GSL 008

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Annual MembeGBP 249USD 379EUR 286

Plus: Asia - opening up?ERC Meeting round-up

MARKETS

Brazil, Russia

INDUSTRY INSIGHT

Euroclear, Northern Trust

PROFILE

Tony Venditti, Ashley Wilson

GlobalSecuritiesLending|

tll ndeege?

New regulatoy

mnefields

SL ISSUE 08 Q2 2010

www..tv

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2 | Global Securities LendingMagazine | 2010

Qick Qrr Vi

Lend an earIn my last letter I discussed

regulators research into short

selling and securities lending

and I was optimistic that much

of the resulting output was

positive news for the industry.

I also dubbed 2010 The Year of

Collateral, but now it seems that

The Year of Regulation deserves

equal billing. GSL has so far

hosted four summits in 2010, and

regulation has been an increasinglyhot topic among panellists and

audience members alike.

We have seen a wave of new short

selling restrictions in developed

markets, new guidance for benecial

owners from the UK Pensions

Regulator and even repo entered the

mainstream medias parlance with the

publication of a damning report on

the Lehman Brothers bankruptcy.

In this issue GSL looks behind

the Repo 105 headlines and

takes an in-depth look at the

new US short selling restrictions

as well as discussing how the

industry can ght back.

But if developed market news

has been less than rosy since our

last issue, various reports from Asia

have caused many to be optimistic.

We look at the short selling and

margin trading trials being set up

in China and provide a detailedoverview of some of the liberalising

developments in the Indian market.

Additionally, some of the

panellists at the recent PASLA

conference provide their summary

on what was deemed by many

attendees to be a great event.

Moving to the southern

hemisphere, we provide a prole

of the Australian market and

look into some exciting new

developments taking place in Brazil.

Our increasing focus on repo,

collateral management and liquidity

continues as Godfried de Vidts

provides us with a review of the

recent European Repo Council

meeting. This is a follow up to

Godfrieds excellent industry

summary which appeared in the last

issue of Investor Services Journal.

Finally, the magazine features

two executive proles, with TonyVenditti of BMO Capital Markets

talking about his career in securities

lending and his outlook for the

future, and Ashley Wilson of

Barclays Capital outlining his plans

for growing the prime services

division at the British bank.

Z

Roy Zimmerhansl, Editor-in-Chief

Asian promise

Godfried de Vidts

Tony Venditti

Chris Poikonenon Brazil

Repo 105

Ashley WilsonIgor Marichon Russian repo

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Have a safe journey.

ooking or liquidity? Dont take the wrong turning. The route to our Liquidity Hub

sae and dependable and youll fnd a solution thats exactly right or you.

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cNN

Editor-in-Chief

Roy Zimmerhansl

[email protected]

Deputy Editor

Craig McGlashan

[email protected]

Contributors

Anthony Harrington

Cherry ReynardLeanne Wang

Business Development Manager

Richard Marshall

[email protected]

Front Cover

Morgan Miller

2i UK, 16-17 Little Portland Street,

London W1W 8BP, UKT: +44 (0) 20 7299 7700

F: +44 (0) 20 7636 6044

2i USA, 410 Park Avenue,

15th Floor, New York, NY 10022

T: +1 212 231 8421

F: +1 212 231 8121

2010 2i Media

All rights reserved.

No part of this publication may be

reproduced, in whole or in part,

without prior written permission from

the publishers.

ISSN 1759-0728 Printed in the UK

Contents

6 | News

Top industry stories.

10 | xeutve pofile

Tony Venditti,

BMO Capital Markets

12 | cong up shot

US short selling restrictions

16 | in ehan's tes

Investigation into Repo 105

18 | fghtng ba

The industry's response

22 | eung the utue

Ashley Wilson,

Barclays Capital

26 | azl shapes up

The Brazilian market

32 | estng te n chna

Margin trading, short selling

trials in China

34 | indan outlne

Description of the Indian

market

36 | & rm

Panel summaries from the

conference

News

eople

asten ose

tll nde ege

It's like stopping a soldier fromshooting when the general has giventhe command to go to war. Theregulators are reacting to the publicperception, but this did not happenbecause people were shorting stocks"

Who said this?

Find out, page 13

futue Vew

copanes/nsttuons

eatued n

alays captal 22,24

m captal maets 10,11

cental nvesty o fnane &

onos (chna) 33

cleastea 56,57

avs ol & adwell 12,13

eutshe an 26,28

eeendng 28,30

uex repo 57uolea 48

uopean repo counl 44-46

uota Juna 33

katten muhn rosenan

consh 13,14

aven atnes 13,14

mic 50,52

Natonal to xhange

(inda) 34,35

Nc (russa) 50,52

New ppoah r 20

Nothen ust 64

36-44

rm 18,20

noln eutes 32

unad 18

ncedt 57

c mashall hool o

usness 14

nast 33

GlobalSecuritiesLending|

Head of Sales

Patricia De La Grange

Account Managers

Cicely Lewis

Eradat Munshi

Chief Technology Ofcer

Peter Ainsworth

Operations Manager

Nicolette Whittaker

Managing Director

Jon Hewson

CEO

Mark Latham

GSL is part of

2Media

44 | ost-rc eetng

with Godfried de Vidts,

ERC chairman

48 | Natual ollateal

with Olivier Grimonpont,

director, head of collateral

services at Euroclear

50 | russan epoluton

The post-crisis Russian

repo environment

54 | uts

report on the GSL Nordic

and London Summits

56 | lobal eutes

fnanng ut

58 | enefial wnes

intenatonal eutes

endng & repo ut

60 | etoy

64 | Nothen ust

repo & collateal

coneenes

etoy

ende pofile

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SunGard appointed Chris

Clark as European senior

vice president for its

Astec Analytics business

unit, which specialises in

trading, perfomrmance and

programme management

for the global securities

nancing industry.

eSecLending, the securitieslending agent, appointed

Ross Bowman as senior

vice president of client

relationship management,

servicing the rms UK

and European based

clients.

Bowman moved from

BNY Mellon, where he

was responsible for the

management of existing

client relationships and

business development

for the securities lending

business across theEuropean, Middle Eastern

and African regions.

Pat Cestaro leftJ.P.

Morgan, following a

30-year career in the

securities lending business.

Cestaro was responsible

for building up the prime

brokerage business at Bear

Stearns before the rm was

bought up by J.P. Morganin 2008.

Hector Sants, CEO of UK

regulator the Financial

Services Authority (FSA),

is to leave his post in the

summer after three years in

charge of the organisation.

The European Central

Bank (ECB) made a new

appointment as it seeks todeal with system risk in

the nancial sector, with

Mauro Grande taking up

the role of director general

of the Directorate General

Financial Stability.

Sun Microsystems

veteran Masood Jabbar

has become the fth

independent director

appointed to the board

ofCalypso Technology, a

provider of trading, risk

and processing platforms.

Jabbar spent 16 years

at Sun Microsystems,

reaching the level of

executive vice president

of global sales operations

before leaving the rm in

2002.

The Risk Management

Association (RMA)

appointed Christopher

R Kunkle to the role ofdirector for securities

lending and market risk,

replacing the retiring

Curtis Knight.

