From the desk of John Arnesen
Consulting lead, Pierpoint Financial Consulting
The Oxford dictionary according to Google defines anxiety as “A feeling of worry, nervousness, or unease about something with an uncertain outcome”. The current predicament over this global pandemic I imagine fits this definition very well with how most people are feeling. Despite the endless speculation as to when our liberty to move around freely and our return to work may be achieved, it’s the sense of ‘ uncertain outcome’ that holds our anxiety to one degree or another coupled with the long- term effect on the economy. This expression of uncertainty was clear to watch via the price movements of exchanges all over the world as they reacted to ever more bleak news. During this volatility, news that some securities lending programmes being suspended began to appear. This isn’t the first time such action has been taken so my thoughts have turned to why some institutions tend to default to this position in times of uncertainty while the majority make no or few changes to their lending programmes. What causes some beneficial owners to suspend or completely withdraw from the lending market? Is it a function of sharp anticipation of huge outflows of funds, insecurities about market participants’ ability to function normally or is something more fundamental driving decisions?
Some stock markets panic when volatility begins to create what they consider to be a disorderly market. As we have recently seen, Spain, France, Austria, and Italy are among the markets that have instituted a short-selling ban. This happened during the Global Credit Crisis and on other occasions since (2011) and while difficult to be certain as to the real reasons for it but on paper, its appears to be driven out of a genuine belief that allowing the continuation of a practice that at all other times is endorsed and supported, will somehow exacerbate the speed of declines in the value of indices and by banning short selling, this will stem the decline. These decisions are taken despite the availability of myriad evidence to the contrary from both academic research and widely respected market commentators. Last week Jamie Powell, writing in the FTAlphaville wrote,
“ As last week was a relatively tepid one for US equity markets, this suggests that, as many people – including this blog – have pointed out, short selling is a net positive for markets as it provides a floor on for equity prices. Indeed, perhaps counter-intuitively, they tend to be net buyers when share prices fall.”
Last week the ISLA Council for Sustainable Finance (ICSF) published its first position paper in which it not only cites the fact that markets that introduced short-selling bans failed to “maintain an upward trajectory for stock prices in affected markets” but reminded readers that the Fed has made comments that by introducing short-selling bans during the stresses of 2011, it created a lack of liquidity and a poorer performance than those stocks not subject to a ban. At the back of the ICSF paper are a page and a half of references that includes numerous papers on why banning short selling is bad for markets. And yet, in light of this and no doubt fully aware of this research, several exchanges decided to temporarily ban short-selling, counter to the view of the World Federation of Exchanges. Why? I was hoping for some insight from the CEO of the Vienna stock exchange, Austria is one of the countries that introduced a ban but in something of a bizarre comment he defended its position by referencing a 35.6% increase in equities turnover in Q1 2020. If the desired measurement is turnover, would that figure not be higher with the continuation of short-selling activity and subsequent short-covering? It must, therefore, be something else that drives the decision. Is it fear? Fear of pushing prices lower as mentioned before, fear of public perception that still holds that short-sellers are the cause of the erosion of stock prices? I doubt a single solid reason will emerge as I don’t believe one exists. Analytics of those markets that introduced bans will follow at some point and I will wager that the findings will point to what they always do: Banning short-selling does not produce a positive outcome for markets.
While some exchanges were doing this, several beneficial owners were either restricting their programmes, suspending new activity or recalling and withdrawing completely. It is completely reasonable during times of extreme volatility to be extra vigilant in reviewing that those elements of securities lending that represent the most risk are performing as they should. Are loans being marked-to-market and are those marks in either cash or securities received on time? Are pricing sources liquid and stable for the service provider to carry out this process with confidence? A beneficial owner may be selling a higher number of stocks than typical so is the provider able to substitute or recall loans and settle them on time? These are critical functions that should, regardless of increased market volatility or volume, perform exactly as they do at all other times of the year. These processes are designed to withstand increased volume and frequency and should not be a cause of anxiety for beneficial owners. Almost all financial institutions have triggered their Business Continuity Plans (BCP) and very few plans likely envisaged that their back-up sites domestically and at other branches internationally would be unavailable to access. Despite these truly extraordinary circumstances, beneficial owners can and should expect these important risk-mitigating functions are executed with a high level of efficiency.
During the Global Credit Crisis, it was counterparty risk that caused the greatest uncertainty and the risk of contagion after Lehman defaulted was a valid concern as no one had a handle on who was exposed to whom. The current situation is less about the financial strength of market participants (for now) and more about anxiety over the unknown outcomes for the global economy. Securities lending can and does thrive in all circumstances and is even adding increasing and significant revenue at the moment for those holding the right Government debt for example. Anxiety is uncomfortable but it can be managed and it would be a shame for it to unnecessarily drive decisions to cease a lending programme. If you have concerns about aspects of your lending programme why not speak to us at Pierpoint, we are more than willing and able to help.