GSL 003

MARKETS Asia, Nordics

INDUSTRY INSIGHT Interactive Data, books and records, collateral management

PROFILESPirum Systems, Hermes, Lionhart

GSL ISSUE 03

GSL | Global SecuritiesLending

Plus:Short selling regulation

Changing world of prime brokerageSecurities lending in China

CounterpartiesRisks and resolutions

GBP 50

USD 85

EUR 60

Raising the Bar

eSecLending provides services only to institutional investors and other persons who have professional investment experience. Neither the services offered by eSecLending nor this advertisement are directed at persons not possessing such experience. Securities Finance Trust Company, an eSecLending company, and/or eSecLending (Europe Ltd.), authorised and regulated by the Financial Services Authority, performs all regulated business activities. Past performance is no guarantee of future results. Our services may not be suitable for all lenders.

United States +1.617.204.4500

Europe +44 (0) 207.469.6000

[email protected]

www.eseclending.com

Securities Lending Manager of the Year

Global Custodian Securities Lending Survey 2008

Awarded Top Rated and Best in Class in North America

European Securities Lender of the Year 2008

eSecLending is raising the bar in securities lending by providing lenders with

High-touch client service Comprehensive risk management Customized programs Optimal risk-adjusted returns

As a leading securities lending agent, we take a consultative, highly customized approach when it comes to structuring lending programs for our clients. Unlike traditional models, where many lenders’ portfolios are grouped together and their securities wait to be borrowed on a best efforts basis, we utilize a competitive auction to determine the optimal route to market for their assets. Based upon results from the auction, we manage clients’ portfolios either through exclusive arrangements for specific portfolio segments or on a discretionary basis, where securities are lent individually.

We focus on maximizing intrinsic returns in accordance with each client’s specific risk tolerances. Having built the program to incorporate investment practices such as the use of specialists, multiple-managers, unbundling, price transparency and competition, our approach ensures best execution and also provides clients with greater control over their programs, allowing them to more effectively monitor and mitigate risks and counterparty relationships.

2 | Global Securities Lending Magazine | 2009

EDITOR'S LETTER

Counterparty credit risk, the changing world of prime brokerage and the new short selling regulations have all featured heavily in the securities lending landscape. For the first time in more than 15 years there has been a depletion in volumes and market participants, as people weigh up the risks and rewards. However, it is clear that this is very much viewed as a period of reflection and change rather than the end. Securities lending is viewed as an increasingly

“Securities lending is the missing building block for market completeness”

important part of the securities services industry. It provides vital liquidity to the fixed income, equity and money markets and stability to the market as a whole. It has also demonstrated that it can cope with a large default. This issue of GSL focuses on risk and the resolutions. Ben Roberts looks at counterparty credit risk and debates the value of the first securities lending central counterparties in Europe and the US. The impact of the various short selling regulations on the securities lending market in Europe and the US are analysed, while Brian Bollen reviews the arrival of China's securities lending market. Giles Turner focuses on the changing world of prime brokerage and the

impact of the inabilty to rehypothecate on hedge funds. Joe Corcos provides an overview of naked short selling, what it is and where the problems lie. And Spitalfields Advisors report on the impact of the Lehman Brothers collapse on beneficial owners. The conflict between the views of the long investor verses the short term have been a central theme. GSL talks to Paul Lee of the Hermes Equity Ownership Service about the thought behind lending securities (pg 24). We also talk to Jason Kennard head of SLB and Collateral Management and Neill Ebers, COO at Lionhart about why securities lending is important to their strategies(pg 36). Preparing for the future

by improving operational efficiency is an ongoing theme. GSL talks to Rupert Perry co-founder of Pirum Systems about need for operational efficiency as volumes increase. Cherry Reynard looks at books and record systems. Bob Cumberbatch, Interactive Data, writes on the vital necessity of accurate data in managing risk and our panel looks at collateral management. Many view this as a time of decision: are you in or are you out? If you are in you should gear up for increased volumes, by improving operational efficiency and examining risk perameters and procedures. If you are out, you may well return later.

Catherine Kemp

Nordic Market Update 60

GSL News 6

Interactive Data 54

Michael P. McAuley of the RMA 10

Paul Lee, at Hermes Equities Ownership Services 24

News Analysis: Watson Riot 8

Counterparty Credit Risk 15

David Rule, ISLA 11

Prime Time 19

Rupert Perry, Pirum Systems 12


CONTENTS

6 | News Top industry stories

8 | News analysisWatson Wyatt causes a stir and Standard Bank makes a change

10 | Across the AtlanticTwo trade association figure heads give their view from either side of the pond

12 | CEO profileGSL talks to Rupert Perry at Pirum Systems about growing demand for operational efficiency

15 | Counterparty credit riskBen Roberts looks at the rise of CCPs and the resolutions to risk

19 | Prime TimeHow will the changing face of prime brokerage affect securities lending?

24 | Lender profile: HermesCatherine Kemp talks to Paul Lee at Hermes' Equitiy Ownership Service

26 | Benificial owners Spitalfields Advisors asses the impact of the Lehman collapse on beneficial owners

28 | Sold Short IIWhat has the impact of FSA and SEC regulation on short selling been?

30 | The short selling regulationsShort selling bans, disclosure rules and naked short bans around the world

31 | Naked ShortJoe Corcos looks at the problems of naked shorting

Editor: Catherine Kemp ([email protected])

Senior Reporter:Ben Roberts ([email protected])

Group Editor:Giles Turner ([email protected])

Contributors: Brian Bollen, Nick Pratt, Cherry Reynard, Joseph Corcos

Photographer: Lucy Johnston

Front Cover Illustrator: Morgan Miller

Operations Manager: Sue Whittle ([email protected])

Associate Publisher: Justin Lawson ([email protected])

Commercial Director:Jon Hewson([email protected])

CEO: Mark Latham ([email protected])

Companies

Aite 31

APG 6

Asset Control 7

BNY Mellon 6,7,39

Carne Global 19

CalPERS 28

Clearstream 7,33,39

Conifer Secuirties 7

Credit Suisse 19

Citi 36

Data Explorers 28, 56

Deutsche Bank 19

EquiLend 63

eSecLending 7

Eurex 6,7

Euroclear 39

FSA 10,31

Greenwich Associates 14

Goldman Sachs 19

ICAP 31

Interactive Data 6,54

ISLA 10,15,28

JPMorgan 39,56

Lehman Brothers 10,29,24,26

Lionhart 28,36

Lombard Risk 6

London Pension Fund Auth. 6

Morgan Stanley 19

Northern Trust 6,14

OCC 14

Omgeo 22

Penson 58

Pirum Systems 13

Quadriserv 7,14

RBC Dexia 6,

RMA 10

Rule Financial 39

SecFinex 7,15

SoftSolutions! S.r.l. 64

Spitalfields Advisors 26

Standard Bank 8

State Street 6,35

SunGard 28,50

Watson Wyatt 8

Zimmerhansl Cons. Serv. 8,24

33 | AsiaChina embraces sec lending, Brian Bollen reports on the impact of short selling regulations on Asia

36 | Borrower Profile: LionhartCatherine Kemp talks to Jason Kennard and Neill Ebers about value of securities lending to hedge funds

38 | Panel collateral managementIndustry experts give their view on the market

61 | 101 ReykjavikNick Pratt looks at the challenges facing the Nordics

50 | Back to frontCherry Reynard reviews books and records systems against a landscape of growing complexity

54 | Interactive DataBob Cumberbatch looks at the vital importance of data in managing risk

56 | StatisticsAvailable inventory and lending on US and UK retail and banking stocks

58 | People MovesAppointments and departures

63 | DirectoryConsulting, data, lending and technology service providers

64 | Meet the future Amy Sussman talks to GSL about work, life and cowboys

16-17 Little Portland Street, London W1W 8BPT: +44 (0) 20 7299 7700 F: +44 (0) 20 7636 6044© 2008 Investor Intelligence. All rights reserved. No part of this publication may bereproduced, in whole or in part, without prior written permission from the publishers. ISSN 1759-0728 Printed in the UK


News

People

Industry Insight

Technology


Natixis

London - Lombard Risk, a global provider of specialised software solutions for collateralised trading and regulatory compliance, has won seven contracts for its COLLINE collateral management software since March 2008. Contracts have been won from: Lombard Odier Darier Hentsch & Cie, Jyske Bank A/S, SBAB and Daiwa Securities SMBC Europe, a large US East Coast based asset manager with over USD 120 billion under management.

New York - It has been reported that J.P. Morgan's collateral management business has grown 40% over the past several years. The company began a three-year, multimillion dollar initiative in July 2007 to build a new technology and operating environment for collateral management to serve its clients as well as internal investment bank and asset management divisions.

Collateral Management


NEWS

It has been reported that BNY Mellon's collateral management business has expanded. The firm handles more than USD1.8 trillion dollars' worth of collateral management business. BNY Mellon's global collateral management services team facilitates the tri-party collateral management process, helping to manage its clients' inventory. It also helps firms manage collateral to mitigate risk.

Luxembourg - Eurex Repo and Clearstream announce that the eligible collateral for the GC Pooling market and the Eurosystem Collateral Management Services is extended to French bonds. This means that customers now have access to a wider range of securities to pledge as collateral to the European Central Bank (ECB) allowing them to access liquidity in an efficient and secured way.

London - Lombard Risk has announced new automated transaction reconciliation functionality as part of the company's end-to-end proactive collateral management solution at the ISDA Symposium in Sydney. The Colline Reconciliation module expands Lombard Risk's collateralised trading solution by automating more of the critical post trade workflow, which historically has been a time-consuming manual process within the OTC derivatives market.

New York – It has been reported that the USD7 trillion US repurchase or "repo" market has been judged by traders and analysts to be frozen as rates fall close to 0%. Banks and fund managers are under pressure to accumulate less risky assets and as a result lenders are hoarding safer government securities and activity has dried up.

Illinois - The Teachers' Retirement System of the State of Illinois (TRS) has selected State Street to serve as its new master custodian and securities lending provider, subject to contract execution. State Street replaces Northern Trust who had been TRS' custodian since 1996.

London - A survey released by RBC Dexia Investor Services, which maintains the industry's most comprehensive universe of Canadian pension plans and money managers, shows that in the CD 340 billion RBC Dexia universe, Canadian pension plans suffered the largest quarterly decline in a decade, tumbling 8.6 % in the three months ending September 30.

Top industry stories at deadline. For more recent updates go to www.isj.tv/securities-lending

London - Vanguard, Strathclyde pension fund, E. On pension fund, and London Pension Fund Authority all stopped securities lending temporarily. A spokesman for Strathclyde pension fund says: "Our concern is with the disorderly nature of the markets at the moment. Ultimately the reason we have stopped lending is, it is a very marginal source of income for us. So if there is increased risk, it is simply not worth our while to continue."

London - APG, the Dutch pension fund, stopped lending a number of US and European stocks to help try to stabilise the market following the UK Financial Services Authority's (FSA) ban on short selling and the US Securities and Exchange Commission's (SEC) ban on naked short selling.

New York – Interactive Data Corporation announced that its Pricing and Reference Data business now provides daily independent evaluations of commercial paper issues to Standard & Poor’s Index Services for its recently launched S&P US Commercial Paper Index. The S&P US Commercial Paper Index is a new, broad-based index designed to serve the

Repo

Securities Lending

Technology

investment community’s need for a benchmark for US commercial paper.

London - BNY Mellon Asset Servicing has launched its new Trustee Board Reporting solution. This advanced reporting package combines asset liability matching information and advanced analytics alongside more traditional core performance and historic risk reporting to assist trustee boards and investment committees in evaluating the progress of their investment programmes.

San Francisco - Conifer Securities is now offering prime brokerage services to hedge funds including financing, securities lending, asset custody and daily account reporting. Conifer is a provider of business and operations solutions to asset managers and institutional investors, and is offering these new prime brokerage services through J.P. Morgan's Broker Dealer Services business.

New York - Asset Control, a financial data management solutions provider, announced that eSecLending, a full-service securities lending agent, has chosen Asset Control's AC Plus financial and reference data management software following a rigorous search and selection process. eSecLending will use AC Plus to support the company's efforts to further increase automation in their securities lending programs which rely on complete and accurate securities data including

ratings, end of day prices and corporate actions.

London - The International Securities Lending Association (ISLA) published a statement of market guidance on billing comparison in the securities lending market. The statement recommends that monthly billing statements should be communicated using automated reconciliation tools where possible. Statements should be received by the second business day of each month and cleared by the tenth business day where possible. In the event of a discrepancy, partial payments should be made for the undisputed portion of the bill. Best practice is for no billing to be outstanding at the end of a month.

Zurich - SecFinex Limited, a NYSE Euronext Company and the leading European electronic trading platform for equity finance, and SIX x-clear AG, the Central Counterparty (CCP) and licensed Swiss bank, announced that they have signed an agreement to launch CCP services for stock borrowing and lending across the SecFinex Order Market multilateral trading facility for key European markets.

Madrid - The International Organisation of Securities Commission's (IOSCO) Technical Committee has created three task forces to deal with regulation for short selling, derivatives

trading and activity by currently unregulated entities such as hedge funds. A task force will work to eliminate gaps in various regulatory approaches to naked short selling, including delivery requirements and disclosure of short positions. It will also look at how to minimise adverse impacts on legitimate securities lending, hedging and other types of transactions that are critical to capital formation and to reducing market volatility. The Task Force will be chaired by the Securities and Futures Commission of Hong Kong.

Luxembourg - Eurex Clearing AG and Clearstream Banking Luxembourg S.A. announced that they will introduce a central counterparty service (CCP) for securities lending in Q2 2009. Eurex Clearing will act as the clearinghouse for Clearstream's widely used strategic securities lending program ASLplus.

New York - Quadriserv, Inc. is working with the Options Clearing Corporation (“OCC”) on an agreement to operate a centralised securities lending platform. The OCC would provide clearinghouse services for all securities lending transactions submitted through Quadriserv’s AQS™ securities lending platform, bringing market structure, transparency and efficiency to borrowers and lenders of securities. AQS will operate a centralised securities lending platform for domestic equities.

NEWS

Market Infrastructure


NEWS ANALYSIS

A new Standard?

What is Standard Bank up to? Llewelyn Ford, head of securities lending and futures at the Cape Town-based custodian, has given a few hints concerning a new model for its securities lending operation. “We are looking at a new system to have in place within the next 12 months connected with India,” he said, regarding the challenges of South African securities lending. Aside from these plans, the challenges to South African securities lending are very similar to other places. Ford states: “Up until June this year there has been significant growth, often as much as 35% growth year on year. But recently we have seen the total loan position drop of between 30-40%, along with a sell off in bond portfolios.” He added that many clients have been re-evaluating their securities lending set-up and the bank has fielded “a lot of enquiries”. One ongoing sticking point seems to be the fact that cash collateral must be in South African Rand, a volatile currency. “The volatility does affect things a bit, particularly offshore borrowers who would like to trade in a more stable currency.” Standard Bank has a few countries in its sights to develop securities lending: Nigeria and Kenya. The Central Bank of Nigeria invited Ford to talk about securities lending amid a wider summit about inflation targets. Botswana is also a potential next step. “It is open to securities lending in terms of liquidity and a higher number of stocks listed there,” said Ford. “We’re looking at dual listings and countries with strong operations.” Mark Kerns, global head of Investor Services at the bank, said: “Nigeria is a target, although, while there is rationale for a securities lending program the Central Bank has not yet introduced it.” For the bank’s home market, he said: “The trading volume has not been too bad given the volatility.” Kerns adds that South Africa has benefited from not

having short selling restrictions, though further enquiries by beneficial owners have continued nevertheless. “People are very focused on the dynamics of securities lending and understanding risk.” He adds that Standard Bank's policy of only dealing in cash collateral was a cautious but timely policy in risk-averse, cash-hungry market circumstances. “You can see the benefits of that in terms of cash flow where the issue for clients becomes, ‘what risks are there of broker default’.” However, there is some room for government bonds. “Fixed income we can leverage on our clients behalf and make a return on that.”

Watson Riot

The November 2008 Watson Wyatt report: Securities Lending Loses It's Shine, has caused controversy. It advises pension funds to ‘suspend securities lending activity if they are in any doubt about their lending guidelines and arrangements’ and identifies counterparty, collateral and indemnification risk as the main areas of concern. It also says that 'by and large' the securities lending industry coped well with the Lehman Brothers default but that the default demonstrated the risks within securities lending. Although it acknowledges that agents were able to re-purchase most clients’ assets within two days of the Lehman Brothers default. In some ways the report is difficult to argue with – if the risks outweigh the rewards, perhaps lenders should stop lending. What is controversial is that many think the report infers that the

industry is now more risky than it was before without explaining why. Roy Zimmerhansl of Zimmerhansl Consulting Services, said:“What is lacking is any kind of substance about what they think is a potential issue. Do they think the market has changed, do they think there is some new experience as a result of Lehman where the legal agreements haven't performed as proposed, or that the controls and risk procedures or the liquidation of the collateral hasn't worked well? ” David Rule, CEO of ISLA said:“The headline: Securities lending loses it's shine, was not merited by the report's substance. It just reiterates what has always been the case, which is that beneficial owners need to understand the risks they are taking. The headline seems to be designed to scare lenders. Some risks have been crystallised, and we have had a counterparty default, but as they say very few people who were lending securities to Lehman have ended up with losses because of the way that the industry manages risk. ” Another crucial aspect of the report that concerned Zimmerhansl was the recommendation to accept government bonds as safe collateral. “The big challenge in a default is to make sure that you can liquidate collateral,” he says, “ensure you have enough money to buy back the stocks you've loaned out. Ideally you want assets that track each other so that if the value of the stock you have on loan goes up or down, so does your collateral. Treasury bonds are therefore not necessarily the safest collateral. Frankly I don't think Watson Wyatt has the expertise to give advice on this subject.” In response to questions put to them about these issues, a Watson Wyatt spokesperson said: "We accept there have always been risks and we have always made sure our clients are conscious of these risks. However, the losses suffered in some programmes this year do make it sensible for asset owners to rethink the cost benefit trade off of these programmes."

News Analysis

News Analysis


ACROSS THE ATLANTIC

Trade association fi gureheads from either side of the Atlantic update GSL on their activities over the last few months.