Merlin Securities co-

founder Andy Lando has

returned to the rm in a

senior partner role which

will see him head up

the rms new securities

lending group. Lando, aformer managing director

and global head of

securities lending at Banc

of America Securities, was

one of the ve founding

members of prime

brokerage services and

technology provider Merlin

in 2004.

LCH.Clearnet Group

appointed a new non-

executive chairman,

Jacques Aigrain. Aigrain

replaces Chris Tupker, who

announced his intention

to step down in September

2009.

Brown Brothers Harriman

(BBH) upped its presence

in Asia following the

appointment ofRobert

Lees and Richard Meek

respectively as head of

securities lending trading

and head of securities

lending relationship

management for the Asia

Pacic region. Both men

will move to BBHs Hong

Kong ofce, with Lees

reporting to Jeff ONeill,

global head of securities

lending trading, and Meek

to Elizabeth Seidel, global

head of securities lending

relationship management,

business development

strategy and marketing.

Business and IT

consultancy Rule Financial

appointed Dr Chris Potts

as CEO, a move which the

rm said was part of its

plan for global expansion.

Potts moves from 3i

Infotech, where he was

president and CEO of the

rms Western Europe

division. He has also heldhigh-level roles at Cap

Gemini, Cap Consulting

and Misys Asset

Management.

Amaces appointed former

State Street and Aegon

Asset Management client

managerTom Robertson

as a director. Robertsons

most recent role was

at Legal and General

Investment Management,

where he was a client

account manager.

Joe Cassidy will take up

the role of head of prime

brokerage and derivatives

clearing for global rates at

Deutsche Bank in May.

He will report to Fredrik

Gentzel, head of credit

portfolio management and

prime brokerage for global

rates and commodities.

Cassidy moves from

Nomura where he has

held a number of roles,

including global co-head

of prime services, global

COO of prime services,

head of equity strategy

and head of European

corporate strategy

N

News Round-up Top industry stories at deadline.For daily updates go to www.gsl.tv

People Moves

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Richard Newman will join

Deutsche Bank as a senior

risk manager for global

prime nance within the

global markets division,

the bank announced

today. Formerly head of

European prime brokeragerisk management at J.P.

Morgan, Newman who

takes up his new role

on 4th May will be

responsible for providing

risk management solutions

to hedge fund clients with

a European focus.

The Chinese regulatorapproved a short selling

and margin trading trial.

British MP Frank Field

criticised custodians over

their securities lending

programmes, after a

pension fund told him

it had been entered into

a programme without

permission.

At the same time, the UK

Pensions Regulator issued

guidance for benecial

owners.

ISLA approved

amendments to the Global

Master Securities Lending

Agreement 2009.

A Bank of England deputy

governor called securities

lending "absolutely vital"but called for reforms.

German regulator BaFin

lifted its uncovered short

selling ban.

Northern Trust was sued

by the Public School

Teachers Pension &

Retirement Fund of

Chicago and the City

of Atlanta Fireghters

Pension Plan, over claims

that the bank broke its cash

collateral reinvestment

pledges.

The National Stock

Exchange of India (NSE)

held a special live tradingsession on 6th February

2010 for its securities

lending and borrowing

scheme.

The US Securities and

Exchange Commission

introduced new short

selling restrictions.

Former Morgan Stanley

and Banc of America

stock loan trader Salvatore

Zangari was charged by

the US Securities and

Exchange Commission

(SEC) over alleged

kickbacks from Clinton

Management, a Brooklyn-

based loan nder.

State Street succeeded in

dismissing a complaint

from a law rm over

an alleged breach of

prudence and loyalty

within its securities lending

programme.

The City of St Petersburg

suedWachovia Global

Securities Lending,

claiming that the bank

broke the terms of its

securities lending contract

by investing cash collateral

in Lehman Brothers bondsand failed to act when

the now-defunct bank

appeared to be in trouble.

Citigroup was ned

USD650,000 by the

US Financial Industry

Regulatory Authority

(FINRA) for violations in

its Direct Borrow Program

(DBP).

The Investment Industry

Association of Canada

(IIAC) selected the

Canadian Derivatives

Clearing Corporation

(CDCC) to develop acentral counterparty for

the Canadian repo market,

in a move welcomed by

the countrys central bank.

Bank of Canada governor

Mark Carney described

the move as a critical rst

step and cited the effect

of an efcient repo market

in helping the countrys

core markets function

continuously.

A loophole in the UK

Corporation Tax Act 2009

which could allow rms

to avoid paying tax on

manufactured payments

in repo transactions

was closed by the UK

government.

The long-awaited

report into the collapse

ofLehman Brothers

has criticised senior

executives at the rm and

highlighted the large role

of an accounting practice

known at the bank as

Repo 105. The report,

written by lawyer Anton

Valukas, outlined how the

bank used Repo 105 to

give its balance sheet a far

healthier appearance than

it warranted, in the run up

to its bankruptcy in 2008.

There was a strong

recovery in the European

repo market, the latest

survey from the European

Repo Council (ERC) of

the International Capital

Market Association

found, although the study

included pessimistic news

for the UK economy.

Investment bank BOCI,

a subsidiary ofBank of

China, implemented

SunGards Global One

securities nance solution

to help boost its recently

launched securities lending

business. BOCI will use

the Global One Lender

module to support its

lending business, which

lends Hong Kong and

Chinese stocks listed on

the Hong Kong Stock

Exchange.

Syncova and RiskMetrics

Group announced plans to

launch a risk-based margin

management solution via

the OPTIMA platform for

hedge funds and prime

brokers. The integrated

solution will include

features such as VaR

and client-specic stress

scenario based margining,

what-if scenarios and

combined risk and margin

rule-based portfolio alerts.

LocateStocks real-time

stock locate platform

Matador was launched on

ConvergEx Groups order

management system, the

Eze OMSTM.

BNY Mellon enhancedits Workbench reporting

platform with a new

securities lending

dashboard, aimed at asset

owners and managers.

Clients will now be able

to access data including

earnings, loan values and

credit quality from both

an executive summary and

detailed view point. Z

N

Repo

Securities Lending

Technology

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LCH.Clearnet: the essential link in the chain

In the event of member default, LCH.Clearnet guarantees the management of positions thereby protecting thenancial community against the risk of contagion.

LCH.Clearnet is the leading independent central counterparty group (CCP) in Europe, serving major internationaexchanges and platforms. It clears a broad range of asset classes including: securities, exchange traded deriva-tives, energy, freight, interbank interest rate swaps and euro and sterling denominated bonds and repos.

www.lchclearnet.com

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ciV rfi

The beginning to Tony Vendittis

securities lending career may

have been a case of right place,

right time, but his rise through

the industry was anything but. A

securities lending operations position

opened up when he was applying for

a job at Mabon Nugent Securities

and, despite having never heard of

the business before, he thoroughly

enjoyed his new position.

He explains: Six months later I

approached one of the partners at

the rm about a front ofce move.

He said, Id much rather youd be

a bond sales assistant, youll have a

great career this stock loan thing

will be automated in two years and

everyone will be out of a job. That

was 1985.

