practices that the industry has developed to make lenders safer. Twenty-five years elapsed between PTE 1981-6, the original exemption that permitted the lending of securities by ERISA plans, and 2006-16, an exemption that conservatively broadened acceptable counterparties and collateral. rEGuLaTion: a HoT TopiC As the industry grapples with the latest shorting bans – on financials in Spain, France, Belgium and Italy and across all equities in South Korea – the question of naked short-selling is coming to the fore in Brussels. The European Commission’s proposed ‘locate and reserve’ requirement, which would mean short-sellers have to secure the relevant stock before going short, could have a larger long-term impact than the current temporary bans. Among likely consequences would be initiatives by hedge funds to form exclusivity arrangements with beneficial owners to ensure that there is always a portfolio against which they can short, a trend which has already begun. European institutions are discussing the proposals this month. Of the two key institutions responsible for negotiating the new rules, the European Parliament favours the locate and reserve regime, while the Council of Ministers favours a more pragmatic approach. At the core of the Parliament’s position is that widescale naked shorting creates large numbers of open positions which participants have no intention of covering, increasing systemic risk. But tough locate and reserve requirements are not necessary to mitigate this risk, notes McNulty: “When you look at countries like France and the US, both have rules that require the investor to have a reasonable expectation of securing the stock, and this process works well”. Nor would a locate and reserve requirement favour lenders. It is sometimes argued that there would be demand for stock placed ‘on reserve’ or otherwise stamped with the investor’s intention, for which they would be paid. But McNulty believes there is little willingness to pay for placing reserves: instead the stock will be tied up but not borrowed. “ We did some anecdotal soundings with the prime brokers,” he warns. “For every stock that is loaned, roughly 50 locates take place; if all of those 50 had to be reserved in the market there would be serious consequences for availability.” // Over the next decade I think lenders will make informed decisions to widen the range of collateral acceptable” Kevin McNulty, ISLA 50:1 Ratio of locates to loaned stocks in London >> EL.indb 20 26/08/2011 09:56