It continues to be a challenging and unprecedented time in the global fi nancial markets. The future of the securities lending industry will be determined by how we respond to the extraordinary events taking place in today’s environment. In the US we are working feverishly to address the issues presented by these events and striving to deal with the many unintended consequences impacting our industry as a result of the regulatory changes in other parts of the fi nancial markets. Much of this effort involves establishing new relations and maintaining ongoing

dialogue with various government regulators, and providing education about how our industry works both at a high echelon and in detail at the operational level. I believe providing this counsel will be one of the most important tasks for our committee over the next few years. The Risk Management Association (RMA) remains resolutely positive about our industry. Although attendance at our recent 25th annual Conference on Securities Lending was understandably lower than anticipated, the lending and borrowing professionals who did attend participated in several notable panel presentations and were privy to some of the liveliest and most frank discussions about topical issues and concerns that I can recall from any conference. The RMA and its subcommittees continue to work on behalf of its members. Of recent note is the work the securities lending committee did, with the help of counsel Rom Watson of Ropes & Gray and other industry groups, with respect to obtaining a revenue procedure from the Internal Revenue Service (IRS) that addressed the tax issues relating to the default of a borrowing counterparty. After opening a dialogue with the IRS and explaining the concerns, the IRS responded quickly and issued Rev. Proc. 2008-63. This welcomed ruling prevented recognition of gain or loss as

a result of a borrowing counterparty’s failure to return securities and, in effect, treated buy-ins as if they were returns of the loaned securities. Rev. Proc. 2008-63 also provided a blueprint for resolving similar tax issues in other countries. The securities lending industry is also struggling with the close-out requirements imposed by Regulation SHO. As executing brokers have rushed to comply with the new rules and avoid potential penalties, many of the market practices that previously existed regarding the notifi cation of buy-ins are no longer being followed. The RMA and the Securities Industry and Financial Markets Association (SIFMA) are collaborating to help resolve these issues. We are hopeful that, together, we can reach a solution that is mutually benefi cial to the industry and our clients, while still meeting the regulators’ requirements. Lastly, I am pleased to announce the securities lending committee has formed a new legal subcommittee which has participation from a broad range of our members’ legal and product development staffs. Its objective is to help the committee respond to legal and regulatory changes. The legal subcommittee’s fi rst challenge will be to partner with our operations subcommittee to provide an industry response to the request for comments on the changes to Regulation SHO.

Michael P. McAuley, Esq. chairman of the Risk Management Association's Committee on Securities Lending and managing director and chief product offi cer in State Street Corporation's securities fi nance division, writes of tax, Regulation SHO and the RMA's ongoing dialogue with regulators.


ACROSS THE ATLANTIC

In September, regulators around the world introduced emergency restrictions on short selling without consultation or notice. ISLA has focused on countries where short selling restrictions have affected securities lending. In France and Belgium, regulators have asked institutions to refrain from lending financial shares except for outstanding transactions or where not facilitating short selling. In Italy and Spain, regulators have interpreted naked short selling to include selling where shares are on loan. ISLA aims to influence permanent regulations put in place when the current temporary restrictions expire, to avoid any restrictions on securities lending and to promote disclosure of short interest in shares at aggregate rather than individual level. LIBA, AIMA and ISLA commissioned a study by Professor Ian Marsh of Cass Business School into the effectiveness of the short sale restrictions in major markets. That study found that the restrictions had had no discernible effect in reducing share price volatility (see table below

for UK shares). As part of its review of the Global Master Securities Lending Agreement (GMSLA), ISLA members discussed the Lehman default. ISLA intend to adopt the post-default procedures of the Global Master Repurchase Agreement, which give more flexibility to the non-defaulting party. Freshfields has written a protocol that allows market participants to substitute the new procedures in existing documentation. We hope to finalise the new version of the GMSLA and the protocol early in 2009. In October, ISLA wrote to the UK tax authorities following the default of Lehman asking for relief from capital gains tax on unintended disposals of lent shares following a counterparty default and from stamp duty/SDRT on sales of collateral and repurchases of lent securities in the market. The UK Pre-Budget Report in November included a paper stating that measures to introduce these changes would be introduced in the Finance Bill 2009, with retrospective effect to cover the Lehman default. ISLA conducted a survey on how members managed counterparty risk, including counterparty limits, collateral eligibility, and haircuts. It asked for views on the introduction of a central counterparty in the market.

The importance of disclosure by agent lenders to borrowers of their exposures to underlying principal lenders has been highlighted. On 15 July, ISLA published its agreed model for EU Agent Lender Disclosure and subsequently the FSA welcomed the model reiterating its requirement for UK-regulated borrowers to receive full, daily disclosure by January 2010. In November, ISLA conducted a survey gauging members ALD plans following a well-attended roundtable on 20 November. Results show agent lenders intend either to adopt the ISLA EU ALD model or to disclose principals at point of trade and use collateral allocation letters, while borrowers expect their agent lenders to use a mix of these two approaches and bilateral email. The Lehman default understandably led many beneficial owners to reconsider risks in securities lending, including counterparty selection, collateral eligibility, collateral valuation and haircuts, cash reinvestment mandates and indemnities from agent lenders. Some suspended lending programmes, in most cases temporarily. Securities available for lending globally are estimated to have decreased by 10-15%.

The International Securities Lending Associations’s (ISLA) CEO, David Rule, writes of short selling regulations, ISLA's GMSLA review and the Lehman default.


CEO PROFILE

As dot.com boomed in 1999, Rupert Perry and Jeff Armstrong were inspired by Hotmail to co-found Pirum Systems, a leader in the automation of post-trade securities finance. “It was the first time we had seenthat a complex application can bedelivered through a web browser,” says Perry, who was working with Armstrong at UBS on the automation of its securities lending department. “At that time there was really no automation to speak of between banks, only internalautomation. We felt that there was an opportunity to link banks together and make processing more efficient using the web. The aim of the company is to automate all post-trade processes, making them more efficient and more controlled. Funnily enough, most of the ideas that we had back then have since been done either by us or others.” Rupert Perry graduated with a degree in computer science in the early 1990s. He became an accountant at Ernst and Young. He entered securities lending when he moved to SG Warburg, now UBS, setting-up Global One, the transaction software now owned by SunGard. “When I started at SG Warburg, back in the early days when Global One first went in, it wasn’t connected to any other systems at all,” he recalls. “Everything was double-keyed and there were a lot of problems, which very much affected volumes. "You can get to a certain level without putting the automation in place and then, thereafter, it reaches a point where manual procedures don’t work any more. As you get more and more transactions coming through,you need the automation in placeto manage the growth in volumes." The vision for Pirum came from realising the necessity of having an IT

group working outside of the banks to develop systems that would enable the banks to link together. An attractive aspect of securities lending is that it is not completely vanilla, says Perry, nor as straight-forward as a buy transaction or a sell transaction. This is where much of the job satisfaction resides. “The wholelifecycle is a lot more complicated thanpeople seem to realise - it’s a challengeto get all of the processes fully automated. Our services are designed to make operational procedures much more efficient, controlled, automated, less volume sensitive, and generally so that they work much better.” Contract comparison and billing comparison are Pirum’s two original

services. Both were designed with greater speed and operational clarity in mind, as well as an essentially paperless future. The contract comparison extracts information from clients books and records system daily and compares it with the counterparty’s records to highlight possible discrepancies. “Without this system, people have tended to send a faxed report of the outstanding positions to the other side, and somebody has then had to go through it by hand, ticking all the details off. This takes a long time and means people don’t do it nearly so often, certainly not on a daily basis, because they would need an entire

Rupert Perry, co-founder of Pirum Systems, talks to Catherine Kemp about automation and the quest for better lender-borrower communication.

army in the back office to do so,” he says. The billing comparison system takes information from both counterparties on a monthly basis and compares the bill with what the counterpart expects to pay. The system compares the trades daily and highlights exactly where the discrepancy lies between the bill and what people are expecting to pay. This means that the bill is paid or received on a more timely basis, and improves the relationship with the counterparty. They also take the data in most formats, which reduces development costs. “Without this automation,” says Perry, “one side will send the bill to the other on paper. If it’s a big relationship with thousands of trades the bill may run to hundreds and sometimes thousands, of pages and at the end of it there is a grand total line. The first thing they do is look at that total and hope and pray that the number is close to what they were expecting on their own system. If it isn’t close, they then have to work out why, which is like looking for the proverbial needle in the haystack.” Perry says client inform him that the bills paid first are from counterparties that they reconcile with automatically. “All the more difficult manually reconciled bills get put to the back of the queue, which causes friction with the counterparty.”The firm is also now providing billing on an Excel spreadsheet, he adds, making it easy for the recipientto search and filter the bill as required. A couple of years ago Pirum brought out the marks and exposure service, which was the first exposure reconciliation system with a real time reconciliation capability. All transactions between the lender and borrower that contribute to the


CEO PROFILE

system and enter a return, so that both sides then instruct the custodian to return the stock. As with contract comparison, the system is looking for parity in the instructions between the counterparties."The evolution of the industry is very much tied up with volume, as with any market, he says. “Back in the early days there was very little volume by comparison to what there is now. This is the first time, certainly in my experience in the industry, that volumes are actually shrinking.” People are going to have to decidewhether they are going to be a marketparticipant for the long term, Perrybelieves, and technology will be

integral to their decision. “For peopleto continue to play in the marketgoing forward they are going to needto use all of the different technologyplatforms, both pre and post trade, so they can make their business processes as efficient and controlled as possible -particularly around operational risk." “In current conditions it is essential that you have confidence in your books and records, and in order to do that you need efficient, automated, straight-through processing, with tools that help you understand any exceptions you’ve got, why they are there. They get identified quickly and easily so that your operational staff can investigate them. “Automation means that you are much more scalable and that you can grow your volumes. So that when the

industry recovers and volumes start to rise again, you have the right platform in place so that you can grow the volume in a controlled manner. “What can happen is that volumes get very high – people get behind in dealing with the exceptions because they are trying to cope with the enormous volume of transactions that are going through, so by using automation and getting all the processes as automated and controlled as possible, it provides the platform for the industry to grow the volume to the next level. If you are a very small player, that doesn’t have enough volume to justify the investment in technology, it’s going to be difficult to stay in.” The International SecuritiesLending Association (ISLA) and theRisk Management Association (RMA)in the US have both produced bestpractice papers saying that automatedoperational tools are recommendedas best practice. This is used as abenchmark between borrowersand lenders as to whether they areoperating in accordance with bestpractice. “Some lenders now tell us that they view this as an important consideration, and will direct more business to those who have automated platforms in place,” he says. “What I’m seeing is that there are people in two camps: there are those that are sure they are going to be in the industry long term and if they aren’t already using a tool they are being pushed very hard by counterparties; on the other side there are others who are looking at the turmoil going on, and putting any technology initiatives on hold to wait and see what will happen.”

exposure or that need to be marked to market, are compared and prioritised by those causing the biggest problems, or biggest differences in price.Non-cash collateral is a classic example of this, he says. The exposure in this case is on the collateral side, where fixed income securities are often used. He says traders commonly run into problems with the static data, where they are unaware they are not calculating the accrued interest correctly as some data is missing. “They are getting a price coming in from the vendor every day, a clean price - but in order to use it for valuation process they have to convert it into a dirty price, which means adding on the accrued interest,” he explains. “This is the accrued interest since the last coupon was paid. If they don’t have the right coupon rate and payment date set up for that coupon they won’t calculate the accrued interest, to date correctly and the system will undervalue the collateral as a result." Other problems include prices fed through at 10 times the valuation, or the accrued interest is missing, or only one party is updating their price each day, or data is present but it is based on an old security. Corporate actions, he adds, have also caused problems. “If you haven’t got the time to find these sorts of issues they come back to bite you later because you valuation will be wrong, and that effects your view on what your exposure is to the counterparty,” he says. “The right automation gives you confidence that your data is accurate and complete and that you’ve got everything re-collateralised on a daily basis.”The newest service to be rolled out focuses on a better automation of borrowers communicating the stock they would like to return. Currently borrowers produce a report saying what securities they want to return and the lender has to relate the corresponding transactions in their


US lawsuits and portfolio re-evaluations have redefined securities lending in the last quarter. But how will the market take to central counterparties to minimise trading risk? Ben Roberts reports.

Securities lending’s move out from its back-office origins has connected the industry with many of the major themes of the credit crunch. Counterparty risk, the fear that disrupted inter-bank lending and exploded credit default swaps market, has found its place within lending and borrowing just as it had done in out-and-out trading. Amid wider regulatory upheavals, securities lending participants and technology vendors across continents have taken a long hard look at the roulette of bi-lateral agreements and responded in different ways. In the US, this has occasionally ended in a legal dispute. In September 2008 the University of Washington, Seattle filed a lawsuit against Northern Trust on the back of losses incurred from its securities lending program and the refusal by the custodian to fully compensate. Then on 21 October, the BP Corp. North America Savings Plan Investment Oversight Committee filed a lawsuit against the same bank after incurring losses resulting from investments linked to its securities

lending programme. The disputes highlighted for some the need for greater clarity in the responsibilities of bank and pension fund trustee. In the wake of the case, numerous pension funds pulled their securities lending operations. In parallel with these cases, plans have developed on both sides of the Atlantic to create central counterparties for securities lending. On 9th October Quadriserv, the technology provider, announced it is to create a centralised securities lending platform with the Options Clearing Corporation (OCC). The OCC would provide clearinghouse services for all securities lending transactions submitted through Quadriserv’s AQS™ securities lending platform. In Europe, SecFinex, the online market for securities lending, is leading the development of three central counterparty using different clearing houses. Dev Clifford, principal at Connecticut-based Greenwich Associates, says doubts around the credit worthiness of collateral and cash reinvestment have joined fears

surrounding counterparty risk to make the traditional side project of asset lending more dangerous than it was worth. “From the lenders perspective they weren’t netting a lot of money; it was typically used as a way to offset trust and custody fees and bring those from a cash outlay stand point to zero.” “The original problems that cropped up late 2007, early 2008, had to do with the fact that some of the collateral being offered, while rated very highly, contained some of the mortgage securities that caused the trouble. With the declining value this would lead to calls for more collateral being added and, of course, if you’re a distressed participant, you may not have the collateral to put up.” Greenwich Associates recently undertook detailed research into the concerns of pension fund boards. In a survey of 141 institutional investors, 92 had tightened investment criteria, 43 made changes to their lending programs, and six had cancelled lending altogether. Clifford expects many more pension funds to at least review their lending programs.

COUNTERPARTY RISK


COUNTERPARTY RISK

He highlights the danger in blurring the division between a custodian and a trustees’ responsibility, and says securities lending is now taken more seriously whereas the potential risks may have been overlooked before. “There have always been some questions about the fairness or adequacy of the split with the trust and custody bank that run the programmes,” he says. “I wouldn’t say they got a ‘free ride’ but probably not far from that, at least from a risk standpoint. I think with the issues that arose… you need to step back and take a look at this and ask yourself ‘is it worth the risk?’” That some may have considered securities lending as ‘free’ is echoed by Bo Abesamis, senior vice president and manager of the Master Trust, Global Custody, and Securities Lending Group, at San Francisco-based advisers Callan Associates. “What has happened here in the US, and all over the world is, complacency. Because some have classified securities lending income as ‘free lunch’ – it has masked the other side of the equation, which is ‘there’s a risk attached to this lunch’,” he says. Mark Faulkner, managing director of Data Explorers, the stock lending analyst, is incredulous that any lender or adviser involved in securities lending could ignore the risks. According to the firm’s data, the industry, even post global deleveraging, is generating annualised income in excess of USD14.6 billion a year. “This income is not risk free. There’s no such thing as a free lunch – if it seems too good to be true then it probably is. In the US, the vast majority of the collateral taken is cash and currently an average of 98% of the US lender’s revenue comes from reinvestment rather than the intrinsic securities lending rental. Not all programmes are configured this way and some lenders are lending stock for nothing (or even at a loss) to hold on to the cash they have. The process by which collateral is reinvested is still a central part of the

debate.” Abesamis, who heads the team for securities lending advice at Callan, reports an increase in client enquiries as to the risks attached to lending and borrowing. “It’s very tough to take the emotional argument when the expectation is that securities lending should be relatively safe. The intent really is to look at this is a rational, logical manner.” Abesamis cites counterparty and reinvestment risks of quite startling complexity, with a lack of transparency underlying much of the confusion. “Securities lending could be in any part of in investor’s portfolio: it could be in index funds, in mutual fund holdings, or in a custody-based programme

or the cash funds. So there’s a lot of confusion and frustration.” In this way, a client may not be aware they are engaged in securities lending indirectly if part of the portfolio is invested in funds that lend securities. The result is greater dimensions of complexity with a further challenge to risk management. Abesamis adds that many pension plan sponsors know who is borrowing their securities, and says there are potentially two forms of counterparty risk. The first instance is in the solvency of those borrowing the securities. The second is in the reinvestment of the cash collateral, where “there is a counterparty to the issuer of the short-term debt instrument”. The ratings assigned by the much-maligned agencies such as Standard and Poor’s and Moody’s to certain investment products also compounds the doubts surrounding this latter form of counterparty risk, he adds. “If a rating agency says a

product is AAA, Aa1, then it’s less risky. But is the transparency correct? In an environment where there is a liquidity crisis I think everybody realises now that the triple-A rating may not necessarily mean it’s less risky.” Ahmed Maudarbocus, equity trading and financing, Paris head of securities lending trading at BNP Paribas, says the upshot of compiled risk and greater lender awareness will inevitably cause the market to cautiously retract. “The only thing you can do is be more careful in the market and be more careful as to which counterparty you’re taking your risk.” For the last four months, SecFinex has made its intentions public to establish a central counterparty for

European stocks. It has undertaken a tentative, staggered approach using different clearing houses for the stocks of different groups of countries. At the Sibos conference in Vienna, the firm announced a link-up with LCH.Clearnet to develop a central counterparty for stocks on companies from the Euronext market: France, the Netherlands, Portugal and Belgium. Francois Cadario, director of business development at LCH.Clearnet SA, explains that a central counterparty would nullify the default of a borrower by guaranteeing delivery, effectively taking on the counterparty risk. “The risk of default and the exposure of credit risk for members are so tight the benefit of effectively having a position of a clearing house and the guarantee provided up to the final delivery is effectively something more than attractive for the large set of big players,” he says. Then on 25th November 2008, SecFinex announced a link up with SIX

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x-clear, the Swiss central counterparty, for an identical securities lending exchange, this time for the Swiss, Austrian, German and Norwegian, Danish, Swedish and Finnish markets. A third link-up is planned which will create a CCP for a third set of markets, including the UK. Much seems to be riding on the success of these central counterparties. Robert Reynolds, global head of sales at SecFinex, says the majority of its shares had been bought by parent company NYSE Euronext in anticipation of these new developments. “I think it would be fair to say that NYSE Euronext’s interest in SecFinex was because we were looking to introduce a central counterparty, or hoped to do so, for the securities lending markets.” SecFinex has two existing major platforms. One is a private, bilateral market where the borrower and the lender know each other and negotiate trades as if via the telephone or Bloomberg. The second is an order market, with a bid/offer details market showing best bid and best offer depth of book. The latter, says Reynolds, is “pre-trade anonymous” but with post-trade name disclosure - it is this platform method that will form the securities lending CCP to create “a real price-driven marketplace”. The model will contain trade members for the transactions through SecFinex, and clearing members for the LCH.Clearnet side. The CCP will guarantee to cover the default of a clearing member, and a clearing member will sign an agreement with a trade member to clear their trades and provide capital cover in the case of a trade member defaulting. Francois Cadario says if a clearing member and a trade member default at the same time, they will be treated as distinct cases to minimise market impact. Reynolds adds that he has been surprised there is no existing central counterparty for securities lending. “The electronic platforms that service the securities lending markets are

pretty small, and the market share is pretty insignificant. In this bilateral world people prefer to use relationships and the electronic platforms have carved out a very small market share. So we think the move to credit implications and the move to CCP will redefine the market.” Some believe the introduction of a CCP is timely. Ahmed Maudarbocus at BNP Paribas says after the collapse of Lehman Brothers, a central counterparty is a “step in the right direction. One year ago or two no-one would have thought it useful; now it’s definitely something which can be very interesting.” Others have reservations. Patrick Hannon of M&I Global Securities Lending believes that although a central counterparty would nullify the default risk of the borrower, a beneficial owner would still be

exposed to the potential default of the CCP trade members. Dev Clifford at Greenwich Associates believes the idea would simply concentrate risk, adding, “As we’ve seen, there is no limit to the size of an institution that can get into serious issues.” Chris Taylor, head of securities finance in Europe at State Street, says a CCP will only really benefit broker-to-broker stock loans. An agent lender will not only have to buy into becoming a trade member but will be restricted to receiving cash collateral. Bo Abesamis is more welcoming to the idea, in theory. “To have a central counterparty, the idea is very noble. But at the end of the day we still need to make information, we need to quantify and often quantifying the level of risks, quantifying what’s really underneath,

is a big issue. The realisation there is would you be able to look into every portion of the off-balance sheet items that are in the books of a counterparty. That’s one thing. Because of what’s happening in the industry I’m pretty sure transparency would evolve and regulators would probably inflict requirements for people to disclose. If that’s the case, a central counterparty might make sense.” However, he warns that you can only create a central counterparty when everybody agrees to the same rules of disclosure, and says he would actually prefer to have a concentration of risk in one place. “But would that achieve it in totality? In the US, especially with the large institutional investors, the big corporate funds, the pension funds, the endowments, they normally have their own risk modelling that they undertake. It will have to match up with those risk-modelling parameters.” One influential factor to the success of the CCPs is if agent lenders are willing to part with cash to be part of the operation. Mark Faulkner says the involvement of sufficient agent lenders capable of becoming active trading members is uncertain in the context of a market already nearing its monetary, information technology and psychological resource limits. “Capital is the scarcest commodity – whether agent lenders will want to step forward and become principles is still to be determined,” he says. My concern is that there is so much going on already that despite this being the right time to consider this – the market may not be capable of doing so.” Amid diverse views, there is a common interpretation is that the traditional agent lender model will not be revolutionised tomorrow by central counterparty. Chris Taylor says State Street will remain outside the CCP and continue to receive a variety of collateral. Mark Faulkner also sees potential limits to the CCP initiative unless agents can be involved – “the agent lender is deeply embedded in market structure,” he says.