Rolling on 25 years, manual

securities lending is still here and

so is Venditti, by way of two stints at

Paloma Securities, with a number of

years at Nomura in between. Now he

is at BMO Capital Markets, after the

bank took over Paloma Securities in

November 2009.

So what has changed during his

time in the industry?

When I started, it

was interesting how

many people said

securities lending was

hard to understand I

thought it was one

of those things that

if you understood

stocks, pricing and

interest rates, it all

made sense, so I

was fascinated how

the smartest people

would always say, I

dont understand that

part of the business.

Back in the 1980s it

probably was true,

but now when you look at pricing

and liquidity, it shows probably

the biggest change of the past 25

years - how integral it is to so many

platforms and companies.

Venditti is keen to talk about this

history of the industry in terms of

phases, marked by major events.

I think the Asian crisis, where

liquidity really dried up, was the

rst elevation of the business, with

securities lending and repo being

used to protect liquidity. It was no

longer just an operational business

but a funding business. I also think

that, with the growth of hedge funds

in the 1990s, stable access to supply

and pricing became much more

important.

Now were into the transparency

phase. I think the credit crisis of

last year will bring much more

transparency what people are

doing, how they are doing it, how

they book it. However, Ive never

been one to say that the business

is that opaque, its like any other

market, its about how active you

are.

Venditti counts his achievements

during his second stint at Paloma as

among his best. When I went back

to Paloma it had just lost a lot of its

front ofce employees. My challenge

was to take a strong securities

lending platform, with a fair amount

of counterparties, and expand the

business.

We used the existing counterparty

base, the existing operations and

brought in strong front ofce people

not only focused on securities

lending, but also nance, delta one

trading and later government bond

repo. We turned it from just a global

Tony Venditti,

BMO Capital MarketsCraig McGlashan talks to themanaging director of BMO CapitalMarket's securities lending team,about his past and future

"Our securities lendingbusiness was really ableto self nance itself and

it proved that securitieslending can helpproprietary trading andindex arbitrage"

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ciV rfi

We felt, given the relative strength of theCanadianbanks through the crisis period, that we had

an opportunity to look for growth and the ability to

expand. It gave us an opportunity to consider areas

where credit rating, stability and so on were important

for businesses and their success.

The securities lending business is one where we

saw an opportunity to look for growth and the ability

to expand. So thats what led us to spend time with

Paloma and investigate the opportunities around the

acquisition.

At this point we are focusing on operating in all

the jurisdictions thatPaloma was operating in before we expand into any new

jurisdictions. We are three months into the acquisition

now and from our perspective things are going very

well, its been a very smooth integration process, and

we are very impressed and very happy with how the

business had been run and continues to be run.

That said we constantly keep an eye on where

market growth is occurring and are always interested in

extending core businesses and as opportunities present

themselves we make sure that we are in a position to

take advantage of them.Z

securities lending shop to trading

nance repo. Our business really

grew in the three years I was there,

we had a great run and that led us to

BMO.

He says his time at Nomura

helped pave a lot of my success.

Specically, during the Asiannancial crisis when the bank

was downgraded, our securities

lending business was really able

to self nance itself and it really

proved that securities lending can

help proprietary trading and index

arbitrage.

But the move to Paloma allowed

Venditti freedom to take what he had

learned and use it in an environment

where he was able to exert greater

change.I touched a lot of businesses at

Nomura. Nomura was very equity-

nance driven and we used all our

collateral quite effectively, and at a

smaller player like Paloma that model

tted perfectly, he says. Also, at

Nomura, I was only on the equity

side so I couldnt intertwine with

xed-income products or repo, but

when youre at a smaller shop you

have more control so its easier to

bring on businesses not really byproduct but how you can integrate

them with your client base and

infrastructure.

So now

that Paloma

is operating

under the BMO

name and

stable, what are

Vendittis plans

for the business?Paloma was

never a rated

counterparty

even though we

had the benet

of long-term relationships and

transparency in our nancials, and

a credit department that discussed

our structure and capital effectively -

because of this we were lucky enough

to have many counterparties treat us

as an investment-grade counterparty.That being said we always were

looking to do more business - in turn

eventually we needed more credit

which led us to BMO. BMO has a

very sound name. The institution has

been around for a long time and has

a solid reputation. We look forward to

using BMO as our credit instead of

Paloma as a hedge fund in hopes of

continuing to expand our business.

However, Venditti feels that the

acquisition will also boost BMOsother offerings. The one thing that

were really hoping is that our global

platforms could help propel some

of BMOs existing sales and trading

businesses, he says.

So aside from Vendittis plans for

BMO, what of the industry as a

whole? I think the industry has a lot

more room to grow and the market

making side of securities lending -

where its much more active - willbecome more electronic, he says. I

think one of the stumbling blocks as

always is about where the credit will

go CCP will have a role, Im not

sure how it will play out, but I think

you will see change there.

Venditti bet against

automation at the beginning of his

career and it proved fruitful if he

is right this time, it certainly proves

how much the industry has moved on

since 1985. Z

Luke Seabrook, executive managing director &head of nancial products at BMO Capital Markets,outlines the reasons behind the Paloma purchaseand BMO's current plans for the business

Factle: BMO Capital Markets

Employees: 2,200

Clients: Nearly 8 million

Total Assets: USD373 billion

2009 Revenue: USD9.6 billion

Tier 1 Capital Ratio: 12.24%

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tll nde ege?2010 has seen oe egulatons, lawsuts andnegatve pess o the seutes lendng ndusty

n the next ew

pages we exploe

soe o the ajo

developents and

how the ndusty

an fight ba

Coming up shortNew US rules on short selling have been poorly thought out - and couldspread across the Atlantic, ndsCherry Reynard

The Securities and Exchange

Commission (SEC) has been under

pressure to introduce new rules

on short-selling for some time.

Approximately 4,400 companies

have petitioned the SEC to clamp

down, with industry heavyweights

such as John Mack, chairman of

Morgan Stanley, blaming short-sellers for perilously driving down

company share prices in 2008. The

new rules have nally emerged. What

impact are they likely to have?

The SECs new rules aim to

promote market stability and

preserve investor condence by

placing restrictions on selling stock

short if a company is experiencing

signicant downward price pressure

on their share price. The alternative

uptick rule will restrict short-sellers

from driving down the price of a

stock that has dropped more than

10% in one day. Once this circuit

breaker is triggered, holders of the

stock will be rst in line and can sell

their shares before any short sellers.

Once the circuit breaker has

been triggered, the rule applies toshort sale orders for the remainder

of the days trading, plus that of

the following day. It applies to

all equities listed on a national

securities exchange, whether they

are traded on an exchange or over-

the-counter. Importantly, it offers

no exemption for market-makers.

Also, companies will be required to

have written procedures in place to

prevent the execution or display of

prohibited short-selling transactions.

Robert Colby, deputy director of

trading and markets division at law

rm Davis Polk and Wardwell says:

It is not a complete prohibition.

It means that a short-seller cant

execute at the bid price. This means

they cant chip away at the price

people are willing to buy. If, forexample, a stock is trading at 105-110

and a trader was trying to short-sell

and it triggered the circuit breaker,

they could no longer sell at 105.

They could only say that they were

willing to sell at 106 up to 110 and

wait for people to come to them.

