From the desk of Roy Zimmerhansl
Practice Lead, Pierpoint Financial
Making predictions is a mug’s game, with no upside and plenty of downside. If I’m right, I’m lucky; if I’m wrong, people will remind me. Nevertheless, that hasn’t stopped me, I’m ok with either outcome, so I’m going to give it another shot here, this time viewing the second half of the year.
First, a review of some of my previous prognostications:
In 2016 I was on a panel at the annual ISLA conference, and we were asked to predict the impact of Blockchain on securities finance. I professed not to know, save for my expectation, that whatever we were focusing on at the time, the likely “killer app” would almost certainly not be where we were looking. Today, Common Domain Model and smart contracts are the focus whereas back then trading was arguably the odds-on favourite.
My LinkedIn article at the end of 2019 where I predicted a glorious new decade ahead for securities lending based on three signals:
An article by Wolf Richter who penned a story saying while he had vowed never to short again, he had just taken on some new positions. To me, that seemed sensible given the relentless bull market lasting over a decade. I hadn’t anticipated the pandemic, the crash a couple of months later, and it seems that Mr Richter looked at a set of conditions, likely profited from the outcome, but probably not for the reasons he expected.
The drive by the Nigerian Stock Exchange to push securities lending as a necessary tool to improve market liquidity, encourage the growth of domestic ETFs and facilitate listed derivatives. The Philippines is the latest market hoping to add short selling and securities lending, and the CEO recently said he still hopes for that to go live this calendar year.
The announcement by Japan’s GPIF that it was suspending securities lending for its non-Japanese equity portfolio. Significant milestones like this promote discussion and debate, and no doubt still gets mentioned in most ESG/lending discussions.
On September 10, 2020, I identified “3 Trends for the Future of Securities Lending” in a YouTube video, with one of those being the rise of retail investors via Robinhood and similar firms. That proved to be the case a few months later, but certainly not in the manner I had expected.
In January this year, I started with a confident blog post declaring, “Securities Lending Outlook for 2021 – Guaranteed to be Accurate!” My focus was really about individuals taking responsibility for their own actions and career development as the prediction was that the year would hold “Opportunity mixed with difficulty”. I’ll try to be a bit more visionary in the coming months.
Where do we go from here?
So halfway through the year, we see consistent reporting from the handful of service providers that produce public data that 2021 revenues are ahead of 2020. Hardly surprising given the comparator year was besieged with short selling bans and human displacement, some of which spilt over into 2021 but are having a less disruptive impact given refined coping strategies at the corporate and personal levels.
On the face of it, we have a buoyant but reluctantly bullish stock market. Some media panic if we haven’t reached new all-time highs for 72 hours. If you look at the continuous rise in the S&P 500 futures in the first chart, it looks pretty good. Yet, peel the impact of the FAANG and look at the same chart with equal-weightings rather than capital weighted, and you can see how a handful of these super-market cap stocks are supporting the overall market. The SPAC-a-mania seems to be levelling off, and the zero-interest-rate convertible bond issuance has cooled off. Less irrational exuberance reduces the likelihood of a crash but makes it more likely that main index hedging will increase. Bigger balances, but due to the GC nature of that business, the return per dollar at risk will drop. Practically, some agents will further de-emphasise GC.
[Source for both charts is Big Picture Trading from a free weekly research roundup I get as a subscriber to the MacroVoices podcast which is sponsored by Big Picture Trading. Macrovoices remains my favourite investing-related podcast. Aside from Pierpoint Perspectives, of course]
Hedge funds have performed well this year (+10% in H1, the best performance in more than 20 years) have experienced capital inflows and has a positive outlook, reflected in the latest Hedge Fund Confidence Index, which is at its highest level for many years. New money follows past performance, so it is reasonable to expect more capital moving to alternatives. More money will be searching for more opportunities, and while not all strategies involve shorting, it is likely that borrowing demand will rise.
Many economies have experienced a boost from pent up demand and, while surging at the moment, may/will cool off. Although interest rates remain near zero, QE liquidity remains in place, and government support packages for businesses and individuals remain, time is running out on all these items, cumulatively resulting in rising future uncertainty. That will create hedging requirements and shorting opportunities.
Demand for government bond borrowing looks set for continuous growth, with Phase 5 of Uncleared Margin Rules coming into effect, adding to the need for collateral transformation trades.
It all looks very positive for an upward rise in both balances and revenues. But I sense that it will be an upward grind rather than smooth sailing. If my projections are correct, income will come from lower margin loans – more trades, more maintenance, more capital reserves for indemnifications. There will be some relief for those firms continuing to invest in automation, including robotics and AI, but net returns will face a challenge. (Check out our playlist of video interviews with technology providers - another new one will be coming this week).
The implicit question – do you know what it costs for you to do your business? That’s a subject for another blog, but it will become ever more important as we move forward.