The relationship between prime brokers and hedge funds has become increasingly volatile. Giles Turner looks at who the costs are being passed to, and how this affects short selling.

Hedge fund mangers focus on short term decisions. It is not surprising that these same managers cannot make up their mind regarding their prime brokers. After the fall of Bear Stearns, prime brokerage was a two-horse race, with Goldman Sachs and Morgan Stanley accounting for 70% of the market. The collapse of Lehman Brothers spread market confusion and soon other players were picking up brokerage business from nervous funds. Credit Suisse and Deutsche Bank have been substantial winners, along with BarCap, with its acquisition of Lehman’s US operations. Initially, hedge funds were chopping and changing prime brokers due to counterparty risk, and avoided traditional prime brokers for the safer

triple-A rated custodians. At present, Goldman Sachs and Morgan Stanley’s counterparty risk has been reduced because of capital injections from the US government. And if counterparty risk was the sole reason for worry,

then Credit Suisse and Deutsche Bank should be the industry’s major winners, as no company named after its country of origin will be allowed to go under. But the collapse of Lehman Brothers and Bear Stearns in 2008 has

CHANGING WORLD OF PRIME BROKERAGE


broken the faith of any fund to reply on the old broker-dealer model. Today, the multi-prime model is prevalent as a result of the need to the need to difuse counterparty risk. The ‘one-stop’ shop for prime brokerage has been broken. According to John Donohoe, CEO of Carne Global, an independent adviser to the global hedge fund, mutual fund management and private wealth industries: “Between September and October, managers have been setting up multiple brokerage arrangements. Instead of the two dominate players we have four or five major players. A lot of managers have also focused on the fact that their securities might be better off at a traditional custodian, rather than a prime broker.”


Custodians, some with less volatile balance sheets and credit lines straight to government coffers, are seen as safer bets than the straight forward prime brokers. At present, these brokers have a lot to lose. A significant amount has be earned on the back of providing financing for certain types of structure using high levels of leverage. This financing has decreased due to the contraction of the prime brokers balance sheets, but as conclusions are drawn about the scale of de-leveraging, it is important to remember that the typical long-short fund wasn’t over-leveraged to the hilt. Certain arbitrage strategies had high levels of gross leverage, and as financing changes, so will the these types of investment structure. But if the instruments change, will the model change? Donohoe continues: “A major factor for prime brokerage is custodianship. It is a very hard to say what the model will be going forward. There is a fine balance between diversification of counter-party risk versus operational risk, so the more prime brokers you have, you end up with a much more complex operating environment, and the risk of mistakes and losses increases.” A major debate is building around the practice of reypothocation. This practice, where client’s collateral is used by their own prime broker to finance deals, can cause major problems when a prime broker goes under. In mid-September, it became clear that USD22 billion of the USD40 billion held by Lehman’s European arm had been rehypothocated. Much like the queues that trailed around Northern Rock, clients are waiting in line to see if they can extract their collateral. This time, they are hedge fund managers, not UK pensioners. Ironically, the more cautious the clients are with their prime brokers, the more prime brokers will be forced to pass the cost back to the client. If funds refuse to allow

their broker to use their assets for reypothacation, the prime broker will suffer a major loss of traditional revenue, and need to make a return in some form or other. Caution comes with a price, and can make some strategies uneconomical. This outcome will highlight to managers and hence to investors the constituents of their brokerage relationship and the real costs versus risks being taken. Whatever path investors end up taking, there will be a cost. Donohue explains: “The future of the prime broker is tied into the future of the hedge fund industry. There is increased cost in terms of operations, as a multi-broker model is more expensive to run, you need more staff, you need more systems and you need more controls,” he says. “But also in terms of costs in running the actual strategy, if you take away the methods prime brokers use to generate revenue, then there will be a direct passing on of cost. This in turn will have a direct effect on the account size a prime broker can take on.” By wishing for safer prime brokers, hedge funds will be forced to focus on their own expenditure. Performance fees and management fees have already reduced. According to Norval Loftus, senior investment manager at Ansbacher: “A lot of hedge fund managers are going to be working for next to nothing next year.” If this continues, there will be an event horizon concerning the viable size of a hedge fund manager. Imposing the multi-broker model on top of already pressured hedge funds will increase cost and increase the viable economic size of a hedge fund. The trading ability and sustainability of small hedge funds will come under question. With investors demanding better risk management, prime brokers will be forced to turn smaller hedge funds away as the revenue generated will simply not be sustainable. “Hedge funds are going to contract, that is beyond doubt,” states Donohue. “The only question is if it goes back to where we were three years ago, where the focus was on managers with a



not what it said on the tin, but there were lots of added options that almost became more important to them.”


Historically pillars of safety for hedge fund managers, the reliability and the viability of service providers has recently come into question. Managers can no longer feel completely confident that their service providers offer absolute safety. The bankruptcy of Lehman Brothers revealed a new type of risk for hedge funds, who now have to worry about the viability and the balance sheet of their prime brokers. Those managers stuck with assets frozen in Lehman’s bankruptcy proceeding have learned this lesson the hard way. Fortunately, the average hedge fund employs two or three prime brokers, either to access liquidity or asset classes or to protect their “intellectual property.” This practice made moving assets and switching prime brokers easier in the run-up to Bear Stearns’ and Lehman Brothers’ collapses.

good relative performance. However the reality is that the breakdown of beta from alpha is still at large and is still in demand from institutions. Consolidation may be a factor but there will always be a demand for good quality alpha managers. What may happen is that these managers may become more institutionalised, and the top managers will increase their segment of the hedge fund pie.” Whether the eventual model is one of various prime brokers or a blend of traditional prime brokers and custodians, the players ability to leverage hedge funds has decreased. As a result, the amount of collateral required for leverage has increased, and leverage per asset has decreased. Certain types of assets, such as convertibles, have seen a dramatic change from a high to low level of debt-to-equity, dramatically impacting hedge fund strategy. This passing of costs between the prime broker and hedge funds has been exacerbated by the short selling bans. A consistent source of revenue for brokers, the ban on short selling will “impact the profitability of prime brokers,” according to Andrew Shrimpton, a partner with hedge fund consultants Kinetic Partners. This does not help the evaluation of balance sheets and the decision on who will bear the brunt of the cost. Goldman Sachs has been shedding hedge fund clients rather than pass on the costs in an attempt to gain efficiency. There is a silver lining to the short selling ban. The California Public Employees Retirement System (CALPERS) has reportedly banned the lending of shares of Goldman Sachs and Morgan Stanley in attempt to stem the instability of these companies. CALPERS has also sent a letter to 60 fellow pension funds urging a similar tactic. In an unusual symbiotic situation, the revenue prime brokers may have earned from short selling has been

It will certainly be important to watch how the prime broker space evolves in the year ahead. Will we see a shift away from bank-owned primes to more of a custodian or outsourcing model? Surely the trend of diversifying risk across multiple primes will continue to grow, as hedge funds simply cannot afford to put all of their golden eggs in one basket.Fund administration is not without its challenges either, given that two of the top prime brokers had established strong franchises in fund administration, this new “viability risk” has to be considered with the choice of an administrator as well Highly public fund failures, which were blamed on negligence of the fund’s administrator, also show that risk exists in outsourcer and service provider relationships. Monitoring and managing this risk should be a part of every hedge fund managers’ daily operations.

offset by pension funds continuing the ban in order to protect the stability of the brokers share price. This may be an attempt to protect the portfolios of the pension funds, however it will be difficult to know when the pension funds should stop their self-enforced ban, as many prime brokers will become increasingly desperate for revenue generated by short selling. Perhaps people are over-reacting. As Mark Higgins, Vice President, Global Collateral Management, Bank of New York Mellon, states: “The short selling issue is not such an obvious issue as we all thought at the beginning.” What is inevitable is that prime brokers have changed beyond recognition. They will no longer be able to offer a multitude of add-ons to their prime broker package, and hedge funds are now talking to AAA-rated custodians regarding ring-fencing accounts and avoiding the problems of reypothocation. As Higgins succinctly states: “What the prime brokers grew up to become was

Marianne C. Brown, president and CEO of Omgeo on hedge funds, on the future

of prime brokerage


LENDER PROFILE

Paul Lee, a director at Hermes Equity Ownership Services (EOS), talks to Catherine Kemp about the thought behind what stock to lend.

1. What is Hermes’ relationship with securities lending?

Hermes is a fund manager wholly owned by the BT Pension Scheme (BTPS), the largest scheme in the UK. We look on the world through the eyes of the pension fund trustees and as long-term owners of companies and have always taken the view that lending was a nice income to have, but not the be-all and end-all. Hermes used to have its own stock lending team but closed the desk about a year ago largely because it had become a completely scale game. We outsourced the lending but retained various powers over those assets, not least voting and also influence over lending. This is partly in cases of a key vote but also because we have concerns about the value of shares when rights issues are happening. We take the view that borrowers short selling the shares could have a very long-term effect on the health and future of the companies

2. So you don’t want the value of the shares you own to potentially be undermined by short selling?

Exactly. Short selling in normal markets is a way of attaining the right price and maintaining market efficiency. In some markets it goes beyond that. Certainly in the markets that we have seen recently it’s looked like short selling was undermining individual companies. Particularly if you have a rights issue and the selling pushes the share price to within the range of the rights issue price, then you’ve got a very real problem. We actually saw this happening with HBOS over the summer. They mounted a rights issue and the share price got severely squeezed. And you

will recall that it was that week that the greater disclosure on the short selling of financial stocks came in because the regulators were, frankly, very scared by what was going on in the market.

3. So how did Hermes react?

Prior to the big noise on HBOS and the disclosure rules, we put HBOS and Bradford and Bingley onto our stock lending ‘stop list’ - an actively managed list of stocks that should not be lent. We added another 15 odd financial stocks to the list, just prior to the regulators taking their dramatic step of banning short selling. In October we added Spanish stocks to that list, because for whatever reason the Spanish regulators had not installed any ban on short selling and it looked like those companies were being exposed. The Hermes Equity Ownership Service (EOS), maintain the list on an active bases,

identifying problem issues. We have about a dozen pension fund clients internationally with whom we share that stock lending stop list.

4. There is a view that banning short selling has not supported the prices of the stocks of those financial companies and has made the market more volatile?


LENDER PROFILE

It’s a pretty blunt instrument isn’t it? In a sense you wouldn’t need to ban short selling if all long-term owners acted in a responsible way. I’m not sure that a ban on short selling would have been necessary if they all actively managed their lending policies in the way that we have.

5. The responsibility lies with the beneficial owners?

I can’t see that responsibility sitting anywhere else. One of the problems is that a lot of the beneficial owners don’t actually recognise lending for what it is. If they are lending, they are actually selling the shares and agreeing to get them back at a later stage. Perhaps the industry needs to help those beneficial owners to understand what’s going on a little more so the beneficial owners can take those decisions more actively than they currently are. I hope that people in the industry will take this as opportunity to reassess and start afresh with a few more protections in place. The risk is that the lending industry falls into further disrepute and actually loses its licence to operate if you like, because nobody will want to touch something which is so badly tarred.

6. What about the need for liquidity?

The list typically has no more than 20 companies worldwide. That’s 20 out of 8000 in which our clients currently invest. But certainly 20 out of the biggest four to five thousand companies in the world. At the moment the list is longer on the financial side. So we are talking nearer 50 companies on the list. It’s still not a huge proportion of those 5000 companies. So you are not stopping lending adding to the efficiency of markets. You are just being a little bit

more responsible and therefore making sure that the industry can continue into the future and doesn’t get tarred with some very black brushes.

7. So you still lend stock, but not the 50 on the list?

Actually BTPS took a decision in October to cease lending altogether until January, when they will reconsider at the same time as the FSA reconsiders their short selling ban.

8. The difference between the long and short-term investor is an important theme. It’s the Warren Buffet distinction, seeing the value of shares in terms of balance sheet rather than the flux of market opinion?

Very few people are brave enough to be contrarians and actually think on those sorts of time scales. Most people in this industry act on a rather more short-term basis. The financial markets would be a great deal more efficient for the underlying owners if there were more Warren Buffets around. Sadly, we seem to be in a cycle where everybody’s thinking about the next quarter rather than the next 25 years. Frankly, that’s what our team is there to do, to help pension funds to think on longer time horizons and to change the dynamic of the discussion.

9. The relationship between the pension fund market and the alternatives market is fairly symbiotic. Pension funds use hedge funds to increase returns and participate in securities lending for similar reasons. How do you reconcile this?

If you hire short-term focus managers with the right parameters and controls

then that’s wholly appropriate. If you just hire them and give them free reign then that’s a very dangerous thing particularly for the long-term beneficiaries. Just as lending, though wholly appropriate, can have some risks at the margins, you need to manage those risks

10. Like cash reinvestment risk? Didn’t the risk really lay with beneficial owner reinvesting their cash in asset-backed securities, like AIG?

AIG stopped being a pure insurance company a long time ago. They didn’t quite admit it, and the regulators didn’t quite admit it.

11. So is the research that you have done into the relationship between short selling and the value of shares done by internal data analysts and market analysts, or is it just from observing the market?

We are active participants in most markets around the world and we get to take a view.

12. Have you seen Data Explorers press releases on this subject?

We’ve been subscribers to their data for years. They are great people, love the product, and that’s why we use it. But they do have a vested interest in maintaining the industry and therefore spinning us a line. It’s not surprising to see the press releases they put out, and good on them. They at least have some sensible data on which to make some sensible comments. We take it with a pinch of salt.


BENEFICIAL OWNERS

Benefi cial owners have reacted in different ways to the default of Lehman Brothers and regulatory changes. Some were comfortable with events, probably due to good communication with their counterparts or lending agents, while others struggled to get reliable and timely information. Without exception, lenders will have weighed up the rewards with the risks. Regulators haven’t lost sight of the benefi ts of securities lending and the vital liquidity this activity provides. Meanwhile, volatile markets have reemphasised that short selling cannot be the only thing that drives down prices as the restrictions on short selling have demonstrated. But how will these events change the securities lending industry?

The argument that if a bank goes into default there are bigger problems than the securities lending programme held true when Lehman Brothers fi led for chapter 11 protection in the US and went into administration in Europe. But the exposures needed to be unwound. For lenders accepting non-cash collateral, the process was relatively calm – lending agents largely took the view that, regardless of legal wording, the best practice is to sell off the collateral and buy back the

lent securities. However, those who dismantled the situation based on wording in individual legal agreements have potentially complicated matters and caused concern to their lenders. Falling equity prices (the lent securities) and rising bond prices (the collateral) has assisted in ensuring that suffi cient available collateral. However, for lenders participating in a ‘collateral upgrade’ trade - for example, lending bonds and taking equity collateral - there may still be a shortfall in the liquidation of collateral. Lenders taking cash collateral may be feeling more nervous. It is a rare money market fund that didn’t hold some form of Lehman Brothers paper that is now as good as worthless. Some lending agents have stated that they will stand behind certain losses in their money market funds – essentially suggesting they will cover losses in cash collateral pools for lending clients. Other custodian banks have admitted that they hold Lehman Brothers paper in their money market funds but have not yet clarifi ed what this means for lenders. There are also tax implications of the ‘unwind and buy-back’ process and the industry is now addressing this with the authorities.

Lenders now have a better

understanding of the value of their indemnifi cation – the insurance that the lending agent will cover some of the costs incurred from costs counterparty default. The lending agents approach to covering the cash pool shortfall also requires exploration. Lenders need to understand that if providing cash indemnifi cation is likely to become market practice, it needs to be explored with each lending agent in detail and documentation of any implied protection will be required. Lending agents will be aware that any formal acknowledgement of such an indemnity will require a relevant balance sheet calculation.

Exclusives were popular among benefi cial owners, but we suspect that perspectives will now be fundamentally changed. Although they are a good way for lenders to lock in value, with borrowers continuing to require key assets and indexes to satisfy their hedge fund clients, the days of whole portfolio exclusives to a single borrower are probably limited, certainly in the short term. A survey Spitalfi elds Advisors conducted in August/September 2008 highlighted that borrowers will also be constrained by capital and will be more selective about the portfolios they bid for. For those in the process

Regulatory changes and the Lehman Brothers default dramatically affected benefi cial owners, and many reassessed their participation in securities lending. Spitalfi elds Advisors reports on the impact and advise on the future.


BENEFICIAL OWNERS

of auctioning portfolios for 2009, there will be many challenges to price them. The short selling restrictions is one factor, but the changing face of financial institutions also makes appetite difficult to gauge. Firms merge, and as hedge funds change prime brokers, the market is too dynamic for borrowers to bid on anything but the most attractive portfolios. We have spoken to a number of lenders who have rather smugly admitted to recalling all loans from Lehman Brothers in advance of recent events. We caution that this needs to be managed consistently. Wholesale restrictions to individual counterparts based on bad news may be disruptive to the ability of the lending agent to lend securities. It could lead to the counterparty effectively refusing to borrow from the lender and generally put stress on the relationships in the securities lending chain.