The SEC is clear in its intent. SEC

Chairman Mary L Schapiro says

that the ruling recognises that short-

selling can have both a benecial

8/9/2019 GSL 008

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r iN

and a harmful impact on the market.

She continues: It is important for

the Commission and the markets

to have in place a measure that

creates certainty about how trading

restrictions will operate during

periods of stress and volatility.

There has been considerabledebate as to whether the new rule

will achieve its goal of greater

stability. The Securities Traders

Association issued a lengthy response

to the SECs regulations, suggesting

that they were based on inadequate

analysis, a lack of empirical data, and

questionable rationale by the SEC.

It also accuses the SEC of not

being consistent. It says in its letter

to the SEC: This inadequacy

was noted by SEC CommissionerParedes in his opening statement...

there is an insubstantial empirical

basis to support the commission in

adopting the rule, especially in light

of the rigorous economic analysis

that led the SEC to repeal the

original uptick rule in 2007 after

years of study. The commission bears

the burden to justify its rules. It has

not done so in this instance. The

regulations were voted through the

SEC on a paper-thin 3-2 majority.The STA suggests that the new

regulation will not resolve the issue

of manipulative short-selling that it

was designed to address. As such,

it cannot bring about the investor

trust as intended. It will also

have signicant implementation

costs. Many broker dealers, for

example, will need to upgrade

their computer systems to ensure

that they can distinguish between

short-sellers and those investorswho hold stock and wish to sell.

In particular, the STA requested

that the regulator make an exemption

for options market makers, saying:

The nature of the derivatives market

is such that market makers must

be able to hedge their positions

easily and cheaply to reduce trading

costs. Failure to do so would

cause a decoupling of prices in the

options markets from the prices

of the underlying instruments.

This would result in reduced

liquidity and wider spreads to the

detriment of individual investors.

The group believes that the

regulations may be counter-

productive, resulting in less liquidity,

greater volatility, and wider bid-ask spreads, none of which is

conducive to boosting investor

condence. Furthermore, a short

sale restriction that makes it more

costly for investors to manage their

risk by hedging can hinder the ability

of companies to raise capital.

With the two sides clearly

delineated, what do industry

participants believe will be the

likely outcome of the regulations?

Jerome Lussan, managing director

of hedge fund consultancy Laven

Partners, says: This will impact all

international hedgers operating in

US markets. It will limit their abilityto make prots in falling stocks.

That said, it doesnt kick in until

there has been a 10% drop, which is

relatively rare, but if you sell stock

with small volumes it could happen

a lot faster. Therefore mid and small

cap managers may nd themselves

disproportionately affected.

It has been suggested that

the decision could have a

disproportionate impact in the

equity options world, as market

makers will not be able to hedge

their risk without an exemption.

Lussan believes the market-maker

restrictions could result in a loss

of liquidity. Market-makers receive

no help in trying to hedge their

positions and will therefore be lessinclined to make a market in certain

stocks. Plus, a perfect hedge becomes

more difcult because it cannot be

predicted whether the stock will

be hit by the new regulations.

Edward Black, special counsel at

law rm Katten Muchin Rosenman

Cornish, explained that in the UK,

the disclosure obligations apply

to short sales whether of a stock

or a derivative on it. The new US

restrictions only apply to short salesof the actual security. The impact of

the restrictions will depend on the

nature of future market movements.

The SEC has said that its approach

establishes a narrowly-tailored rule

that will target only those securities

that are experiencing signicant

intra-day price declines and that

it believes that addressing short

selling in connection with such

declines in individual securities will

help address erosion of investorcondence in our markets generally.

There is still debate on the likely

impact of the new regulations on

trading. The SEC has suggested that

on an average day approximately 4%

of the market would be hit by the

circuit breaker. This gure would

rise during a more volatile period.

Colby says: It is difcult to predict

how it is going to affect trading. It

means some people are in some

cases - not going to be able to hedgeby selling short and it may be at a

time when they most want to hedge.

Overall, it is likely that if someone

thinks the market is falling, they

will have to act immediately. As

such, it will make hedging more

unpredictable. Lussan agrees that it

will become more difcult to predict

how a stock will fall, adding: It may

fall 5-6% and then fall very hard.

Larry Harris, professor of nance

It's like stopping asoldier from shootingwhen the general hasgiven the command togo to war. The regulatorsare reacting to the publicperception, but this did

not happen becausepeople were shortingstocks"

Jerome Lussan,Laven Partners

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r iN

something must be done mentality

in reimposing a new price-based test.

The European exchanges have

similar, though less onerous, trading

restrictions in place. The London

Stock Exchange, for example, has

an automatic suspension period in

place to provide a pause in trading

when stock prices move severely.It can suspend any stock at its own

discretion if it believes that market

manipulation is taking place.

However, Black says that for the

most part, the US and Europe are

pursuing different regulatory models.

CESR and the FSA are focusing on

public disclosure and the ability to

intervene in an emergency rather

than any generalised restrictions. In

the US FINRA regulated broker-

dealers are obliged to report toFINRA twice each month all short

interest positions in all customer

and proprietary accounts in NYSE

and other listed securities as well

as OTC securities. That reporting

is on a combined basis and only

global short positions in issuers are

published, not individual positions

held by any broker or customer.

The goal of strengthening public

condence is sufciently nebulous

to make any real judgement on thesuccess of the rules difcult. With a

relatively small majority in favour of

the new regulations at the SEC, there

may be room for a re-examination

of the rules on market-makers and

possibly for a full change of heart

if the rules are found to create

additional volatility. Lussan sums up

the view of many when he concludes:

This is the least bad alternative.

The market was expecting something

and was afraid it could be worse.Z

but the crash happened because

there was insufcient regulation of

banks. Its like stopping a soldier

from shooting when the general has

given the command to go to war. The

regulators are reacting to the public

perception, but this did not happen

because people were shorting stocks.It is difcult to see how the new

regulations will act to stop additional

market abuse. The SEC had already

introduced changes to tackle

manipulative and naked short selling.

In normal circumstances, if RBS

looks over-valued, the short-sellers

move in and create a temporary fall

in the share price, but then the shorts

go too far and the long investors

come in and scoop up value. Black

suggests that much of the criticismof short selling should properly

be directed at market abuse; for

example the spreading of negative

rumours to articially depress prices

accompanied by short selling.

There has often been a creep

in US legislation across to the

UK. Clearly the new regulations

will affect all European traders

operating in US markets, but could

its impact be more widespread than

that? Lussan says: The EuropeanCommission has recognised that

hedge funds are not responsible. But

it may creep in because everyone

trades in US markets. America likes

to be the worlds policeman and

tends to take a populist approach.

Black says: Different regulators

have come at regulating short selling

in different ways. Some regulators

appear to be more suspicious of the

potential for short-selling to be used

for market abuse, while others believeit is a legitimate technique. The FSA,

for example, takes the latter view. It

has said that while it reserves the right

to introduce emergency short-selling

rules if market conditions warrant

it, the focus of its regulation of short

selling is to require more disclosure

of short-selling positions. CESR

has similarly proposed enhanced

disclosure of short positions. The US

appears to have displayed more of a

at the USC Marshall School

of Business, has suggested that

the new rules may prevent the

efcient functioning of markets.