The liquidation of collateral positions has been necessary for the first time in recent years. Some lenders have increased haircuts on certain collateral, and to certain counterparties. A survey conducted by Spitalfields Advisors in September 2008 showed that haircuts have moved from industry standard 2% and 5% (depending on the currency of the collateral vs the lent security) to as much as 20%. This has emphasised the increasing importance of tri-party collateral agents and their ability to manage a number of different parameters that has allowed lenders to tweak their collateral requirements. We suspect that this model is likely to be an ongoing trend, but we caution that this needs to be arranged in conjunction with lending agents. Not all lending agents will have the capability to manage restrictions to this level, particularly where there are a number of different lenders participating in one collateral pool. Borrowers will also be reluctant to

post increased collateral and lenders are less likely to lend the security at 20% if others are prepared to accept 2% and 5% haircuts. Remember also that providing a haircut to a lender is effectively an unsecured loan that requires a balance sheet hit. Borrowers will also be reluctant to pre-pay, the process for pre-collateralising loans to avoid intraday exposures. This brings us to cash collateral. It is likely that some may choose to restrict cash collateral. Lending agents are keen to hold cash balances that will allow investments to mature. Generally, lending agents and borrowers have been successful in managing this, although recent events will have had a detrimental effect on overnight liquidity in some money market funds and cash collateral pools.

There have been emotional discussions regarding the various short selling bans worldwide. Each is slightly different and there is no consistency in timeframes or coverage. We understand why regulators felt the need to act and think this has provided a pause in the somewhat aggressive headlines aimed at short sellers. In fact, it has demonstrated that short sellers have not driven down prices as stock indices have continued to decline. Also, the majority of loans by value are fixed income loans that are not required by hedge funds for short selling but actually provide important liquidity as collateral for other financing activities. Most of the restrictions applied to financial securities, which regulators felt were most vulnerable. Interestingly, during the preceding days we had seen a gradual shift of lenders to restricting lending of these securities. We certainly don’t advocate a wholesale restriction of financial securities but accept that lenders always have the right to recall or restrict securities from lending. On the other hand, companies like JP Morgan have requested to be removed from the list. Further, the

Chinese authorities have approved rules that allow short selling. We continue to read stories of lenders who have stopped new lending or are recalling loans. This is not a decision to take lightly. In falling markets, the additional revenue from securities lending is welcome. Reduced lending activity will also result in more assets under custody, which will incur custody fees. A full pull out of lending for cash takers is more serious. In addition, if all lenders decide to restrict activity then this will have a detrimental impact on liquidity in the cash equity and derivatives markets.

Many lenders wish to continue securities lending but say that they need to revisit their programme structure to reflect best practice. We recommend that all lenders should consider this, which is likely to include a review of the following elements: risk management, risk adjusted returns, counterpart exposures, legal documentation (including indemnification language), use of triparty agents, collateral requirements, the use and application of exclusives. Benchmarking can no longer be restricted to performance and monitoring risk. The supply and demand mechanics have changed – some lenders will take a while to come back to the market and others will restrict the counterparties they are prepared to lend to. There are less counterparties to lend to which will restrict general collateral demand. Prices will increase for high quality government bond portfolios and “hard to borrow” securities. On the demand side, short selling regulations have led to questions about the 130/30 and hedge funds that typically short sell. Investors potentially putting on hold investment decisions may pull money from these strategies as the regulatory uncertainty impacts performance. Both will have an impact on demand for securities from lenders.


THE SHORT SELLING BAN

On 19 September 2008 the Securities and Exchange Commission (SEC) and the Financial Services Authority (FSA) banned the short selling of financial stocks. It was a coordinated response to what Callum McCarthy, chairman of the FSA, described as “volatility and... incoherence in the trading of equities, particularly for financial institutions”. The regulators did not change the rules on securities lending, nor did they change the rules for market makers – except for in relation to uncovered, or ‘naked’, short selling. Similar regulations were then rolled out in most securities lending markets around the world (see table on page 30) and have been hotly debated. For some it is hard to distinguish between the effects of the new regulations and other market events. The credit crunch had been unfolding for a year before the Lehman Brothers collapse and the buyout of Merrill Lynch. The rules have directly affected the trading strategies of hedge funds. As the primary borrowers of securities, this has impacted borrowing volumes in the securities lending market. Volumes of borrowed financial stocks have significantly decreased since the ban’s inception. According to Data Explorers Securities Lending Index (DESLI), a weighted average of the quantity of stock that is lent

and borrowed indexed at 100 on 1 September 2008, had fallen by 60% by 14 November. Jules Pittam, head of sales at Data Explorers, said: “After the ban we saw people stopping short selling securities and so there was a buying back of short positions. If you look at the bank sector, for example, there was a 60% drop in the amount of stocks being borrowed. Not so much in the UK, which has a 40% reduction by 14th November.” The US - whose ban was repealed on 8 October - has also seen a significant decrease in borrowing. According to SunGard ASTEC Analytics (see graph, facing page), ex-financial stocks on loan reduced by 20% during the ban. Even after the the ban had expired, the volume had reduced by 30% on 1 November 2008. Over the same period, financial stocks on loan reduced by 42%, and to 50% by 1 November. Aaron Gerdeman at SunGard ASTEC Analytics says he expected to see an influx in short sellers back into the market to reclaim short positions, but this did not happen. “We’ve only seen a stabalisation, a new norm,” he says. “It’s hard to measure the effects of the short selling ban without factoring in other market events, but from what we hear about hedge funds, who are the primary borrowers of securities,

many of them are on the sidelines not executing as many trades today, or they are receiving large amounts of redemption requests from their investors. So as hedge funds’ assets decline, the increased decline in borrowed US equities demonstrated on the chart, after the end of the ban, makes sense.” According to Gerdeman, the ban has meant that hedge funds have been unable to carry out normal trading

operations because they have been unable to hedge their purchases with a short. This has resulted in less new borrows and more managers pulling their capital out of the market and buying back positions that they are no longer able to hedge. The retraction of cash has not supported prices. Valuations of financials and ex-financials have continued to decline since the ban. According to Bloomberg’s S&P 500

Speaking to a cross section of market participants including

beneficial owners, market analysts and borrowers,

Catherine Kemp reviews the impact of the various

short-selling bans.


THE SHORT SELLING BAN

index, prices fell from 1250 basis points on 1 September 2008 to 750 midway through November. Some say it is too early to fundamentally analyse how much the declines have been influenced by other market events, though some see the bans as a major factor. “Once the regulators put these short selling bans into place, the share price of the banks dropped substantially,” says Neill Ebers COO of Lionhart, a global multi-strategy arbitrage fund. “The new regulations froze out affordable liquidity. It forced people to unwind trades that they had already positioned and prevented increased activity, which was very damaging, at a time when the market was already illiquid.” VIX, the volatility index, shows increased turbulence since the bans, leaping from 20 on 1 September to 80 on the 5 December, having previously been reaching highs and lows of 30 and 15 on average. Gerdeman says: “Buying and selling interest in the market ultimately helps to reduce volatility in the market and to add liquidity. Taking that away has made the market more volatile.” Volatility has also impacted convertible bond arbitrage, says Ebers. “You could hedge out the credit and interest rate component but you couldn’t hedge out the equity, because you couldn’t go short on banking stock anymore. So a natural arbitrage which would actually increase liquidity because you’ve got more buyers of the debt who are looking to hedge out one of the risks within that component, were stopped from being able to do it. It froze out a part of the market which has actually grown rather large as an asset class.” Hedge funds have also been ushered out of the market having received redemptions as a result of poor performance. Deleveraging as a result of the Lehman’s collapse and the lack of liquidity has also decreased borrower volumes and stock prices and increased volatility.

Available inventory on loan has also decreased since the beginning of the ban. DESLI’s weighted average of the quantity of stock that is lent and stock inventory available to borrow for all regions and industry sectors globally, shows that inventory dropped from 100 to 80 since the inception of the ban. Pittam says people were still able to lend because the regulatory environment had only targeted short selling, but they didn’t want to. The California Public Employees’ Retirement System (CalPERS) and APG, the Dutch pension fund, both pulled certain financial stocks out of the market shortly after the short selling bans came into place. Hermes, a fund manager wholly owned by BT Pensions Scheme, the UK’s largest pension fund, claims it has stopped lending entirely for the same reason. Strathclyde pension fund and the E.On pension fund have also temporarily pulled out of lending. Karen Jones, head of the GBP6.3 billion Aviva staff pension fund, said it was reviewing its lending policy. Philip Neyt, the chairman of the Belgian Association of Pension Funds (BVPI), called on Belgian corporate and industry-wide pension funds to stop the practice of lending securities in October. Paul Lee, a director at Hermes Equity Ownership Services (EOS), says: “We look on the world through the eyes of the pension fund trustees and as long-term owners of companies and have always taken the view that

lending was a nice income to have, but not the be-all and end-all. We take the view that borrowers, short selling the shares, could have a very long-term effect on the health and future of the companies.” Hermes has not permanently stopping lending, and plans to review the situation in January when the FSA repeals its ban. According to DESLI, around 13% of stocks globally have been withdrawn from the securities lending market, says Pittam, higher than the 8-9% withdrawn when the dot.com bubble burst. “It has taken liquidity away from the market, driven up fees in some circumstances, which for lenders can be a good thing. We expect the market to flatten out at around 13% and then bottom out. We expect people to come back to the market as and when the regulatory environment returns to a more stable footing. Very few have said it will be permanent.” Gerdeman estimates that the availability of shares borrowed by institutional investors or hedge funds, declined by 12%. “This reflects sales by hedge fund borrowers as well as sales among suppliers of securities,” he says. “In the US it was 10%.” Gerdeman explains that, on average, 90% of beneficial owners are still continuing their securities lending programmes, because lending has provided good income. Many lenders are making more income than ever before because the lack of lenders has driven up fees. Jane Miller, a market specialist at SunGard Securities Finance, says: “One of the things stock lending does for investment managers, specifically ones who accept cash collateral, is to provide liquidity, which as we know is a problem right now. Additional liquidity, as well as income, may well be another factor influencing decisions to stay in or get out. It gives them another reason to lend over and above what was considered a primary reason in the past.” Pittam explains the other side of this.

PRIME BROKEN: US borrowing declines


THE SHORT SELLING REGULATONS

“Lenders are very keen to maintain cash balances, as has been reflected in some of the figures where people are lending at very low rates in order just to get the cash,” he says. “Banks don’t want to give cash because it’s expensive. This hasn’t helped the money market funds at all, and caused problems if anything. “Volumes have also reduced because of long selling. Investors are selling stocks because they were going down in value so significantly.” As stock prices decline pension funds are selling their stock, and pulling out of investments with hedge funds. In the US short sellers did not rush back into the market after the ban was lifted, it remains to be seen what will happen in the UK. At the moment it seems that hedge funds and lenders are being extremely cautious and regulatory risk will be a primary concern. “The one things hedge funds, or any other investor hates, is regulatory risk,” says Pittam. “Short-term regulatory flux, that you can’t legislate for, can’t hedge for, and that can have a dramatic effect on market activity and prices, worries people. I suspect hedge funds are now looking for a more normal period of activity but they will be very nervous about the future and they will be taking that into account, which will have an impact on securities lending, because no short selling means no demand to borrow securities.” However, overall Miller concludes that it won’t affect volumes in the long term. “The majority of people clearly understand how important the ability to short-sell is,” says Miller, “and that securities lending facilitates that capability. I would say that while positions have gone down, there’s still a lot of volatility in the market, and it’s probably going to take a while to stabilise, the need to borrow, as a result of shorting, will not go away.”

Country Ban still in effect? Naked shorting? Disclosure

Australia Until 27 January 2009 Banned All daily stock lending

Austria No Banned for shares of Erste AG, Raiffeisen AG, UNIQA Versicherungen Wiener StadtischeChina No

Denmark Banned for Shares issued shares issued by banks wth by banks with Danish banking Danish license license France Equity securities issued by credit or insurance firms traded on French markets Greece No (expired 31 Dec) Shorts positions in excess of 0.1% of company Ireland Yes, for Irish bank Banned stocks

Italy Banned

Lux’bourg Banned

Korea Banned

Norway Yes Banned

Portugal Yes, eight banks’ Report naked Mandatory for all stock banned shorts to CMVM Euronext/PEX Russia Yes Banned

Switzerl’d No Banned (all Swiss stock)

Taiwan Yes, all listed stock except shares trading higher than previous closing price


If president-elect Barack Obama`s inspirational speeches ushered in a new and more positive zeitgeist for America and the rest of the world, the markets didn’t notice. As stock prices continue their depressing plunge, regulators are still trying to figure out where it all went wrong. Short selling continues to be an area of hot debate and political action, and naked shorting - selling a stock short without first borrowing the shares or ascertaining that it is possible to borrow them, which some would see as the ugly side of the shorting - has particularly come under the microscope. In the next quarter it looks certain that a final decision will be made as to how to effectively control naked shorting for the health of the financial system. Despite the debated connection between short selling and volatility, regulators have generally considered it an acceptable investment strategy. All this changed in September 2008 when the markets went into freefall,

Lehman Brothers collapse, and suddenly short selling became public enemy number one. Many countries acted swiftly to ban the practice either on specific stock or outright a move that many saw as being more political than practical. Now in retrospect most will agree that any positive impact the ban has had on the fortunes of the various companies it protected was debatable at best – as prices have not been supported. Some would agree that short selling does play a valuable role in ensuring stocks are not overpriced, providing liquidity and reducing volatility. However, far fewer are of the opinion that there is a place in the system for naked short selling – undoubtedly the black sheep of the short-selling family. In naked short selling a ‘fail to deliver’ occurs when the seller cannot obtain the shares in time, or had no intention to. While tracking the number of fail to deliver cases is not a concrete indicator of naked short selling activity, an elevated number of failures is usually taken as a sign that naked shorting has occurred. Naked shorting is a potent speculative tool in manipulating the markets, and though its use to this end is illegal, enforcing regulations has proved difficult. “I’m not a fan of naked short selling unless there’s an excellent chance they can locate the security,” says Matt Samelson, a senior analyst for Aite Group and an expert in equity market

structure. “I don’t like the idea of being able to purely leverage what’s out there without anything of underlying fundamental value.” Within the securities lending industry the general feeling towards naked short selling is negative. Securities lending serves a vital function in traditional short selling, and therefore the industry was largely disappointed with the short selling bans. However, this support does not extend to naked short selling. The perception is that naked shorting adds volatility and significant distortion to the market. Roy Zimmerhansl, an industry veteran who was previously securities lending marketing director at Deutsche Bank and recently the head of e-securities lending at the interdealer securities broker ICAP, says: “I believe that naked short selling – defined as selling shares where there is no availability of shares to borrow, or indeed even where there is no intention to borrow – is inappropriate and should be permanently banned. “It distorts the market and injects counterparty risk into a cash transaction which is wholly improper.” David Rule, chief executive of the International Securities Lending Association, specifies that naked shorting comes in three forms. The first form is temporarily going short prior to borrowing for the purpose of a quick trade to hedge a position; the second form is day trading, consisting of not covering a sale with a borrower because one expects to close the position before settlement; the third is deliberately trading to fail. Rule believes that only the first two should be permissible. He says: “Personally, I would limit naked short selling by having effective settlement discipline that penalises failed trades and by enforcing market abuse rules that would penalise anyone who deliberately sells a large value of a security that it could not possibly cover in the borrowing market with the purpose of temporarily moving the

As the financial crisis contin-ues the practice is now firmly in regulators’ sights, writes Joe Corcos.

NAKED SHORT


price.” However, while most in the industry agree that naked shorting is undesirable, the role that it played in the fall of financial royalty like Washington Mutual and the Lehman Brothers has probably been inflated by politicians. “I personally think that naked short selling has played little to no fundamental role in the failure of these banks, though it did come in to play at certain stages,” says Josh Galper, the managing principal of the financial consultant Finadium. “I think that naked short selling was possibly contributed to some decline in the stocks price, but I think that these banks would have failed with or without naked short selling being present. Rather, I would say that a lack of reporting and knowledge about short selling activity allowed for possible bear raids or other directed market activity outside the radar of market regulations.” Some have even argued recently that naked shorting can provide a beneficial service to the financial markets. In their paper ‘The Economics of Naked Short Selling’ Christopher Culp, a professor of finance at the University of Chicago, and JB Heaton, a partner at Bartlit Beck Herman Palenchar & Scott, argue that the only difference between naked shorting and traditional shorting is who is effectively lending the security. They write: “Naked short selling creates competition in the market for security lending by allowing a new buyer to provide the service of being owed the share rather than allowing only the current owner to do so. “To the extent that competition in the securities lending market is desirable then naked short selling, far from being detrimental, may be valuable in facilitating the gains from short selling.” Whether many would agree, especially in the current climate, is doubtful. The financial services industry is in disarray and it is now

obligatory to question processes which were more or less permissible in the past. Regulators and politicians are unlikely to be receptive to arguments favouring practices like naked shorting. Though the extent to which naked short sellers have deliberately traded to fail in the past is impossible to quantify, as is the effect of such naked shorting, naked short selling has now come under the regulators’ collective magnifying glass. In September the SEC adopted rule 10b-21 which requires short sellers and broker dealers to deliver securities within three days of the sale transaction date – known as T+3. This essentially makes fail to delivers a violation of the law. When the rule was adopted SEC

chairman Christopher Cox said: “These actions today make it crystal clear that the SEC has zero tolerance for abusive naked short selling”. More recently Cox called an emergency meeting of the International Organization of Securities Commissions on 24 November to discuss the current financial crisis. The result of this was the creation of three task forces focussing on coordinating global regulation of the financial system. One of these is to tackle naked short selling. All three task forces are set to present their results to IOSCO in February and to the next G-20 summit early next year. Like many recent government and regulator measures, this is being seen as something that perhaps should have been done before the crisis hit. Already many have accused the SEC and others of effectively shutting the stable door after the horse has bolted.

Galper says that action had not been taken previously because naked shorting was simply not a problem for the investment banks and firms under the auspices of the SEC. He says: “Naked short selling allegedly created some level of profit or at least operational efficiency; traders were incented to lobby for its protection. Once those same banks were negatively affected by naked short selling, or at least the threat of it, they became incented to lobby for its elimination. “I do not believe that until now regulations on naked short selling have been enforced. Further, I feel that the fines that have been meted out for naked short selling violations have been too small to influence changes in behaviour – they have been more additional tariffs on the cost of doing business, not a deterrent themselves.” It is hard to predict the concrete results of the task forces. However, when being seen to take strong measures against financial volatility is the order of the day politically, strong new rules against naked shorting will be the most likely result. Zimmerhansl says: “Time will tell as to what the outcome will be, but I am a very big supporter of the task force objectives. “My concern with the initial restrictions and bans on short selling was that they were hastily imposed and done without forethought. The task forces are the correct way to approach the issues.” Whether this is so is yet to be seen. What seems certain is that soon enough naked short selling may become much harder to do undetected, and may become a thing of the past.

NAKED SHORT


wait for we impatient westerners, but the Middle Kingdom has never been renowned for placing the emphasis on the short-term. Putting developments in the region in further context, Philippe Metidou recalls that when he first posited setting out guidelines for securities lending there in 1993, the reaction was less than enthusiastic.

“I was crucified,” he says. “Everyone was against it! Things have changed dramatically since then and it’s now part of daily life; it is those centres that don’t have securities lending that are the exception.” Increased interest in securities lending reflects the broader changes

ASIA

Anyone predicting the arrival of securities lending in China would have probably been given a wide berth by most sane people until relatively recently. But we live in extraordinary times, and - whisper it gently - such is the pace of change in the People’s Republic that securities lending has appeared on the financial services industry’s radar and could well be with us in the not too distant future. “China is the most obvious example of the radical changes in attitude that are taking placing in the region,” says Phillipe Metidou, head of client relationship for Asia Pacific, the Middle East and Africa at Clearstream in Hong Kong, a veteran of 20 years there. “It used to be very restrictive, but securities lending is being spoken about openly in the market, has pretty much been accepted, and preliminary consideration is being given to implementing it there.” Nothing much, in fact, needs to change, he observes, given the sophistication of the CSD’s systems, and the support that key players are offering. “It is more a question of the political will, and the arrival of convertibility and transparency of the Chinese currency,” he continues. “We should see that within the next five years.” That might seem a long time to

in underlying investment behaviour. “More and more investors are interested in the region and we have introduced direct links to a number of markets, including Japan, Australia, New Zealand, Hong Kong, Singapore, Malaysis, Indonesia, Thailand and Korea,” continues Philippe Metidou. “There is a political will in most countries in the region to develop a yield curve; everyone is keen to attract and retain international investors, and without a strong securities lending and repo culture, the big boys just won’t play.” However, Asia is not looking to simply replicate developments in other international markets in the use of securities lending, he contends. “Asia is looking to establish its own best practices. It hasn’t implemented securities lending to catch up with others who are doing it but because it wants to do it. Asia now has critical mass and is much more independent than in the old days.” Roy Zimmerhansl, creator of the ICAP securities lending platform and now an independent industry consultation, argues that no other region in the world has made as much progress with short selling and securities lending as Asia over the past decade. “However, given

Brian Bollen looks at the arrival of China’s securities lending market, against the backdrop of short selling restrictions throughout Asia.


ASIA

the unprecedented market turmoil this year, regulators in the region have revisited on short selling and by implication securities lending,” he says. “Having spent years removing outright restrictions on short selling, eliminating up-tick rules and paving the way for a vibrant securities lending business, each market across Asia and Australia re-evaluated their regulations.” Pretty much every country already had a prohibition on “naked” short selling (selling shares without having borrowed them), he continues. This may be intentional, or accidental - the net effect is that the sold stocks will not be delivered. Some countries - including Japan, Hong Kong and Singapore - have reiterated their stance against naked shorts. Since the summer of 2008, most countries in the region have implemented short selling restrictions on a temporary basis. The notable exception here is Hong Kong, where the Securities and Futures Commission has very publicly led the way by saying it was confident in its rules and reporting requirements and never felt the need to further restrict market activity. However it emphasised that it would keep monitoring the situation and would act swiftly and harshly if it felt the spirit or the letter of the rules were being violated. Hong Kong’s leadership is best exemplified when it took the lead role in the recently announced IOSCO Task Force on Short Selling. Japan and Australia have announced new disclosure requirements and Singapore has issued a paper seeking comments on enhanced disclosure reporting requirements. Australia found itself embroiled in securities lending scandals throughout 2008 concerninghe bank ANZ and the failed prime broker Opes Prime (see the Spitalfields Advisors report of March 2008: Putting Australian Securities Lending in Context). As a result, recent legislation has been introduced on short selling and a more rigorous

disclosure system implemented. The bottom line on stock lending in Asia is that it has made tremendous strides in the past few years, says Roy Zimmerhansl. “Some of that good work has been undone, but importantly there hasn’t been any market that has banned stock lending in the same way as Malaysia did in the Asian crisis in the late 1990s. Any restrictions on short selling have been temporary, with the exception of naked short selling which almost everyone globally agrees is manipulative and should be outlawed.” The bigger story in Asia is the demand side, he argues. “What has

been the experience with respect to Asian hedge funds? Many Asian hedge funds have employed trading strategies that involved market neutral or hedged positions. The impact of short selling restrictions therefore had a very large impact on these funds. For example, convertible bond arbitrage is a very traditional Asia focused hedge fund strategy. If you are running a convertible bond arbitrage fund, and you suddenly can’t short sell the stock, it dramatically affects your ability to hedge and engage in any trading. It forces the fund to change its strategy and may result in closure or style drift to more of a credit focus.” “The Asian hedge fund industry

is relatively new, and has been expanding rapidly after enjoying five straight years of double digit growth. More frequently with newer funds, Asian hedge funds have employed equity long-short strategies and have had far fewer credit-based funds. Thus the equity turmoil has had a disproportionate impact in Asia.Asian hedge funds have suffered worse performance than their counterparts elsewhere in the world. According to Eurekahedge its universe of Asian hedge funds showed a loss of 22.2% for the year as compared to a loss of just over 12% for their total hedge fund universe. Some analysts predict redemptions from investors in Asian funds to be in the neighbourhood of 25-30% and this does not take into account those hedge funds that have restricted withdrawals or those funds that have shut down. Eurekahedge also reported that hedge fund closures in Asia jumped 19% from a year earlier by the end of August and anecdotally that trend has continued.” Hedge Fund Research (HFR) reported a 13% decline in assets under management at Asian hedge funds in the third quarter alone. This compares to an increase in assets under management in the third quarter of the previous year in Asia of 8.7%. Assets in Asian hedge funds dropped in the third quarter of 2008 by over USD13 billion with USD10 billion coming from performance losses and the remainder from client withdrawals. KSD, Korea’s central securities depository, which introduced securities lending and borrowing in 1996, mainly for the purpose of settlement facilitation, tells us that it is the leading intermediary for stock lending and borrowing with roughly 80% of transactions done via its programme. The programme has about 110 participants with borrowing positions, and 183 with borrowing positions, with a considerable overlap between lenders and borrowers, reports the KSD. “In the case of Korea, the current


ASIA

financial crisis has had a deep impact on the stock lending and borrowing market as well as other sectors,” the KSD says. “One, short-selling: plummeting stock prices have focused on short-selling as a possible culprit, which in turn has led to stock lending and borrowing being singled out as a contributing factor. Short-selling was banned in October 2008. The ban is temporary but there is no definite date set for lifting the ban [the KSD is referring to covered short-selling; naked short-selling has never been permitted in Korea, it reminds readers]. Two, risk management: market volatility and the bankruptcy of Lehman Brothers have made market participants more cautious regarding risk management. In the case of securities lending and borrowing, the Financial Services Commission (FSC) increased the collateral level for securities lending and borrowing transactions to 130% and SLB intermediaries are placing stricter rules for eligible collateral. Three, foreign investors currently account for the majority of stock lending transactions, although there are some restrictions on their activities due to foreign exchange regulation issues. The limit on borrowing by non-residents borrowing from local lenders without prior-reporting to the Bank of Korea was increased from KRW 10 bn to KRW 50 bn from 17 December 2007. At the same time, it became possible to use foreign currency collateral for securities lending & borrowing transactions.” Prospects for securities lending in Korea in the near future do not appear favourable, the KSD says. “Market conditions are currently uncertain. The ban placed by the FSC on short-selling is still in effect with no definite date set for the lifting of the ban (time of writing: early December 2008). Many big lenders (e.g. the National Pension Fund et al.) have suspended or reduced lending activities for the time being. The resumption of securities lending

activities as usual will depend largely on the improvement of the financial market situation. Interest in securities lending has been on the rise in the region, adds Francesco Squillacioti, senior managing director and regional business director in Asia Pacific for State Street’s securities finance division. “This is a factor of increasing asset growth among institutional investors and their desire to earn incremental income through established, well-respected securities lending programmes. State Street has seen clients and prospects closely reviewing and considering overall

programme parameters — such as performance reporting capabilities, counterparty risk management and collateral guidelines — all leading toward a requirement for greater transparency. This scrutiny has been with a view toward understanding and addressing the different risks in securities lending. State Street has historically placed a great amount of focus on these aspects of securities lending and that discipline resonates with our clients and counterparties. The change in the Asia-Pacific region has been to look beyond just revenue generation, and toward to risk-

adjusted performance. State Street believes this is the right approach. Our philosophy has long been to provide our clients with incremental revenue within the context of sound and prudent risk management.” “We believe the future looks optimistic for securities lending in the region. The long term dynamics and growth prospects of the capital markets and the various institutional players in the region who would ultimately participate in securities lending programmes point to continued demand for the product. As with any other industry, technology is vital to securities finance. The goals of heightened efficiency and transparency in the face of growing and more complex business conditions are very much present in State Street’s strategy. That’s why we invest significant resources back into the business and our technological infrastructure. In Asia Pacific, our regional clients benefit from the strength of a world class global franchise and our expertise as a niche specialist in securities financing solutions. Our three regional offices and trading desks located in Hong Kong, Sydney and Tokyo house 36 experienced professionals dedicated specifically to securities financing activities — including trading, operations and risk management; product development, legal and compliance; sales and relationship management.” He argues, in effect, that State Street is the only global service provider that has a complete range of product capabilities in this region. Readers should feel free to dispute this claim if they feel so inclined.


infrastructures. I didn’t think that Lehman Brothers would go bankrupt and others have said that to me. But as a firm we identified the risk of Lehman Brothers and Merrill Lynch early on. It’s a counterparty relationship we’ve always enjoyed, especially from a Lehman’s perspective, but I’m happy to say that we weren’t exposed from a prime brokerage standpoint or from a swap standpoint when they fell into demise.

5. What are the major issues with rehypothecation and client money protection?

Ebers: Client money protection is one of the terms that everybody usually waives, especially if you are a leveraged fund. We are a leveraged fund and you tend to waive it because you tend to be a net borrower, as opposed to net long cash, so you don’t really need the forms of protection which client money offers. There are a number of money managers out there who are actually net long cash who can go out and get client money protection. Rehypothecation is one of the most

lending impacted you ?

Kennard: We were in the process of de-leveraging before the short selling regulations came into play. We were reducing our exposure to the market, and just going after the better return in trades that were out there. I have seen a reduced amount of stock available to borrow on the market, increased fees, more attention to counterparty risk, more attention to collateral. It’s had a real knock on effect to the whole industry. You only have to look around on network sights like Linked-In and see the amount of people who are either out of work, or between jobs, it has had a really serious impact on our market.

4. The world of prime brokerage has been changed dramatically by recent events. How is this affecting you as a hedge fund?

Ebers: The first shock wave was Bear Stearns – it challenged the model of a single prime broker. There were a number of people who were trying to run to safe havens and didn’t have anywhere to run to because they didn’t have a second prime broker. With Bear Stearns, JP Morgan came in, which is a safe pair of hands. The continued write down of credit by UBS, Lehman Brothers and Merrill Lynch gave people real concerns about counterparty risk. If you didn’t have concerns about counterparty risk from the first part of this year I think you were probably fundamentally missing something from your risk management process. It was very clear that both firms were actually highly leveraged within this market – their cost for financing and funding was going through the roof as they had to buy more paper in the market place. At the same time, there was instability within their global company

1. What is Lionhart’s involvement in the securities lending market - are you a borrower or lender, or both?

Kennard: Lionhart is a global multi-strategy arbitrage fund. Our strategies primarily focus on capital structure arbitrage, convertible bond arbitrage, special situations and thematic relative value arbitrage. Due to the techniques we employ, we are usually a borrower of securities. These are used to cover the short-side aspect of the arbitrages that we invest in. We have on occasions engaged as a lender of securities; however, our primarily activity is that of a borrower.

2. In what ways is securities lending important to your business works?

Kennard: SBL very much drives the hedging of certain positions and can in itself generate trading ideas. If we are unable to secure a borrow then we cannot hedge the position/strategy and the dynamics of the investment change. For example, if Anheuser Busch was having a rights issue - and assuming these were trading at a small discount - we would purchase the rights while simultaneously [borrow and sell short Anheuser shares] sell the underlying security. At the appropriate moment you would exercise your rights to create shares and these shares would be used to close out your short share position in Anheuser and, subsequently, the stock borrow. As you can see, if you were unable to borrow the securities, you would be unable to execute this strategy.

3. As a borrower, how have has market volatility, the Lehman’s collapse, and the lack of interbank

BORROWER PROFILE

Neill Ebers, COO, and Jason Kennard, head of SBL and collateral management at Lionhart talk to GSL.


hotly debated subjects in prime brokerage and has been for the last couple of years. The Lehman Brothers collapse demonstrated what happens when your balances, which you thought were being held with a London-based company, suddenly disappear overnight and end up in the US. Your accountant says you can’t recover them, because at that moment they can’t actually identify your assets. So you are not able to risk manage your positions, you are not able to cash P&L, you don’t know what to write down against your net asset value and you get into the legal interpretation of what does rehypothecation mean. The other issue is equivalent securities. It means that in rehypothecation someone returning your assets can actually return equivalent securities to you. An example of the legal interpretation of equivalent securities is: if I’m long on Microsoft and IBM is valued exactly the same as Microsoft, someone can deliver back to me IBN shares, rather than Microsoft. The Lehman Brothers collapse opened up Pandora’s box. It raised the issue of your legal rights with regards to the right of substitution, equivalent securities and someone’s right to rehypothecate your assets. Also, where does our free cash go, how is that protected, and how does someone go and get that back? Within 24 to 48 hours of the huge runs on Morgan Stanley and Goldman Sachs, their duopoly broke. I think it’s good that the dominance of those companies has been put into question, but on the other hand it raises the issue of consolidation in the prime brokerage landscape. Lehman Brothers was the largest prime broker and left the market place. Bank of America may – if it’s shareholders vote goes through – actually buy Merrill Lynch’s prime brokerage business. Bear Stearns was brought by JP Morgan. JP Morgan had already launched it’s own very good fixed income prime brokerage business but did not have a very good equity platform so you’ve got consolidation there. The huge question mark is - where

are the safe havens? I think previously there were around 25 different safe havens and now you can probably count them on two hands.

6. Where are the safe havens?

Ebers: Firstly, you look at where they are supported by banking infrastructure. I would say Deutsche Bank as it has already received the confirmation from the German government that it would be supported. UBS I would count as a safe haven and Credit Suisse, as the second largest Swiss bank, will definitely be protected by its government. State Street, is more of a custodian, but has a prime brokerage business. Then there are the favoured four and a half: Goldman Sachs, JP Morgan, Citi, and Bank of America – the half is Morgan Stanley. We may be wrong in this observation but the Federal Reserve has always seemed to approve of these banks. Goldman Sachs and J.P. Morgan have always had a special relationship. Citi has just proved over night that it has a special relationship with the Federal Reserve, having received one of the biggest supporting packages that any company could receive, USD306 billion, on top of USD25 billion that Citi is going to get from the Troubled Assets Relief Program (TARP), and the USD20 billion it previously received.

7. Is the prime brokerage model broken?

Ebers: The model is changed rather than broken. People are looking for client asset segregation, client money protection, the removal of rehypthecation language, and steady and consistent funding. Rehypothection was one of the reasons why prime brokers were able to be very competitive in their financing. With rehypothecation and leverage diminishing the revenue streams have changed dramatically from that which prime brokers were previously securing.

8. How will it evolve?

Ebers: Custodians have always wanted to get into the prime brokerage arena and they now have a wonderful opportunity to do so. A number of firms, such as BNY Mellon, State Street and JP Morgan, are striking tri-party agreements. Comparing all the models out there, I love J.P. Morgan’s model. It’s a prime broker, a custodian, a tri-party arranger, a cash facility, and a retail bank – it offers everything. The bank will be able to pitch its business to anyone, and win some of the large mandates out there. Investors are also going to have much more impact and will drive some of the scrutiny regarding the details of legal contracts, as hedge funds have done with their counterparties. It will be like someone is looking over your shoulder and make sure that you are crossing all the ‘Ts’ and dotting all the ‘Is’. There is a very clear delineation from a FSA standpoint between the role of a custodian and the role of a prime broker. The requirements are a lot tougher on a global custodian than on a prime broker

9. How do you think securities lending industry will evolve?

Kennard: Personally, I think the industry is in survival mode. People have got to look at their internal counterparty risk and operational risk, and really overhaul their risk management and overall returns on the product. Banks are in trouble with deleveraging and definancing. A lot of banks in the past didn’t go into detail about their collateral and funding costs. These have now significantly increased so they are going to have to look at their trades and unwind the ones, which are no longer profitable. A few houses, as with some of the beneficial owners, will pull out of the industry. A few strong houses, which keep all these factors in mind, will get bigger and bigger. It’s about figuring out how to adapt to change, getting through the difficult times and come out with a stronger business at the end of it.

BORROWER PROFILE


PANEL COLLATERAL MANAGEMENT

1. How has the credit crunch affected collateral management?

Morosini: Our volumes have never been so high with record peaks at EUR433 billion in November 2008. Our wide customer base composed of private banks, commercial banks, central banks, internationational banks, investment banks, and local and global custodians has enabled us to support various collateral structures in the last 12 months. Allocations to central banks for tenders and central counterparty (CCP) has grown exponentially. The quest for secured products and liquidity has benefited Clearstream because of its access to central banks and cash via the Euro GC pooling repo offering with Eurex. Funds, insurance companies, and asset

managers are now willing to be more secured towards their custodian or bank, pushing the collateralisation for securities lending to an all time high. Some counterparties have awoken to the unsecured risk they were running in their business – and this has been driving a large part of the volumes. Collateral to cover: Cash Correspondent Credit lines, Securities Loans, Cash deposits, Derivatives, Structured Financing etc. are common these days.

Grimonpont: The recent liquidity and credit crisis means that there is a temptation for firms to curtail their lending activities. However, those firms that are monitoring their risks, exposures and collateral positions tightly are taking advantage of business opportunities while maintaining an

attractive risk/return ratio. Therefore, it should come as no surprise that when firms now trade with each other, they are taking measures to collateralise their exposures against stricter eligibility criteria, with shorter maturities, wider spreads and higher margins. They are also seeking to make the collateralisation process as risk controlled and efficient as possible. We expect this trend will continue into the foreseeable future as an appropriate business practice and, in time, possibly as a result of more stringent regulatory pressures.

Higgins: We have seen a significant growth in the use and acceptability of collateral in the past year. We support the use of collateral as a traded asset in tri-party and as a risk mitigation tool in



the OTC derivatives markets. Throughout the liquidity crisis cash has become harder to access and terms for collateral eligibility increasingly stringent. Collateral schedules were updated during the crisis, reflecting a flight to quality. Many required only minor adjustments, which perhaps reflects the greater awareness of risk. On the risk mitigation side, we have seen considerable volumes of cash collateral, which only goes to reflect the recent statistics published by ISDA. It’s still very much cash and government bonds.

Rivett: Counterparty risk now has a very high profile in all organisations and collateral management is an important mitigant of that risk. Lenders have narrowed their range

of acceptable collateral, focusing on fixed income because of the volatile equity markets, and increased their haircuts. Counterparties have also moved towards entities that have acknowledged strong financial balance sheets in a ‘flight to quality’.

Little: In so many ways the big names have disappeared. Those remaining are rethinking their business strategy from the top down, causing extreme volatility. But I think I’d single out liquidity issues as the most significant for collateral management. The lack of liquidity in the money markets and unsecured businesses has driven banks towards repo and tri-party repo in particular. The lack of liquidity in some securities and asset classes has also caused huge difficulties and

made pricing and valuing positions, even of good quality securities, almost impossible at times. However, the regulators are now focusing on liquidity risk and we will see a major effort to measure and tame this over the coming year - but the benefits of collateralised over uncollateralised lending are undisputed.