Without short sellers, prices of

deteriorating stocks may be kept

articially high, leaving investors

potentially paying too high a price.The SECs focus on equities leaves

a huge amount of hedge fund trading

out of scope. Although there has

been pressure to limit the activities of

hedge funds in the market generally,

the SEC seems primarily concerned

with the proper functioning of equity

markets. This is also where much

of the pressure has been coming

from USA plc has put pressure

on the US government to stop it

shorting its stock. Other hedge fundactivities simply do not generate

the same amount of pressure.

This supports the view of Lussan

and others that the measure is

populist rather than necessarily to

ensure proper control of markets.

Erik Sirri, who ran the SECs

division of trading and markets

during the credit crisis that began

in 2007, has gone on record to

say that commissioners who voted

for curbs when a given stock falls

10% from the prior days closing

price did so without proof that

it would improve markets.

Lussan agrees: What are the rules

trying to achieve? The uptick rule

was rescinded in 2007 and is now

being reintroduced. The SEC has

said that its aim is to protect markets,

The US appears tohave displayed moreof a 'something mustbe done mentality' inreimposing a newprice-based test"

Edward Black,Katten Muchin

Rosenman Cornish

The commission bearsthe burden to justify itsrules. It has not done soin this instance"

Securities Traders'Association response tothe SEC

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Your ambition. Our purpose.

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In Lehman's terms

When is a repo not a repo? The answer, if you

are Lehman Brothers, is any time you provide 105%

more collateral by way of value than the cash you

are borrowing! Called a Repo 105 transaction, the

deal can legally be classied as a sale rather than as

a straightforward repo arrangement at least in the

opinion of law rm Linklaters, who advised Lehman.

But let us back up a few steps for the sake of any

readers out there who have not yet digested an article

or two on the subject of the Court Examiners 2,200

page report into the Lehman failure. It is important to

bear in mind that Anton Valukas, the Court Examiner,and chairman of the US law rm Jenner & Block, was

not asked to nd guilt, but to explore whether there

were colourable claims (actions that might constitute

grounds for litigation) against Lehman ofcers or

third parties. Whether or not those colourable

claims actually result in actions and in parties being

found guilty or liable is a matter for another day and

a different forum, as far as Valukas was concerned.

To the casual observer, which translates roughly

to anyone not involved in day-to-day repo activity,

the truly astonishing thing about this accounting

gimmick (the term used by some senior Lehman staffto describe the Repo 105 transactions), is the idea that

any serious minded person could simply pretend that

one half of a repo transaction isnt there. Consider

the following instance. I give you cash. You give me

collateral. I expect to get my cash back. You expect

to get your collateral back. This is not the same thing

as: I give you cash, you give me assets. In the latter

instance, we have a sale, in the former, a repo deal.

Linklaters has come under tremendous re for

being so obliging in its opinion. As Valukas pointed

out: Lehmans conducted its Repo 105 programme

under the aegis of an opinion letter the Linklaterslaw rm in London wrote for Lehman Brothers

in Europe, Lehmans European broker-dealer in

London, under English law. The UKs legal regulation

body, the Solicitors Regulation Authority (SRA) is

reported to be considering the Valukas Report and

Linklaters role, which of course, does not mean that

Linklaters was wrong. We are aware of the report

and we are currently reading it. After, we will decide

whether or not any regulatory action should be

taken, it said. (See http://www.cityam.com/news-

and-analysis/linklaters-put-alert-over-lehman-help).

The law rm itself has issued a statement to the

The fallout from the discovery of "Repo 105" transactions on the books ofLehman Brothers may have a long way to run, ndsAnthony Harrington

following effect: The Examiner who did not

contact the rm during his investigations does

not criticise those opinions or say or suggest that

they were wrong or improper. We have reviewed

the opinions and are not aware of any facts or

circumstances which would justify any criticism.

To understand Linklaters condence in this

matter, one needs a little inside knowledge of exactly

how Repo 105 has played on the street, as it were.

A securities lending source told GSL: Basically,

Im sick of all the blather over Repo 105. Everyone

post-Valukas pretends they didnt do it, but it wasa widespread and commonplace practice and it

had a benecial impact in that it enabled broker

dealers to address risk on their balance sheets

and to provide more liquidity to the market.

What Linklaters is probably relying on is the concept

of true sale as set out in FAS 140. In brief, a true

sale rather than a collateralised loan can be deemed

to have occurred where the borrower can be said to

have lost control of their collateral. The question

then is, what constitutes loss of control? The answer

comes down to the way in which normal collateralised

deals are marked to market. If you collateralise aloan in the normal way with 100% collateral, and the

value of your collateral shrinks or grows, the collateral

pool is adjusted to compensate for the movement.

In a Repo 105 transaction mark to market is

suspended until the market movement is violent

enough to move beyond some hurdle, such as 112%.

For the period where mark to market is suspended,

the collateral provider is deemed to have lost

control of their collateral, and this transaction in

jurisdictions that accept this rule can be deemed

a true sale. The other proviso is that it cannot be

an overnight loan. However, three days or more areconsidered safe. What was possibly unusual about

Lehmans case is simply the scale involved and the

fact that the transaction, in the words of some senior

Lehman nancial people, had no substantive basis

other than to shift debt off the balance sheet.

For the fourth quarter 2007, Lehman deployed

Repo 105 to shift USD38.6 billion of assets off its

books. In Q1 2008 it upped that to USD49.1 billion

and in Q2 2008 it upped it again to USD50.38

billion. In each instance it was good quality assets that

Lehman provided as collateral against the loan and

r 105


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fiiN ck

in each instance it treated this as a sale, increasing

the amount of cash on its books and decreasing its

leverage by 1.7 percentage points, 1.9 percentage

points and 1.8 percentage points respectively.

To put this in context, in its own internal risk

management, Lehman regarded a movement of 0.2%

of leverage as signicant. In other words, this was

window dressing on a grand scale, unless Lehmansnance team can show that the Repo 105 device actually

served some solid purpose other than to window

dress the quarterly accounts. So far, to my knowledge,

no such alternative purpose has materialised.

Of course, it is not only Linklaters who are under

scrutiny in the aftermath of this wheeze. Valukas also

agged up Lehman auditors Ernst & Young, and was

less than happy with the audit rms decision to allow

Lehmans use of the Repo 105 device to pass without

comment. However, Ernst & Young too, are taking the

view that they stand by their 2008 audit and since they

had not yet done the 2009 audit, wheres the problem?

One outcome from all of this, some way down

the line, is likely to be yet another blitz on window

dressing. However, looked at purely from the

standpoint of a potential case for the defence,both Linklaters and Ernst & Young would seem to

have quite a bit of solid ground to work with. Repo

105 was widely used and the securities lending rms

who provided it took detailed legal opinion - not

just from Linklaters - and they were relying on a

well-publicised Financial Accounting Standard. It

will be interesting to see how this one runs.Z

Fighting backCraig McGlashan gauges opinion on what the industry can do to improve itsimage and help ensure regulators are on side

The hits that the securities

lending industry has taken and

continues to take since the onset of

the nancial crisis are too numerous

to list here few jurisdictions have

not felt some sort of pain. But what

can the industry do to ght back?