2. What will be the impact of the recent FSA liquidity risk guidelines on the market?

Morosini: We saw the impact of these guidelines before the FSA issued them. Liquidity management has been the hot topic in 2008 and many institutions have worked towards establishing all possible routes to liquidity starting with mobilising all assets belonging to different entities of the same group through triparty collateral management. Many liquidity managers have pushed repo desks to put contracts in place with counterparties “just in case” despite no immediate economic benefits. Liquidity has become the priority before profits. This is why all Clearstream Collateral Management participants are setting up the route to the FED discount window to access the TAF, to the ECB, to Euro GC Pooling of Eurex and to other long cash institutions in order to demonstrate their capacity to access liquidity. We even saw members of the same group establishing the same routes, having their own access on top of being interconnected themselves to strengthen their potential via rehypothecation in triparty.



Higgins: From a collateral perspective, liquidity is key. Historically, collateralised lending has been the sustainable method of ensuring liquidity in periods of turmoil. Within The Bank of New York Mellon’s Global Collateral Management programme, there is a greater demand for the re-use of collateral. Collateral can no longer only be used for the initial move, it needs to be re-used to gain the required efficiencies. Now that most firms have moved to a fully collateralised environment, we are seeing a greater demand for collateral. To avoid a collateral shortage in the market, firms can no longer afford not to re-use collateral. And if a cash lending firm needs to raise liquidity, they must be in a position to benefit economically from collateral received.

Rivett: The FSA’s desire to introduce a liquidity risk measure by taking the difference, over a given period, between ‘stressed’ inflows and outflows and dividing them by non-capital liabilities is an understandable addition to their regulatory framework. Companies will be better positioned to understand their future cash positions. They should develop a strategic approach to term repos and financing transactions to manage this risk. While term repos do have other risks associated with them, if they are managed correctly they will provide a useful tool.

Little: The impact will be greater than most people realise. The requirements are far reaching and go beyond the basic additional reporting obligations. There is also a requirement for more modelling and stress testing in order that UK legal entities protect themselves against the actions of other legal entities in the same group. This all adds up to

big changes in 2009. Companies with modern flexible risk architectures will be significantly better off, but it won’t be easy for anyone.

3.Collateral reinvestment risk is one of the main areas of concern in the industry at the moment, what is your view?

Morosini: We don’t use cash as collateral. Although it has affected us on the revenue side, we have kept many lenders in our programme because the collateral is composed of A- Bonds being ring fenced and kept on their behalf. Our simple ‘bonds versus bond’ model proves to be safe and secure.

Grimonpont: Taking securities as collateral is the simplest and most secure market practice to follow,

guaranteeing their return at the time of trading. A triparty agent such as Euroclear Bank is able to enhance returns by accepting more complex collateral, as the agent provides a well-controlled risk environment. This is the model that still prevails in Europe. However, we acknowledge that there might be cases where cash is considered the best form of collateral for mitigating risk or as a means to add extra revenues. In both cases, cash collateral reinvestment is a business in and of itself, with its own risks and returns. Firms willing to use cash as collateral should understand the risks and rewards of both the securities lending and cash reinvestment.

Higgins: When understood and controlled, it is something to be used and viewed positively. For example, the ripples from Lehman’s have created an increasing demand from both buy and sell side organisations looking to

provide segregated collateral accounts with The Bank of New York Mellon. Rather than post all collateral to a dealer as the funds would have usually done (net mark to market and independent amount), we have received requests to provide creative assistance and ways to ‘ring fence’ assets. We have been able to apply traditional tri-party mechanics to support derivatives based exposures and activities. The central custody of the collateral by the custodial agent, as with tri-party, presents an ideal way to access the stock loan and repo markets while knowing that much of the collateral posted will remain in full view at The Bank of New York Mellon.

Rivett: Volatile markets, by their very nature, will increase this risk. Mitigation of this risk has to be conducted as part of a larger strategy of hedging an entity’s exposure to this volatility. This can be expensive and hence the returns from such transactions are reduced.

Little: Hedge funds have been particularly badly hit. According to the Financial Times, USD 22 billion of the USD 40 billion held by Lehman’s European Prime Brokerage had been rehypothecated. Hedge funds haven’t been able to get these assets back and may have to wait years to get a proportion of their money returned. This is likely to be a defining moment for the industry and it’s still too early to say whether it spells the end of rehypothecation; it certainly means it will be priced and monitored more closely. One option would be for a more limited use of rehypothecation where prime brokers could just use the hedge fund long positions for their capital requirement under Basel II. This would reduce the risk of having to get the stock back as it would only be held in the prime broker’s depot.

4.Historically collateral management has been very silo based. Can you see a drive away from this?

Morosini: Some groups have had strict instructions to mobilise all collateral



business all working together, often with the same technical platform. The next challenge will be to see if the business lines can or will need to move closer together. For example, should the fixed income and equity repo/SBL business be separate or would they benefit from operating under one functional line.

Rivett: The increased requirement for collateralised transactions in combination with the need for entities to squeeze more value from their portfolios will drive collateral management away from silos. A risk manager who can draw on a single pool of assets to collateralise any type of transaction will be more efficient.

Little: The trend towards a global cross asset view of collateral has been evident for some years. Current events will strengthen this trend. Vendors are improving their products to offer genuine cross asset capability. I don’t think anyone questions the benefits of merging the silos, but the expense is considerable and it isn’t necessarily the highest priority for institutions.

5.What are the major advantages of using a triparty?

Morosini: Well, the “old” core features such as multiple assets, multiple currencies, eligibility checks and sufficiency checks and the right of unlimited substitutions are the main key differentiators from bilateral agreements. Combined with the rehypothecation feature, in place since 2006, and the increasingly sophisticated eligibility criteria, it is a powerful and reliable way of many types of securing exposures.

from all pools within the group to allocate them to the ECB or the FED. Most institutions had collateral management teams that have suddenly became a more important function. In some institutions, the collateral still remains fragmented in silos with different usage of triparty collateral management. This is mainly due to the fact that there is no centralised collateral management function serving the needs of the treasurers, repo desks, borrowing and lending desks, derivative desks etc.

Grimonpont: In many firms collateral is still managed per business line. I believe those days are over. The recent credit crisis has accelerated this change. It makes no sense for firms to have one line of business wasting good collateral while another is struggling to finance with poor collateral. Similarly, it makes no sense to exchange large pieces of collateral back and forth between business lines, when centralised collateral management increases efficiency by only requiring collateral to cover netted exposures. This is no different from the cash side of the business where, a few years ago, it was not unusual to see different businesses within the same firm lending and borrowing cash with the same external counterparty instead of centralising the financing needs of the entire firm. This practice is now in place at most firms and will become common practice for managing collateral as well. Granted, centralised collateral management is more complex, but the potential benefits are even larger.

Higgins: Over the last ten to fifteen years many of the larger banks have moved their operational and risk management functions to within central ‘Global Margin/Collateral Management’ units. This has given them economies of scale and extended levels of operational risk control. It is now very common to have the SBL, repo, prime brokerage, derivatives and event ETD margin management lines of

Grimonpont: There are a number of critical issues in collateralising transactions. One is making sure that the required collateral is in the right place at the right time. Another is making sure firms are optimising the use of the collateral, that is becoming increasingly scarce due to the demands placed on it. Third, it is vital for firms to understand the procedures and challenges inherent in liquidating collateral in the event of a counterparty default during the life of the transaction. When the worst happens, it is critical to have immediate and reliable information on the collateral received as well as immediate access to collateral. Euroclear Bank, as a triparty agent, enables the immediate transfer

of collateral minutes after an event of default is declared. We think transactions between counterparties will be increasingly collateralised and there will be greater focus on managing the various risk-related parameters involved in managing collateral, such as haircuts and concentration limits, which makes the issues identified above even more difficult to manage. The use of a triparty collateral management agent like Euroclear Bank is an excellent way to manage these issues. We are particularly well placed to manage collateral for clients very efficiently. The service provided is settlement integrated, and highly automated and flexible while providing timely and granular collateral use reporting. Triparty agents, like Euroclear Bank, will be increasingly viewed as the most reliable and safe venues in which to collateralise business.

Higgins: Cost, control, access to new

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business, better risk management to name but a few. The automation of the collateral selection process greatly benefits the collateral giver of securities as it allows them to concentrate on trading in the knowledge that collateral is always perfectly allocated while within easy reach via substitution. Some organisations enter triparty as a way to reduce the operational risk associated with placing and managing the life cycle of a trade in the bilateral world. For example, you may want to invest cash in the repo market but don’t have the ability to book, value and position keep a portfolio of deals. With triparty, you have appointed the central agent to calculate the value of the cash accrual, collateral portfolio and resulting margin requirement. This is all packaged up neatly in a nicely reportable format. I think triparty will start to be seen in a new light and not just in the traditional sense of supporting

collateral trading. Its many advantages are working their way into the derivatives sector as we speak. Rivett: Triparty agents are experienced collateral operators who have invested heavily in infrastructure and technology to mitigate collateral management risks and provide counterparts with a transparent and efficient service. It reduces the cost of entry and minimises settlement risk and transaction costs while also enabling clients to execute same day recalls and substitutions. Triparty lends itself to the ‘single pool of collateral’ concept - most agents have an optimisation engine of some kind that allows a collateral provider to allocate collateral efficiently, irrespective of the underlying transaction.

Little: There are many advantages in a triparty arrangement: operational efficiency in the front and back offices, intra-day margining, use of small

collateral lines, automatic substitution and reduced credit risk being the main ones. These advantages have led to the continued rise of triparty over bilateral lending. Triparty lending also coped remarkably well with the fall of Lehman Brothers, when the agents were able to settle counterparty claims on collateral within a few days. But there are also drawbacks. The lack of visibility and inconsistencies in static and market data are two notable ones. Until recently, triparty agents provided limited reporting of collateral allocations to the principals. Under Basel II and in current market conditions, counterparts are demanding - and getting - daily or intra-day feeds of allocations so they can monitor the exact collateral exposures. Pricing discrepancies between the parties can lead to significant differences of opinion on collateral values. There can also be a lack of standardisation in message

formats and content between tri-party agents.

6. Over the past 12 months have there been any major changes in the rules and agreements that constitute bilateral transactions?

Morosini: Certainly, any adhoc or home-based contracts have been replaced with industry contracts such as the GMSLA or the GMRA. This provided a more industry-like market practice especially for liquidation and valuation of the collateral. After the Lehman default more stringent collateral profiles were established and the default procedures have been reviewed.

Grimonpont: We have seen changes in collateral-eligibility profiles – the trend started off modestly then became substantial with the Bear Stearns scare, and has become drastic since Lehman’s

collapse. Maturities shrank; haircuts and spreads exploded. Clearly, the intense focus on managing exposures against a wide range of risks is a driving force for collateralisation, both bilaterally and through triparty. It is no surprise to see so many initiatives providing central counterparty (CCP) services for securities lending transactions as well as for general collateral financing products. The delivery of a seamless rehypothecation feature in collateral management, such as that offered by Euroclear Bank, was a prerequisite to the introduction of a CCP in this domain. I would also not be surprised to see more regulations placed on banks and other financial institutions to meet higher capitalisation requirements and to run their businesses against more stringent risk management criteria. Market participants will also look for efficient triparty collateral management services through which to allocate pools of eligible collateral in order to obtain seamless access to central bank credit facilities.

Higgins: Since the beginning of this century we have seen a stabilisation of generally accepted market terms and agreements. The Credit Support Annex (CSA), Global Master Repurchase Agreement (GMRA) and Global Master Securities Lending Agreement (GMSLA) are now widely seen as setting the bilateral standards for derivatives, repo and stock lending transactions. But as with past events, we can expect to see new ideas and policies working their way into these types of documents in future. For example after market defaults in the late 1990s, The International Swaps and Derivatives Association (ISDA) worked with the market to publish the 2001 Margin Provisions document. A paper technically admired by many but applied by few as it was too hard or expensive to apply many of its directives. In the triparty space we do not see

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what is negotiated on a bilateral basis, although we see directly what both parties consider as acceptable collateral and the terms under which it can be applied. And as mentioned before, we have seen all sorts of movements up and down in this area over the last year.

Rivett: Most agreements probably have narrower eligibility rules, even in the bilateral world. The Lehman default proved the strength of the legal agreements GMRA and GMSLA, as the majority of counterparts were able to take possession of their collateral and realise its value for their own purposes.

7. What change in the demand for collateral has occurred in the last 12 months?

Morosini: More haircuts, more quality bonds, more liquid securities, more concentration criteria - anything that could contain and soothe the collateral liquidity crisis. Also, we have seen many new types of institutions requesting collateral, sometimes in a rush because they discovered they were exposed for many years -sometimes 100% unsecured.

Grimonpont: Exposure collateralisation was certainly a common practice a year ago. We are now seeing a broader mix of firms that are collateralising exposures across a wider spectrum of transactions, i.e. repos, securities lending, secured loan and derivatives transactions, as well as for central counterparty margin management purposes. As a result of the recent, increased inter-mediation by central banks in order to ease the pressures within the inter-bank money markets, we have seen increased focus on the collateralisation of central bank credit facilities. We have also seen a gentle tightening of the collateral eligibility profiles in 2007 and a more sharply defined trend in 2008. Collateral takers are now more thoroughly reviewing the basket of collateral they are willing to accept. It is very important for triparty

agents to be clear and transparent about their collateral valuation methodologies (including price sources) and operating procedures in general. Regarding collateral valuations, if there are no fresh prices for securities being used as collateral, nobody, including Euroclear Bank, will have a true price. In addition, even when a fresh price exists prior to a far-reaching event of default, such as Lehman Brothers, securities are unlikely to trade at that price post default. It is key for dealers to have a true risk management process in place that will allow them to determine what collateral meets their risk profile, and what haircuts and spreads are required to justify the risks. Euroclear Bank is completely transparent in terms of its pricing sources, quotation ages, i.e. when the price is updated, and in its price collection model. For example, prices used by Euroclear Bank are either true prices,

quoted by dealers or derived from various real-time and dependable sources, or theoretical prices that are based on sophisticated pricing models or directly purchased from data vendors. As we are transparent about this process, clients can then do their own risk management, excluding certain securities or imposing variable haircuts based on newly defined criteria.

Higgins: Flight to quality is the obvious answer. However, the derivatives market was making headway into a new world of collateral forms under Basel II, and then during the recent market turmoil reverted to what it knew and trusted well – cash and government bonds. The stock loan and repo markets have been in flux for much of the year, with a move back into equity as fixed income

became too expensive to source. There is a direct relationship between the use of collateral and the need to raise high quality assets for use elsewhere.

Little: Basel II has had a massive impact in the way firms are now able to use a wide variety of securities to cover their capital requirements. The greater cost of borrowing cash due to the credit crunch has driven borrowers to demand that lenders take non-cash collateral.

8. Have margins increased and has this had an effect on volumes?

Morosini: In general, haircuts have increased. Some borrowers that consider extra collateral as an unsecured risk towards their counterparty have reduced their outstanding and are not willing to pay for an extra risk. It is not a question of a good name or a bad name. It’s just that in front of some

repeated demands by many lenders to increase the haircuts - sometimes with no real justification (8 to 10% on a AAA-AA Government Bonds) - most of the borrowers have used all their counterparties and all routes to do an efficient allocation of their best collateral with the lowest possible cost.

Grimonpont: Margins and haircuts have increased as collateral-eligibility criteria has tightened and maturities shortened. Market conditions have led to changes in risk profiles and risk appetites. Allowing collateral management practices to adapt to those changes is a pre-requisite for the market to continue to function. If the market were unable to cater for collateral changes, volumes would have suffered far more than they have.




Higgins: It is not changes in margins that have effected lending or financing activity, but rather the banks’ risk departments’ reluctance to approve lending. Several banks do not have direct access to central bank funding or other sources of general collateral lending which have been seen to be safer in recent months.

Rivett: The increased margins reflect the increased uncertainty in the market and among lenders and borrowers; this has had a negative impact on the amount of lending and financing occurring in the market.

Little: The long term trend has been growth in volumes and reduction in margin. It’s difficult to say whether one has caused the other as there have been many factors involved. This long term

trend has been violently interrupted by recent events so that volumes are significantly reduced due to fear and uncertainty.

9. How will the market develop in 2009?

Morosini: We think that the actors and some business structures will change. We hope that unsecured transactions will eventually all be secured (collateralised), which will really emphasise the need for triparty. In the meantime, we will continue partnering with the authorities and the central bankers to propose services that will bring back some more OTC trading and restore trust. Whether it goes via a CCP or not, it looks like there is an exciting year ahead for triparty providers.

Grimonpont: Collateral, particularly good collateral, will be of paramount

importance in the future. This trend is not, as in the past, a result of regulatory initiatives such as Basel II, but from more fundamental reasoning. Collateral is used to protect the collateral holder from the default of its counterparty. This seems very basic, but the market somehow overlooked counterparty risk over time. Market participants now want to know, at any point in time, where the collateral is held, what collateral they hold, when it can be liquidated and at what price. Triparty collateral management service providers are helping dealers with those needs, a trend that I believe will continue to increase significantly in 2009 and beyond. Dealers are likely to reduce their leverage and limit exposures to each other in the foreseeable future, we could expect more of the remaining exposures to be fully collateralised.

A larger portion of collateral management responsibilities will be outsourced to triparty agents. And we will see a dramatic reduction in unsecured exposures and an improved, but moderate, reduction in overall exposures. Triparty agents will play an increasingly meaningful role in making that happen.

Higgins: We all need a crystal ball for that one! It is hard to get a clear vision in current markets but when things do finally settle down it will be possible to see a clearer path. Regulation and perhaps even greater depth and transparency of reporting is likely to take hold this year. Many more organisations now require good quality data. Wherever and whenever they need it, it will be down to service providers such as The Bank of New York Mellon to ensure clients receive this information and service.

There are many working groups busily considering what might be best for us all in the years to come, whether derivatives, stock lending or repo. What they are working on will start to influence us in 2009 but has the potential to last a long time. One thing is very clear, and that is 2009 is going to be a different collateral management world than before the recent crisis, last month or even yesterday. The pace of change is fast and to be taken advantage of.

Rivett: While collateralised transactions, as a percentage of total activity, will rise in volume, the total activity itself will probably reduce. The increased internal focus on risk for all firms will almost definitely force them to focus on strengthening their balance sheets. The potential introduction of a liquidity risk frameworks shows the direction of regulation. With financial markets and, in particular, the stability of financial institutions proven to be fundamental to a country’s economic well-being, there will be a move towards increased transparency and management of ‘off-balance sheet’ activity. As interest rates begin to approach zero, the spreads available to repo desks will also reduce.

Little: I think we will see a continued preference for secured over unsecured lending. This will fuel an already buoyant collateral market. Firms will be resetting their business strategies and are likely to choose between returning to core banking values or continuing to seek the higher returns promised by aggressive investment strategies. These choices will result in major changes, with some firms exiting parts of the business. But whatever strategy they follow, they are likely to retain collateral management as an important part of the business. No one can afford to leave their collateral assets unmanaged. Mark Higgins is Vice President and Head of Business

Development for EMEA Collateral Management in the London

office of The Bank of New York Mellon. The views expressed

herein are those of the author only and may not reflect the views of

The Bank of New York Mellon. This does not constitute securities

lending advice and it should not be relied upon as such.

Rule Financial

THE WIDER VIEWGet a global perspective on collateral allocation


TECHNOLOGY BOOKS AND RECORDS

Technology has fuelled significant growth in securities lending. Previously the business was built on old-fashioned relationships between borrowers and lenders, but technology has facilitated the growth of the industry to its current level of around USD 20 trillion. As the business has grown in size and complex-ity, books and record-keeping systems have had to keep pace with new innova-tion on the product side and increased regulatory requirements. Books and record-keeping systems are the utilitarian end of securities lend-ing technology. Frequently these systems are simply parcelled up within a full end to end system. They are something that it is vital to get right, but do not generate significant competitive advantages. They tend to be part of an integrated solution and downstream will be the general led-ger of the firm (for in-house systems) or client firm (for outsourced providers). Jane Milner, market specialist, Securi-ties Finance, SunGard says: “Securities financing tends to be lifecycle-heavy. It’s not like other areas where you do a trade and it’s done. A trade could be on the system for a number of years. There is lots of activity that the system has to manage and record on an ongoing basis.” As such systems need to be sophisticated and scalable. The development of books and record-keeping systems is largely the same as that of the wider securities lending technology market because they are usually part of a bigger system. Until

relatively recently, loans were negotiated over the phone or via email, and record-keeping was done via spreadsheets. It is only within the past few years that technology has emerged to help generate scale and transparency. The emergence of exchange traded platforms has done most to generate these increased flows and it has been a key development for technology provid-ers. The EquiLend system was launched by 11 financial firms and sought to revolutionise straight-through process-ing in securities lending by introducing standard protocols and infrastructure. Compatibility with these systems has become a vital criterion. Now, there is increased automated borrowing where securities are matched when available. Lenders publish their security inventory daily and borrow-ers compete to locate and borrow those securities. However, the European settlement market is still fragmented and this is mirrored by securities financing technology. As demand increases the technology is growing more streamlined and efficient, although there is still a significant amount of off-exchange busi-ness. Milner says: “The vanilla stuff is now automated. This is where little negotiation is required. But there is still a high proportion considered to be ‘relationship’ business. This is hard for any system to automate. The electronic marketplace is still only dealing with the higher volume vanilla deals. Various initiatives have emerged to increase the efficiency of the lifecycle, but noth-ing is there yet.”In terms of providers, for years Sun-Gard’s Global One has been a key application in Europe. Ed Oliver, senior business adviser at Spitalfields Advi-sors, says that their research demon-strates that SunGard is a big part of the picture, but there are a number of other growing players building their

business in this space. 4sight Financial Software is the main contender and has been increasing its client base since BNP Paribas became its first client in 1997, and a management buyout in 2003 made it completely independent. Oliver says that 4sight has been gaining some ground on Global One in recent years with its full front to back office functionality. Oliver says that connectivity to the platforms has become key, but vendors will have other aims. “If you look across the board, vendor platforms must have connectivity to the trading and back of-fice systems such as EquiLend, “ he says. “Buyers look at how well it links in with this and any existing systems, but they also look at how much experience those providers have and their experience spe-cifically in securities lending. Some are more repo-based, for example.” Other systems include Anvil, Murex with its MX3 system, Suncorp’s Dimen-sion, Openlink Findur and Pyramid. Oliver believes that when looking to external vendors people should ask how many clients are linked into the system they plan to use, what it allows in terms of collateral and how it handles triparty services. Each company has a strong sense of how it differentiates itself from its competitors. 4sight, for example, believes its key strength lies in its independence. Judith McKelvey, 4sight’s global sales director says: “We are the only indepen-dent company left and our flexibility is a huge advantage when it comes to focusing on our customers. We meet with our customers regularly and host North American, European, and Asia Pacific user groups. We look towards future developments for the market and our customers help us to prioritise the product’s direction. We work towards a 4sight funded roadmap as a result of this ongoing feedback.” Other considerations include whether

Innovation in the front office is driving the need for efficient back office processing. Cherry Reynard looks at the various books and records systems and the role they play in this.


the system offers the full front to back of-fice solution, covering securities lending and borrowing, total return swaps and CFDs; whether it operates across the full lifecycle and can be used on an agency or principle basis. Some systems, like 4sight, are modular. They slot in easily with other systems and users can cherry-pick the areas they want to use and tack on additional functionality later. SunGard has traditionally been seen as the de facto market standard. Milner says: “So many people use our system it is easier to communicate with coun-terparties. Our reports are standard and well-known and familiarity with our system is often a requirement for people when recruiting.” She believes that the group’s collateral handling also sets it apart: “Collateral has to be realigned every day. Our system au-tomatically marks the trade every day for both players to bring collateral into alignment.” Some, like Anvil, have grown out of the repo market. The group was bought by Dublin-based Ion Trading, a provider of dealing systems for electronic fixed in-come markets, in 2006. Anvil argues that bringing together repo and securities lending has significant benefits, notably in collateral management efficiencies and operational benefits. It says it has seen strong demand for cross-product collat-eral management and says it can reduce operational costs by using one system for multiple functions. Spanish bank La Caixa and Banco-lombia, the largest bank in Colombia, are recent converts to Murex’s MX3 plat-

form. At the time Bancolombia said that it liked the native asset class coverage of MX3 and its proactive approach to risk management. Like 4Sight and SunGard, MX3 provides an integrated cross-asset trading and risk management system, which includes FX and money mar-kets, cash and derivatives, fixed income, emerging market products, interest rate derivatives and credit derivatives. OpenLink’s Findur has largely been an US-based technology with recent new clients such as Ontario Teachers and the Home Loan Bank of Atlanta. But it has made in-roads into Central and South-ern America, notably with the Costa Ri-can Central Bank, and Europe, with the Europe Arab Bank selecting Findur for its treasury and capital markets division. Choosing a technology vendor is also about relationships. Paul Wilson, head of pre-sales at 4sight, says: “We go out of our way to accommodate our clients’ requirements. We have a close relationship with clients and work hard at maintaining that.” Some buyers will appreciate having someone they know on the end of a phone line, while others will appreciate the experience of a larger company. Wilson adds that if securities lending groups are to undertake a large scale outsourcing project, it is best to team up with someone who already has the experience of replacing certain legacy systems. Of course, some institutions will still look to build their own systems. This will generally be groups who want to ensure that they retain control or believe it can give them some competitive ad-vantage.”

Or it may simply be inertia. Oliver says: “Some have patched together a number of systems, particularly those that have been involved with a lot of merger and acquisitions.” They will have a lot of legacy applications and new functionality or applications have been tacked on as securities lending has become a bigger part of their business. Many still use Excel-based models. Wilson suggests another reason: “Traditionally many of these systems were built in-house because securities lending was non-commoditised, but as the market has achieved a level of ma-turity, external vendors can encompass the breadth and depth of functionality required by a global securities finance operation.” Building systems in-house requires huge maintenance and staff-ing costs and many underestimate how much this control is costing them. The outsourced providers will say that they offer more bang for the buck. They can bring down costs and improve efficiency. So why are some institutions hanging onto their old systems? Brian Traquair, president, capital markets and investment banking at Sungard, suggests that this may be a result of a funding battle between middle and back offices. Or it could be an inherent fear of change as the complexity of the process is often held as intellectual capital by those cur-rently doing the work. However, more and more companies are seeing the value of streamlining their processes, using one or a number of outsourced provid-ers and freeing up their front office to do more value-added work. There is also a


risk management element to automat-ing processes fully – corporate actions aren’t missed, trades are automatically reconciled with those of the counter-party and regulatory requirements are fulfilled. Milner says: “Those using in-house systems are increasingly few and far between. There are probably less than a dozen players now. They will have deep pockets, but there is no real advantage. Large parts of the process are not proprietary and are simply day to day administration.” Recent market termoil has created business for outsourced technology pro-viders. Institutions have realised than it may well be cheaper and more efficient to outsource. Risk management has become vitally important and relying on an ancient spreadsheet-based system is a recipe for disaster. Wilson adds that he has seen no drop-off in business since the banning of short-selling on certain stocks: “All of our clients are still in busi-

ness but with reduced budgets; they are looking to us for cost-effective, innova-tive risk reduction functionality as they formulate their budgets and strategies for 2009 and beyond.” The areas where securities lending technology can really add value are in risk management, collateral manage-ment and scenario analysis. The use of these is the only way to predict the im-minent collapse of Lehman Brothers and the impact it will have, but accounting and record keeping systems ensure that securities lending groups meet regula-tory needs. This year’s banking crisis has focused the minds of regulators. Oliver says: “The events of this year have led to much stronger requirements for report-ing in terms of the loans themselves, collateral and the haircuts in place. And on the cash reinvestment side.” He adds that reporting is not simply

a regulatory requirement. Clients will demand a high quality of reporting and a good capacity to run books and records for them that may feed into their own systems. Global One, for example, feeds directly into the sub-ledger within the books and records of the client firm. After the events of this year, securities lending groups want more information on counterparties and their collateral to protect themselves from counterparty default. Judith McKelvey of 4sight says: “The International Securities Lending As-sociation has issued agency lending dis-closure rules. We ensure that our system complies with these and any rules or best practice directives.” Risk management has become much more important over the last five years with the Basel accords and Sarbannes-Oxley. MiFID has meant more scrutiny of the relationship end of securities lending. People now know more about their counterparties and

collateral than ever before, but they have the headache of finding effective ways to use that data. From 2010, daily reporting will come into force. Milner believes this is the kind of thing that will change the market. People will have to gather the data from 200 lenders point to point. Are they really going to do this themselves or will they get someone who can do it through a hub service?”Looking to the future, the real innovation in securities lending technology is likely to be at the front-end. But the back office has to keep up with the pace of change in the front office. Wilson says that as securities lend-ing becomes more standardised and consolidates its view on the potential for exchange-based trading to in-crease. He adds: “We are scaling up our volume handling to a level that would

be unimaginable to even the current largest stock loan business now.” The emergence of the major exchange traded platforms (EquiLend and SecFinex) has been a major shift on the borrow-ing side, freeing up the trading desk for higher value activity rather than simply entering trades. This has not yet been mirrored on the lending side, but could be an important development. Wilson says that 4sight is also focus-ing on collateral management. Collateral requirements change all the time and securities lending desks are moving into new markets. He adds: “People are becoming increasingly sophisticated in their requirements for managing collateral. For example, we have seen a recent upsurge in requests for CSA OTC derivatives support as desks look for solutions for cross-asset class collateral management of their Securities Finance operations” Collateral standardisation and re-use is a big issue for the industry as a whole. Overall, corporate action handling remains a priority for many technology providers. There are also developments in the auctioning of hard to borrow stock and many groups are developing a global locating facility. Technology providers are also aiming to do more quotidian things like improve speed and efficiency. For example, start of day loads are now down to a few seconds. This is an astonishing improvement over the products that were available just 10 years ago. The challenge is to keep up with the innovation going on at the front-end, plus the increased volumes being gener-ated by the growth of exchange-traded platforms. These systems have a vital risk management role to perform. Every technology provider, whether in-house or outsourced, needs to get this right.



INTERACTIVE DATA

Bob Cumberbatch, Business Lines director at Interactive Data, looks at data management as a key component of risk management.

For many years, data management has been seen as an overhead by financial institutions. In today’s market environ-ment, effectively managing data as-sets across the securities management lifecycle, which includes trade confirma-tion and settlement, can be viewed as a strategic advantage towards helping firms meet risk management and regula-tory demands. Effective data manage-ment can also help institutions continue to explore new opportunities and work to grow their business. The ever-increasing volume of data being consumed by large financial institutions emphasises the importance of effective data management. Firms need to have a high level of expertise and flexibility within their technical infrastructure, not just for systems and applications, but also for personnel who

understand what good data is and where to source it. At the core of data management is the need for comprehensive valuation information and high-quality reference data that can help financial institutions power mission-critical operations. Institutions can manage risk more effectively by prioritising reference data management and having a more complete understanding of the financial instruments streaming through their applications and databases. Critical to this approach is the ability to take a 360° view of each financial instrument held by an institution, understanding the behavioural characteristics – both on a stand-alone basis and within the context of the portfolio – under a variety of market scenarios. Determining how an instrument is going to behave under stress is essential to understanding the risk parameters of that instrument. With accurate and consistent reference data, an institution is better positioned to conduct the kinds of analyses which are critical to understanding risk. Financial institutions want to under-stand the concentration and exposure they have to various segments of the market; this might include credit expo-sure and industry segment exposure. Gaining this understanding requires knowledge of the full ‘family tree’ of a financial instrument. For example, if an institution owns shares in a certain com-pany, they may not realise that it is a far-flung subsidiary of a major auto com-pany going through financial difficulties that could impact their holdings. With reference data, an institution could have a better understanding of their ‘concen-tration risk’ in a certain sector or among organisations that are facing challenges. For instance, they could identify that exposure to the auto industry makes up too large a percentage of their portfolio and then make an informed financial decision to address this issue. Reference data providers can offer

clients detailed entity linkage informa-tion that connects families of securities and helps institutions understand the relationships of the securities to the cor-porate family structure. This informa-tion is critical to maintaining compliance with regulations that require institutions to understand their exposure to a given firm, industry or market sector. It is also essential to have a compre-hensive understanding of the underlying elements of a financial instrument. Over the past year, we have read stories about firms that didn’t take these steps and have been impacted by the far-reaching tentacles of sub-prime securities. But it wasn’t just financial institutions that have invested in structured securities, such as CDOs, that had exposure to sub-prime loans; entities from govern-ment organisations to pharmaceutical companies have disclosed losses due to sub-prime-related issues. Effectively managing and review-ing reference data can help investors understand the underlying dynamics of a security and help them determine their risk exposure. For example, even though a security may have an AAA rating, that rating may be supported by internal or external credit enhancement. To un-derstand the risk profile of that security, it can be crucial to know whether that credit enhancement will hold up under stress. Interactive Data delivers the underlying ratings details of municipal bonds needed to assess the underlying risk profile of insured municipal securi-ties. This information is critical as it provides clients with additional transpar-ency to somewhat opaque investments and can be used to measure their risk exposure. With consistent, timely and accurate reference data, institutions can gain additional transparency into these details. Interactive Data provides a huge raft of essential reference data, which can help institutions to realise a competitive advantage by making more informed


INTERACTIVE DATA

investment decisions. Some fundamental issues need to be addressed before we will see the industry making real progress toward the goal of transforming reference data into the high octane fuel that institutions need. First, the industry must come together to agree upon standard definitions for reference data. The lack of standard data defini-tions is not due to a lack of trying – over the years a number of different initia-tives have been undertaken by industry organisations to establish a standard for legal entity identifiers. Despite sincere efforts to address standards for this criti-cal aspect of reference data, agreement has still not been reached. In addition, a much greater under-standing of data utilisation and data requirements is needed across the data management ecosystem. Individuals given the responsibility for improving data quality and ultimately reducing operational risk must have a detailed understanding of how the data is ap-plied across the organisation and how the business units derive value from the data across the securities management lifecycle. This will result in much richer conversations among suppliers, consum-ers and all players in between. It is also essential that senior managers make the connection between data management activities and managing operational risk. It might be suggested that forensic analy-sis of the firm’s data to realise quality goals can be seen as a ‘root cause’ activity for developing effective operational risk management strategies. The drive to understand operational risk across the enterprise is supported by the drive to achieving enterprise-wide data quality. When it comes to valuations, trans-parency and standards are fundamental to the process. Investors and regulators expect consistent, transparent and fair pricing across all alternative investment classes. Independent valuations of complex OTC derivatives and structured products, as well as evaluations of fixed income securities, are seeing increased demand. Financial institutions have been working to ensure that they have a firm grasp on the value of their holdings.

Assessing risk exposure is a key focus. In response to this challenge, Interac-tive Data delivers valuations for a range of alternative instruments, including credit default swaps (CDS), interest rate swaps and bank loan prices. Interactive Data also provides valuations of highly complex OTC derivatives and structured products as part of its wide-ranging pricing and evaluation services through an exclusive agreement with Prism Valuation. Prism Valuation – whose philosophy to valuation is built on three pillars ‘people-data-models’ – provides services that replicate the pricing and risk analysis capabilities of a structured products dealer, with an emphasis on hard-to-value assets. Providers of independent evaluations can deliver significant value to finan-cial institutions during these turbulent times. For example, Interactive Data has teams of experienced evaluators who incorporate available transaction data, credit quality information and perceived market movements into the evaluated pricing applications and models for fixed income securities. Global institutions have also been impacted by a lack of liquidity as the credit markets have tightened and they have had to take a step back to determine

their risk exposure. For their portfolio valuation processes, these institutions have looked to independent providers of evaluations who put an emphasis on building relationships with a broad range of market sources. In recent years, a deluge of new ac-ronyms have taken on almost mythical status in the financial services industry. From the Markets in Financial Instru-ments Directive (MiFID), to Reg NMS, IAS 39 and UCITS III, new regulations, standards and directives have impacted the industry with new compliance processes and procedures to implement and follow. In the midst of focusing on managing

risk and growing their business, firms must follow processes that can help ensure that they can remain compliant with regulations. MiFID, designed to broaden and strengthen the regulation of financial markets in Europe and help ensure market transparency, has posed a series of challenges for financial institu-tions. Interactive Data’s real-time and reference data services can help clients with the requirements of pre- and post-trade transparency, evidencing best execution, trade venue selection and reviews of order execution policy, code of conduct and client classification obli-gations, transaction reporting, managing conflicts of interest and managing risk. Another main focus for institutions during 2008 was the Financial Account-ing Standards Board’s Statement of Financial Accounting Standards No. 157, or FAS 157. This statement has resulted in firms reviewing their existing valuation policies and procedures and having to develop procedures for fair value disclosures in their financial state-ments. To help clients prepare for FAS 157, Interactive Data has developed a set of informational resources that disclose the types of inputs by asset class that are utilised to prepare evaluations. Enhanced transparency can provide cli-

ents with information to establish their own fair value hierarchy determinations as required under FAS 157. Risk management will continue to be a key focus for financial institutions, and regulation and other mandates will con-tinue to be a main driver. By working closely with clients to understand their workflow, vendors are better able to ad-dress market data and information needs and develop services that can help clients more efficiently comply with regulatory requirements.


STATISTICS

Borrowing on UK Consumer Services stocks has increased 60% since 1 Sept 2008, and available inventory reduced 14%. There has been a big increases in the quantity on loan by Whitbread (up 136% since 01/09) and Carnival (up 129% since 01/09). TUI, which represented about a quarter of the weighting went up by 23%.

Stock on loan and available inventory on US retail stocks has decreased since 1 September 2008. By 3 November on loan stock had decreased by 28% and available inventory stock by 10%. Since then the percentage of stock on loan has increased by 17% but available inventory has decline by a further 6%.