Curtis Knight, former director for

securities lending and market risk at

the Risk Management Association

(RMA), believes that a global

industry needs global harmonisation

to deal with its problems and this

includes making sure that regulators

thinking is in tune with the industrys

needs.

Global harmonisation will be

extremely important in making sure

that the correct risk management

tools are being used, that regulators

are working together - and in

conjunction with industry players -

to make sure that the best possible

regulation is being enacted, he says.

I cant see another more

important issue right now. We can't

have situations where one rule in

one jurisdiction conicts with one in

another jurisdiction.

This potential disconnect between

the rules governing different regions

can perhaps be most felt by the many

businesses in the industry which run

a global offering, not least in terms of

the technology they deploy, he adds.

Jane Milner, a market specialist

at SunGard Securities Finance,

describes disparate regulations

as a challenge for the business.

She adds: The US is by far the

most regulated market, with 15c3-

3, RegSHO, Rule 402, Agency

Lending Disclosure and the more

recently introduced short sale circuit

breaker. In the rest of the world

the problem is in some ways more

complex in that regulations vary by

jurisdiction. The recent attempt by

CESR to set standard guidelines for

new post-crisis regulation seemed

somewhat undermined by the

German regulators variation from

the standards.

Interestingly, this problem can be

exacerbated by impacts from other

markets too. Integration issues

may occur when the regulatory

requirement is not exclusive to the

securities nance market, and data

from a securities nance solution

needs to be consolidated with data

from other systems, she says. To

handle this it is important that a

solution has the exibility to export

data on demand, in a user-denable

format with as little need for IT

development as possible.

Milner does feel that current

technology standards are able to

meet this challenge. Typically when

functionality is potentially re-usable,

it would be built in a exible way to

allow it to be adapted as necessary

to a similar, but somewhat different

requirement.

However, even if technology will

be able to meet the challenge, the

problem still exists for the industry

of rules being created on an ad hoc

basis, with each country causing

problems for another.

So what of Knights call for

harmonisation among the various

industry bodies? Chris Kunkle, who

took on Knights role at the RMA,

explains that this process is already

taking place.

My personal key effort just now

is two-fold; its to improve the global

coordination and communication of

the industry associations and their

sub operations, and by that I mean

working with the other bodies.


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fiiN ck

The regulators and IOSCO are

coordinating very well across borders

just now and before they make snap

decisions without a lot of expertise or

a view from the industry, I want us

all to be able to communicate both

the positive and the negative issues.

ISLA, PASLA and ASLA hadtheir rst joint operations meeting

last December and those things will

go a huge way to helping. RMA is

coming into that now.

Indeed, an Industry Leaders panel

took place at the recent PASLA

conference, featuring gures from

some of the major institutions (read

the summary on page 42).

However, this effort to work

together is only one half of the

puzzle, according to Kunkle: Wehave a major effort to improve

education for regulators, academics,

benecial owners and eventually

for the press. We are going through

a serious time and the RMA,

during my last executive committee

participation term, started meeting

with the Fed, the SEC and the OCC

on a periodic basis, and we have a

quarterly meeting with the Federal

Reserve Bank of New York.

The RMA has developed a series ofmodules to help with this education

process and Kunkle believes the

education policy can benet from the

harmonisation policy: What Id like

is to broaden our education modules

so other associations can use these

modules.

Knight concurs: An educated

lender is an important piece of the

puzzle. Education means that, going

forward, some of the situations that

have now developed into lawsuits canbe nipped in the bud early.

However, no one can doubt that

a lawsuit is always bad press for

any industry. But has the securities

lending industry been particularly

poor at presenting itself in the

mainstream media, especially during

the nancial crisis? Jessica Johnson,

managing director of New Approach

PR, a specialist communications

agency for the securities nance,

asset management and hedge fund

industry, believes so.

She says: The error was that

there was no real PR whatsoever!

We are now nearly two years down

the line and just starting to realise

that this industry really needs to

promote what it does and implementa proper defence mechanism that can

promote proper understanding. For

this reason it would be wrong to say

that the industry was too reactive

because it did not really react.

So how would Johnson combat the

negative press that the industry has

received? I want to implement a PR

effort that represents and defends all

aspects of the industry so that the

wider world sees it in a more positive

light. Regulation is also a key aspect

of anything to do with nancialinstitutions, and it is also on the

agenda of every nancial journalists

mind this year. I think the securities

nance world does want to work

within a regulated environment, both

at individual and corporate level. If I

am so permitted, Id like to ensure all

relevant bodies are effectively covered

with regards to how regulatory stories

are handled in the press. I think

that everyone in the industry has a

common goal; to project the businesspositively and as a professional and

well regulated environment. I hope

my company can help do that.

However, Knight is unsure about

how such an operation would work

in practice. How do we manage

PR? Do we need a face, if you will,

for securities lending? I havent

developed a conscious decision on

it either way. You have the RMA,

ISLA, PASLA and so on my

concern has always been over who

the industry spokesperson takes

the lead from. And how does that

directive get translated to this single

rm or individual so they are saying

something that most people in the

industry will agree with?

Individually, at times theinstitutions involved in the product

have not wanted to promote their

product when things were going

good, because its just something they

do as an organisation.

But then when some negativity

hits, someone feels that there is

a need to manage that ow of

information to the various sources

and thats where you get this

concern. I personally dont think

the industry needs a face, and if itdoes choose a face then it has to be

pretty well set up as to how that rm

or person gets their cues. If Im the

RMA, I would want to make sure

that our committee has a strong voice

in whatever edicts come out; my

concern is that if I dont agree, does

that mean the RMA has to put out a

counter piece?

Instead, Knight believes good

PR begins at home. Internally,

the industry players need to makesure that they have good robust risk

management systems, and for the

most part they do. They need to

make sure that theyre being adhered

to and on the agent lender side

that their clients are educated and

understand the product.

While various suggestions will

continue to be put forward and

different opinions raised, the need to

work together seems to be the one

area that most participants agree on.The next opportunity to do that will

be the ISLA conference in Berlin on

22nd to 24th June. GSL will see you

there. Z

Watch Jessica Johnson debate with

Richard Thompson of ISLA and

Northern Trust at the Februarys

GSL London Summit at www.gsl.tv/

videos/1052/gsl-london-summit-10-pr-

debate

It would be wrong tosay that the industry wastoo reactive - because itdid not really react."

Jessica Johnson,New Approach PR

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criN fr

Barclays Capital has had perhaps

more good headlines than most of its

peers of late, with its acquisition of

Lehman Brothers US business and

its move into the European equities

space. Another headline has been

the appointment of Ashley Wilson as

head of prime services for EMEA.Did all the positive news around

Barclays attract Wilson to the job?

Right now there is a huge amount

of energy, growth and focus within

BarCap. There is a lot of talent

joining the rm, especially because

of the Equity division growth across

EMEA and Asia Pacic and in prime

services. To give you an example the

equity division has hired 750 people

front to-back, across EMEA and Asia

Pacic, over the last 12 to 18 months.BarCap is attractive to our clients

- it is a very high credit quality

bank, a UK-centred bank with a

full prime services offering that did

not take any direct bailout funds.

However, other aspects of the

Barclays offering helped to entice

Wilson. Historically Barclays was

very strong with xed-income hedge

funds, due to the xed-income

nature of the rm. Additionally,

we gained a lot of multi-strategyfunds and this was primarily due

to our cross-asset class margining

capabilities. We were also strong in

the quant space, where participants

look for low-latency direct market

access, i.e. using the banks pipes

to access directly to market.

These were the three areas that we

were always very strong in. Now with

the equity build-out we are seeing a

lot of growth in the equity business

and as a result

we are nancing

all asset classes.

This rare

situation is one

of the main

attractions for

Wilson. It is adifferent model,

you have xed-

income, futures

and equities all

within prime

brokerage, and

that is rare

because most

prime brokers

only concentrate

purely on

equities andmy background

has always

been equities,

so the move allowed me to gain

exposure to the other asset classes.

He continues: Our global repo

book is over USD500 billion so that

gives you substantial purchasing

power when speaking to agents

from whom you want to source

securities and so on. Of the 310

Eurex members active in interestrate derivatives, we are ranked

number 2 for traded volume.

We have a very strong xed-

income and futures activity, so we

are now very focused on the growth

of the equity platform. It was a

challenge to grow something again

but also to have this one balance

sheet where you have the chance

to control three different products

which I thought was unique.

Since moving to Barclays Capital

from Merrill Lynch in September

2009, Wilson has been quick tooutline his intentions, including

using his 11 years experience on

a Morgan Stanley trading desk to

introduce a more trading-focused

Ashley Wilson, the new head of

prime services for EMEA at BarclaysCapital, talks to Craig McGlashanabout his plans for growing thebusiness

This renewed focus on risk has meantthat we have had to develop different assetprotection models and as a result of that,the old adage that prime brokerage is a

commoditised business is denitely broken"

Securing the uture

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criN fr

approach to the British bank.

There is term specials trading

for instance, where you go long

stock and short futures to create

inventory because of the miss-

pricing between the future and the

stock-borrow value, he explains.

However, this is not the onlychange he hopes to instigate.

Id like to have a trading focus,

but I also think you need to build

out the product offering, he says.

Weve just introduced swap-

backed ETFs and we are on the

ETF exchange platform. We are

developing a GCM business.

Currently, our DMA pipes take a

lot of business from non-exchange

members but if we start looking

at clearing the exchange memberbusiness, we need to do GC.

Wilsons vision of change is

in keeping with a general trend

being seen in the prime brokerage

industry. Numerous reports have

surfaced of late suggesting that prime

brokerage clients are looking at risk

management and transparency at a

much greater level than in the past,

with terms like multi-prime being

used with increasing frequency.

Hedge funds are denitelylooking at multi-prime, they are

also assessing their current prime

provider in terms of credit quality

and the asset protection solutions

that are on offer, he says. This

renewed focus on risk has meant

that we have had to develop different

asset protection models and as a

result of that, the old adage that

prime brokerage is a commoditised

business is denitely broken.

For instance, at BarCap wehave introduced a US broker/

dealer so our clients can trade

international securities. There

is demand for this because US

investors want SIPC [Securities

Investor Protection Corporation]

protection, which they gain through

exposure to a US broker/dealer.

Additionally, we are launching

Bank Prime, which allows

clients to transact and face

Barclays Bank plc, so it is not an

international offshoot of a big US

parent you are facing the main

parent entity, the rated entity.

Other projects in the pipeline for

Barclays prime brokerage offering

include gaining a SAS 70 (an

independent audited statement on

the controls within the business)

and an asset sweep solution which

allows clients assets to be held

at a third-party custodian.In terms of sourcing securities

Barclays Capital has an extensive

network of exclusives. We have

eight centres where we have staff

dedicated to sourcing securities:

London, New York, Hong Kong,

Tokyo, Madrid, Paris, Frankfurt and

Milan, Wilson explains. We have

a very large exclusive pool of assets

that we go out and bid for. We go

to the underlying benecial owner

and enter into an exclusive securitieslending contract with them.

Despite BarCaps network of

exclusives sourcing centres, Wilson

does appreciate the importance of

agency lenders to the process.

It is critical. We pride ourselves

on not recalling hedge funds on a

hard-to-borrow name and to be

able to do that you need a wide

supply of securities and you need

to mix it up - you need to have

some exclusives and have verygood relationships with the agency

lenders. So securities lending is key

to the prime brokerage business.

Some commentators have

suggested that fewer assets have come

on to the market in the exclusives

model in the wake of the Lehman

default, citing a perceived higher risk

from a benecial owners point of

view, given the lack of diversication.

Is this a trend that Wilson has seen?

There are two models the

exclusive model, where you know

the counterparty you are dealing

with, you know its rating, so as an

AA-rated entity we are not seeing

an impact. Then there is the agency

lender route where you diversify

your pool of borrowers, where within

that pool you might have some AA-

rated counterparties but you might

have some single A or some BBB

companies. Its a securities lendingfunction, you are lending out equities

versus collateral, and if the borrower

goes into default the equities tend to

fall in value so you unwind the trade.

We are not seeing a lack of assets

coming due to credit constraints, I

think people pull out of the exclusive

arrangement when the returns are

not high enough and dividends

are being cancelled so they put

it through an agency lender.

However, what of the future forBarclays prime services offering?

We mentioned the strong hiring

plan in the equities division; we also

have a very aggressive hiring plan

for prime services in Europe. We

are seeing a lot of talent coming in

and a lot of big names are speaking

to us, explains Wilson. In the

European role there are about 150

under me, with around 20 people

hired across sales and traders since

I joined. There is probably aroundanother 10 people on route.

He continues: From the

beginning of the year to now our

European equity balances are up

just under 50%, we have aspirations

of continuing that so we end the

year more than double where we

started, so its all positive.

It seems that, if all goes to plan,

there may yet be more good headlines

for Barclays Capital this year. Z

"We are not seeing a lack of assets coming dueto credit constraints, I think people pull out of theexclusive arrangement when the returns are nothigh enough and dividends are being cancelled

so they put it through an agency lender"

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Brazil

shapesup

These have been strange times for Brazils broker dealers, traders and

securities lending specialists. The market has been on a tear for months and

at the time of writing was still climbing, but the volumes have been thinning

out. As Andre Suaid, managing director at Deutsche Banks New York ofce

explains, investors have grown accustomed to seeing a lot of volume and a

market that was gaining anything from one to three percentage points a day.

Now the upward movement has slowed to 30 to 50 basis points. While Iwouldnt classify volumes in Brazil as light they have normalized to lower

levels than what we saw at the peak, and it may be some time until we see

the hype and the continuous inows we enjoyed in recent years. In London,

dealers would shrug and say: Sell in May and go away, but there is no such

tradition in Brazil.

On the plus side, and it is a very big plus, Suaid points out that this is the

rst presidential election (set for October) where politics has not yet inspired

any real market volatility. One of President Lulas great achievements is that

his government has created a strong sense that after being spoken of for

decades as a coming country Brazil has now well and truly arrived on the

world stage, irrespective of the complexion of the next government. Even

the idea that Lulas nominated successor, Cabinet chief Dilma Rousseff - astrongly left-leaning candidate with a known penchant for interventionist

policies might win the elections is not overly distressing the market.