Available inventory on UK Retailing stocks has decreased by 30% since 1 Sept. At the start of the period, Signet represented c 20% of the lendable qty available in the UK Retailing portion of the DESLI. The availability of Signet, since then, has fallen by 97%. Whilst each of them are individually smaller than Signet’s weighting, Inchcape, HMV and Home Retailing Group all fell by 24%, 20% and 18% respectively.


STATISTICS

UK Borrowing has seen a general decline across the board. A peak though is shown towards the end of November. This is purely down to HSBC quantity on loan jumping from 231 million on 17 Nov to 1.18 billion on 21 Nov.

Apart from Wells Fargo, the quantity of US Banks bank stocks borrowed on DESLI has reduced by 49% since 1 September 2008. Available in-ventory has reduced by 21%.


PEOPLE MOVES

left Deustche Bank. Babbitt

joined in February 2007 after

spending 23 years at Merrill

Lynch.

Jeff Dorman, managing director

and head of Prime Finance

North America in the Global

Markets equities business at

Deutsche Bank is no longer

with the bank. Dorman joined

Deutsche in early 2007 to lead

its prime finance business in

North America. He previously

worked at Bear Stearns and

spent 18 years at Lehman

Brothers.

Andy Jones, former director of

equity finance at Landsbanki

Islands Hf joined Penson

Financial Services Limited,

where he is responsible for

the Equity Financing business

in Europe. He is now based

in London, reporting to Mike

Johnson, Head of Global Equity

Finance.

Zimmerhansl Consulting

Services, which provides

securities lending business

consulatency services.

Morgan Stanley’s Andrew

Amstutz and Victoria Foster

left the firm. Amstutz, a

managing director and Foster,

an executive director had been

with Morgan for more than 10

years collectively.

The Alternative Investment

Management Association

(AIMA), the body for the

global hedge fund industry

appointed Todd Groome as

its non-Executive Chairman

together with the restructuring

of its Executive team. Prior to

this role, he has held senior

positions at the International

Monetary Fund and at

institutions in London, New York

and Washington DC, including

Deutsche Bank, Merrill Lynch

and law firm Hogan & Hartson.

Keith Babbitt, managing

director and co-head of

Securities Lending, Global

Prime Finance North America,

Charlotte Wall, former head of

Morgan Stanley’s European

equity finance desk joined Data

Explorers. She was responsible

for creating the team that

was awarded the number one

borrower by the International

Securities Finance (ISF) survey

for eight years in a row. She

was also an integral part of

Morgan Stanley’s Hedge Fund

Management Team and Client

Relationship Management

Committee.

Leonard Welter, former

executive director at Morgan

Stanley, has joined Data

Explorers as chief technology

officer. At Morgan Stanley

he was responsible for the

global development of new

securities lending analytic tools

and trading systems. He was

also responsible for European

securities lending portfolio

pricing and trading.

Cantonalbank of Zurich (ZKB)

has appointed Felix Oegerli as

head of prime finance. He is

responsible for expanding

ZKB’s securities lending and

repo activities and to build

up the synthetic finance and

Delta One capabilities. Ueli von

Burg, former head of securities

lending and repo at ZKB, is now

head of prime finance trading,

reporting to Oegerli.

ING Global Securities Finance

appointed Ed Donald as

director and head of Global

Securities Finance Asia. He

manages their new office in

Singapore. Formerly he was

global head of European Fixed

Income Repo at ABN AMRO.

Nomura Holdings, Inc.

appointed Hideyuki Terauchi as

managing director of Nomura

International plc (Spanish

Branch) and Masaru Tokiwa

President of Nomura Bank

(Switzerland) Ltd.

Alexis Fosler, who was hired to

run Citi’s Prime Brokerage sales

team in Singapore, has left the

bank.

Roy Zimmerhansl left ICAP

to start his own company,

Felix Oegerli, head of prime finance at Cantonalbank of Zurich (ZKB)

Andy Jones, responsible for Penson’s Equity Financing business in Europe

Roy Zimmerhansl, primary at Zimmerhansl Consulting Services

October

November

December


NORDIC MARKET UPDATE

From the sovereign bankruptcy of Iceland to growth in Sweden, Nick Pratt rounds up the prevailing trends in Nordic securities lending.

Iceland has undoubtedly suffered the worst in the Nordic region. In less than 12 months it has gone from topping a United Nations poll as the “best place to live” to a state of sovereign bankruptcy. Its three major banks, Landesbanki, Kaupthing and Glitnir – all collapsed un-der colossal debts, trading was suspended on the national stock exchange as assets

lost 90% of their value and the central bank was declared insolvent. Securities lending is consequently not the primary concern for Iceland’s financial authorities as they go cap in hand to the IMF for the kind of multi-billion bail-out package to keep an angry population off the streets of Reykjavik. But for the rest of the Nordic coun-tries, the fate of the securities lending market is a more prescient concern with the inevitability that 2009 will bring some kind of downturn. Accord-ing to Chris Angell, principal at pen-sions consultant Mercer Sentinel, the majority of lenders have been review-ing their position in terms of whether the returns are adequate enough to reward an increased risk. “The biggest issues are facing those clients that accept cash as collateral,” says Angell. “Along with Lehman Brothers’ default, a number of cash vehicles have gone to the wall which has impaired cash pools. Those wanting to reinvest cash have realised that the risks of taking cash as collateral in a securities lending pro-gramme is greater than they thought,” says Angell. Nevertheless, any changes are unlikely to be dramatic, says Angell and most borrowers will be able to adjust to any changes in collateral conditions or increased fees. “There will be a short-term reverse undoubtedly but the un-derlying demand for securities lending will remain and will be satisfied.” The Nordic market, in terms of securities lending at least, is best viewed in terms of its individual components. Sweden is the most active of the Nordic countries in terms of securities lending. Not only does Sweden have the most active equity market but it has also been boosted lately by the fact that the country’s regulators have placed no ban on short-selling, unlike most other European countries. Con-sequently many Sweden-based firms

have enjoyed record volumes in their sec lending programmes in the last nine months, even if the value of these stocks has reduced markedly in the last three months. “We haven’t seen many firms pull-ing out of stock lending,” says Joakim Håkansson, head of securities lending and equity finance at Sweden-based Handelsbanken Capital Markets. “Maybe lenders are being more careful about the volume of stocks that they are lending and the GC level [the cost of borrowing for more liquid stocks] has increased a little bit but we have seen little impact in the market so far.” Any impact is likely to be in terms of demand rather than capacity and the short-term prospects for Handelsban-ken’s domestic sec lending market is very positive, says Håkansson, thanks to the fact that Sweden, along with Finland, has no restrictions on short-selling. “I am cautiously optimistic. It is a tough call as no-one really knows what next year will bring but today we are doing well.” Finland is the second most active se-curities lending market after Sweden and is also yet to introduce any restrictions on short-selling. Norway’s stock lending industry is hampered somewhat by the difficulty in accessing Norwegian stocks. Current rules state that listed firms are only allowed to lend 5% of their stock to single clients (so in order to lend 50% of their stock, they would have to find 10 separate clients). While there has been pressure from the market to relax these rules, current market conditions make it unlikely that there will be any regulatory relaxation any time soon. Denmark is still a niche market for sec lending with Danske Bank and Nordea the main proponents. Danske Bank has not been involved in any stock lend-ing in Iceland so the defaults from that market have not had any effect, says Kim

NORDIC MARKET UPDATE

Lilmose, first vice-president at Danske Bank. “We do see clients who want to hedge their portfolios via futures and options and those products have to be delta hedged so there is still a need for stock lending in this area,” says Lilmose. “We have also seen very high volumes on the exchanges so far, even if this is likely to fall in the near future, and we have seen a lot of stock lending to secure settlement on this exchange activity.” Nonetheless, 2009 is likely to see a fall in stock lending activity, says Lilmose, as the poor market conditions take effect and demand for securities lending de-creases. On the positive side, at least there are no capacity issues, says Lilmose. “In terms of capacity we have the same access to securities as we have had before. There have been no changes there. Of

course we have seen some of the inves-tors disappear from the market, par-ticularly on the hedge fund side, so that access to securities has diminished but there are still a lot of long/short investors in the market.” Fees are generally higher at the mo-ment, says Lilmose, due to the increased focus on counterparty risk and un-predictable market movements. “With a volatile market you have to look at higher haircuts, which is something that we have done.”

As for the prospects for 2009, Lilmose says that the Nordic market is still niche in comparison to the more mainstream markets. “Our business on the likes of delta hedging and failing settlement and these are both likely to continue, albeit with lower volumes. “There are less hedge funds out there and less appetite for risk in the market so less willingness from the banks to lend to these hedge funds but securities lend-ing remains a very viable business,” says Lilmose.

End of the beginning? On the eve of the scheduled end of the FSA short selling ban on financial stocks, regulators, industry associations, service providers and participants in securities lending discuss the turbulence of the past year, the ban, and ask are we on the road to recovery?


DATEThursday, 15th January 2009

LOCATIONFour Seasons Hotel, Canary Wharf

1:30PMRegistration/Coffee

2:20PM Panel Debate: RiskChair: David Rule, CEO of ISLAPanellists: Rupert Perry, director at Pirum Systems Ltd.; Roy Zimmerhansl, principal at Zimmerhansl Consulting Services; Brian Lamb CEO of EquiLend; Peter Fenichel, CEO of SecFinex; David Little head of Securities Finance at Rule Financial.

4:05PM Panel Debate: What Next?Chair: Mark Faulkner, managing director of Spitalfields Advisors. Panellists: John McEllin, head of securities lending at Bank of Ireland Securities Services; Paul Wilson, managing director, financing & markets products, Worldwide Securities Services, J.P. Morgan; Jane Karczewski, managing director, Securities Finance Sales, Deutsche Bank; Chris Taylor, senior managing director and regional business director, Securities Finance, State Street.

4:45PMDrinks Reception

Sponsor

For speaking and sponsorship opportunities please contact:

Catherine Kemp [email protected]: +44 (0) 20 7299 7714

Justin [email protected]: +44 (0) 20 7299 7707

If you would like to receive your VIP Pass to attend the event please email: [email protected]


DIRECTORY

Consulting

Data Services

Securities Lending

MX Consulting is a Securities Financing focused IT consultancy offering innovative business solutions. Experts in project management, Global One, 4Sight, Swift and STP solutions, software development, system migrations and back offi ce outsourcing for the securities fi nancing industry.

In 2008 MX Consulting managed the trading system migration of Global One to 4Sight at a large asset manager, built a web-based proprietary payment, exposure and currency management system at a broker-dealer and also concluded a large Swift messaging project for a third-party agency business.

W: www.mxcs.co.ukC: Adrian MorrisHead of MX ConsultingM:07879 475105E: [email protected] C: Richard ColvillSenior ConsultantM: 0777 1928113E: [email protected]

For over 10 years Rule Financial’s specialists have been working alongside their coun-terparts at the world’s top banks and hedge funds, helping to lower costs, improve pro-ductivity and extract the maximum value from IT investments. Our expertise in the man-agement of change, project delivery and complex technology solutions has helped us build long-term relationships on a solid track record of success. Our prowess in system design, testing and rapid application development has earned us a powerful reputation. This means that at Rule Financial we have a thorough understanding of what the front, middle and back offi ces each require from their systems and processes, thanks to our practical experience and capability across the broadest spectrum of domains. Buy-side or sell-side, in both arenas we’ve attracted some of the best in the City to our doors.

C: David Little, Head of Securities FinanceA: 101 Moorgate, London, EC2M 6SL, UK

T: +44 (0)20 7826 4444E: david.little@rulefi nancial.comW: www.rulefi nancial.com

eSecLending is a full service securities lending agent and administrator of custom-ized securities lending programs. Their program has been adopted by many of the world’s largest and most sophisticated asset gatherers including pension funds, mutual funds, investment managers and insurance companies. They are a third party industry specialist providing lenders with customized programs, high touch client service, comprehensive risk management, and superior risk adjusted returns. The fi rm takes a highly consultative approach with their clients by structuring separate, non-pooled programs and utilizing a competitive auction to determine the optimal route to market for their clients’ lendable assets. Having built their business to incorporate investment practices such as the use of specialists, multiple-managers, unbundling, price transpar-ency, and competition, their approach ensures best execution and also provides clients with greater control over their programs, allowing them to more effectively monitor and mitigate risks and counterparty relationships. Additional information about eSecLending is available on the company’s website, www.eseclending.com.

T: US +1 617 204 4500T: UK +44 (0) 20 7469 6000C: Christopher JaynesE: [email protected]: www.eseclending.comA: 175 Federal Street, 11th Floor Boston, MA 02110, USAA: 1st Floor, 10 King William Street, London, EC4N 7TW, UK

Data Explorers is the leading global provider of market information and consulting services to the securities fi nancing industry and the largest provider of global short-side intelligence to investment managers.

Our products provide market professionals with quantitative measures of securities lending, performance and risk. We are based in New York and London and collect data from over 100 of the top security lending fi rms representing over 75% of the global securities lending market. On a daily basis we process more than 3 million transac-tions from over 22,000 funds. On 1 December 2008, this included over 220,000 fi xed income and equity assets worth more than USD11 trillion in lendable value of which over USD3 trillion was out on loan.

New YorkA:75 Rockefeller PlazaNew York, NY 10019, USAT: +1 212 710 2210

LondonA: 2 Seething LaneLondon, EC3N 4AT, UK T: +44 (0)207 264 7600


DIRECTORY

Technology

EquiLend is a leading provider of trading services for the securities fi nance industry. With its robust suite of automated trading tools, EquiLend enables its clients to scale their businesses with great effi ciency on a global basis in all securities fi nance markets. Used by borrowers and lenders throughout the world, the EquiLend platform automates for-merly manual trading and post-trade processes. Using EquiLend’s complete end-to-end services reduces the risk of potential errors and eliminates the need to maintain costly point-to-point connections while allowing fi rms to drive down unit costs. Firms can then free more resources to expand their business and grow trading volumes without increas-ing costs. This makes the EquiLend platform a cost-effective choice for all institutions, regardless of their size.

A: 54 Lombard Street, London, EC3V 9EXT: UK- +44 (0)20 7743 9510C: Michelle LindenbergerE: [email protected]: 17 State Street, 9th Floor New York, NY, 10004T: US- +1 212 901 2224

Eurex is one of the largest derivatives exchanges and the leading clearing house in Europe. Wherever you are located, we provide you with access to the benchmark futures and options market for European derivatives. Eurex also offers short term funding prod-ucts, such as Eurex Repo. Eurex Repo is among the forerunners in providing integrated trading and clearing for repo transactions. Eurex’s latest innovative marketplace is called Eurex SecLend. Eurex SecLend. Europe’s leading investment banks participate as borrowers in the Eurex SecLend marketplace, acting as principal brokers, dealers and in-termediaries. They all benefi t from Eurex’s leading state-of-the-art trading and processing services. For Eurex, service and technology innovation is not just a buzzword. New trends are being transformed into inventions through the adoption of advanced trading practices. Find out more on www.eurexseclend.com.

W: www.eurexseclend.comT: +41 58 854 2066F: +41 58 854 2455E: [email protected] Zurich Ltd.,Selnaustrasse 30, 8021 Zurich, Switzerland

Pirum provides a full suite of automated reconciliation and straight through processing (STP) services supporting Operations within the global securities fi nance industry. The company’s on-line SBLREX service encompasses daily contract compare, monthly billing comparison, mark-to-market & exposure processing, pending trade comparison, income claims processing and custody reconciliation. Subscribers to Pirum’s services signifi -cantly increase their operational effi ciency and reduce their risk by using Pirum’s solutions, as staff are able to focus on fi xing the exceptions instead of using their time to check and process routine business. These automated processes are more scalable and risk controlled too, allowing signifi cantly higher volumes to be managed without correspond-ing increases in operations headcount.

T: +44 20 7220 0961F: +44 20 7220 0977C: Rupert PerryE: [email protected]: Pirum Systems Limited37-39 Lime StreetLondon, EC3M 7AYW: www.pirum.com

4sight Financial Software is a leading supplier of innovative software solutions to the Securities Finance, Settlement & Connectivity markets with offi ces and clients worldwide. 4sight Securities Finance (4SF) is a fl exible modular solution that empowers fi nancial institutions of all sizes, from the smallest direct lender to the global custodian, broker or intermediary on an agency or principal basis. 4SF contains market leading functional-ity that provides greater automation, faster trading, improved risk management, and enhanced relationships with clients and counterparties. It supports borrowing, lending, repo, swaps and collateral management across the equity and fi xed-income markets and provides 24 hour continuous operation, inter desk trading, a ‘global book’, real-time value dated position keeping and a powerful web reporting module, allowing full front to back offi ce processing.

With annual revenue of USD5 billion, SunGard is a global leader in software and process-ing solutions for fi nancial services, higher education and the public sector. SunGard also helps information-dependent enterprises of all types to ensure the continuity of their busi-ness. SunGard serves more than 25,000 customers in more than 50 countries, including the world’s 50 largest fi nancial services companies.

Visit SunGard at www.sungard.com

C: Judith McKelveyT: +44 (0) 207 043 8319E: [email protected]: Jason HayesT: +1 416 548 7922E:[email protected]: Peter SandersT: +61 (0) 2 90378416E: [email protected]: www.4sight.com


PEOPLE

impossible. The growing use of securitisation has increased the funding capacity of banks. With the securitisation of money market transactions, banks will no longer have unsecured counterparty risks in their books. This development has resulted in a significant increase of the volume traded in GC baskets on electronic trading platforms.

Both the advantage of the securitisation of the repo deal and the advantage of a central counterpart guarantees that there is no counterparty risk. As a result, more and more banks are moving from unsecured transactions to the secured money market.

Being nominated employee of the year must mean I doubled sales this past year so I would celebrate by “inviting” my boss to treat us all out for dinner.

I would choose Prague. Up until the RMA/ISLA conference last May, Prague had been one of the few remaining European cities I had not visited and I found it to be one of the most beautiful. I would choose to have the party in one of Prague’s magical fairytale castles.

My parents are my biggest role models. They have always pushed me to stand up for what I believe in and encouraged me to speak my mind. They motivated me to stay focused on my goals and have been so supportive in everything I do.

It was exactly two years ago this month when I joined the SoftSolutions! sales team. My responsibilities include increasing the presence of our real time multi-market solution - XTrade! Square Repo, plus account management and identifying sales opportunities.

Travelling adds variety and gives me the opportunity to see new places, experience different working cultures and meet new people. The majority of SoftSolutions! repo customers and prospects are located outside Italy, so I am quite the road warrior.

Resulting from the recent financial market situation: Repos (as an instrument of secured money market transactions) have become an important topic. Financial institutions have been forced to increase secured short term funds, as the access to unsecured interbank liquidity has become very limited; for some banks nearly

I was raised in a multi-cultural family. It has prepared me to not only successfully deal with people from different cultures but also with colleagues and clients with different backgrounds to mine.

I would choose an out-of-this-world experience - a trip into space. Pun intended.

It would the late 1800s - the Cowboy Era. I think I would fit right in to that period. I have always loved horses. I was very young when I moved from New York to New Mexico. I immediately took to the Western lifestyle... riding in rodeos and practicing target shooting on the range.

I can’t give you an accurate answer due to the current state of the market. It’s wait-and-see. I do hope to continue to advance professionally in a challenging and rewarding environment taking with me the valuable lessons I have learned over the last five years.

Amy Sussman, SoftSolutions

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