Of course, Brazil cant make the running on its own. Like any country it

needs a favourable global economy, particularly since commodity-related

stocks make up anything from 47% to 60% of the countrys index, depending

on how one measures such things. There have been so many hard-to-read

factors swirling around, including the latest bout of jitters over sovereign debt

fears in Europe, that the risk appetite of market participants is having a hard

time getting up a consistent head of steam. As Andre Suaid observes: If the

market can continue to rally there is a tremendous amount of money in the

money markets right now that would move across into global equities.

All of this makes for a tremendous desire in the market to engage insecurities lending. Suaid points out that there has been tremendous growth in

the last two years in the local hedge fund community and in the multi market

funds and long/short funds in Brazil. Plus, of course, the high frequency

algorithmic trading funds are now global in their outlook and they all want to

get involved in securities lending in Brazil.

However, and it is a big however, Brazil is a regulated market and all

securities lending has to go through the CBLC [Brazilian Clearing and

Depository Corporation]. The CBLC has been managing securities lending

for the last 10 to fteen years and it has a very sophisticated approach. They

look at underlying market risk from a total portfolio level. If you are using the

CBLC for different strategies they will cross margin the risk, but there is no

doubt that it is an approach that works for local players but not for offshoreborrowers, explains Paul Busby, also a managing director at Deutsche Bank.

For would-be offshore players the fact that the CBLC stands squarely in

the middle of the trade makes it extremely difcult to relate the Brazilian

securities lending model back to the familiar world of securities lending that

benecial owners and borrowers are comfortable with in Europe and the US.

Basically, to be active in securities lending in Brazil you need to be a broker

and a member of the CBLC. For a US benecial owner, for example, there is

just no easy way to lend stock in Brazil.

What you will nd is that right now a lot of the natural hedges and

proprietary assets are coming from the domestic market and not the broker

dealers themselves, Busby says.

Anthony Harringtoninvestigates thecomplexities andpeculiarities of the

Brazilian industryand nds a 'watchthis space' market

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However, things are on the move. Busby points out that the CBLC has

acknowledged that it wants and needs more foreign participation in Brazils

equity markets. It also understands very clearly that a vibrant securities

lending environment would bring a substantial amount of very welcome

liquidity to the market. This is a culture and a climate that is looking

to adapt to change, and the CBLC is the hub that will shape the future

development of the market. It is far more ready to talk to market participantsand to listen to what is said to it than central depositories in almost all other

emerging markets, he says.

Suaid says that he was in a meeting recently with ofcials from the CBLC

where market participants told the CBLC about their concerns over high

exchange fees and high costs. As a result, at the time of writing, the exchange

(BVM &F) was holding a meeting to talk about lowering exchange fees for

high frequency trades. It is very clear that both the CBLC and the Brazilian

Exchange are willing to be more exible to attract foreign capital. They are

very responsive to the fact that we and others have a vast array of clients who

in some capacity or another are either actively trading Brazilian equities or

who are looking to get more exposure to Latin America in general and Brazil

in particular. And securities lending has a big role to play in this, he says.Chris Poikonen, executive managing director at eSecLending argues that

the role of the CBLC in securities lending in Brazil can be viewed either as

a tremendous risk mitigator, by offering a sophisticated centrally cleared

platform, or as a signicant hurdle to having offshore investors participate in

the market. The clear issue right now is the lack of offshore lending supply

in the Brazilian securities lending market. The activity that is currently taking

place is largely between local market participants, he says.

Brazil has the second largest exchange in the Americas, and that makes it a

very big market for overseas borrowers and benecial owners to nd difcult

to access. The CBLC is a wholly owned subsidiary of BOVESPA. It offers

cash, futures and options trading and has all the securities that are eligible for

securities lending transactions. Both BOVESPA and the CBLC are regulatedby the Brazilian Securities Exchange Commission (the CVM) and the

National Monetary Council (CMN).

They are responsible for setting the maximum limits for securities lending

open positions and they regulate the CBLC by ensuring that it is always

in a comfortable position with respect to any exposure it is taking on.

The regulators also dene the parameters for what constitutes acceptable

collateral for securities lending, typically FRB bonds, and Poikonen points

out that they have a fairly sophisticated algorithm which is used to determine

the creditworthiness of parties and limits maximum loan balances as a

percentage of the free oat in the system. Poikonen too, says that a robust

securities lending system that appeals to offshore participants will help

increase the overall liquidity in the market. BOVESPA has a deep marketand many offshore benecial owners have substantial allocations to the major

index constituents within their emerging markets portfolios. Having them

participate in lending will be key to further progression.

However, Poikonen argues that the central counterparty model should not

be viewed as a bad thing, in and of itself. If you look around the world there

are central counterparty (CCP) models in many markets, so the fact that

Brazil has a CCP model should be viewed positively, he says.

Of course, it is a different transaction, in securities lending terms, for a

benecial owner, since their exposure lies with an exchange, rather than with

a broker-dealer. This means that benecial owners have to get comfortable

with the exchange as counterparty, and they need to clearly understand how

The clear issueright now is thelack of offshore

lending supply in theBrazilian securitieslending market.The activity thatis currently takingplace is largelybetween localmarket participants"

Chris Poikonen,

eSecLending

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the exchange model works and what it offers in terms of security. Some

benecial owners are not yet that comfortable with taking exposure to an

exchange. However, we believe that the way to promote liquidity in this

market, at least in the short to medium term, is to educate the lenders in the

considerable merits offered by this model, he says. On the subject of CCPs,

when one looks around, there are considerable efforts going on to set up CCP

models in markets that are currently OTC and bi-lateral, the credit defaultswap (CDS) market being an obvious case in point. The whole derivatives

space is under tremendous pressure at present to shift across to a CCP

approach.

At the same time both in the US and in Europe there are initiatives

underway to set up CCP models for securities lending, at exactly the same

time as a number of parties are trying to persuade the Brazilian regulators and

the ofcials of the CBLC to initiate a more standard approach to securities

lending. It may well be the case that if the CCP approach to securities lending

got off the ground in Europe and the US, it would really help the growth of

securities lending in Brazil. The point, of course, is that there are very different

kinds of CCP models, with very different rules, and what is needed is a model

that will inspire the right degree of condence in benecial owners.The model in Brazil contrasts sharply with the model in Mexico, where

there is an active securities lending market run along US lines, and which

benecial owners can access via bilateral deals in the usual way. Latin America

is clearly an area of focus for many organisations right now, and Brazil is

undoubtedly the largest and the most interesting. However, it is very much

still a developing market and there is a real buzz in the air right now about

securities lending in Brazil.

One of the big concerns that offshore benecial owners have about the

Brazilian CCP model is their direct exposure and the fact that collateral is not

held in their own name within the CBLC, If either the CBLC or BOVESPA

went down, benecial owners need to understand what the unwind position

would be. This is a pretty obvious question for a benecial owner. They needclarity on the issue of how loan transactions would be unwound if the CBLC

was, for some reason, to become insolvent, Poikonen says.

However, common sense tells you that when you are talking about one

of the largest e

GSL 008

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