Securities Lending: The First Forty

From the desk of Roy Zimmerhansl

Practice Lead, Pierpoint Financial Consulting


This month marked my fortieth anniversary in the financial markets. I had quite an auspicious entry into financial services. I was selling insurance policies door to door and decided that my future might be better served elsewhere. One Wednesday I answered an ad in a Toronto newspaper asking two questions: ‘Do you want a job in the financial industry?’ and ‘Are you willing to start at the bottom?’ That was a resounding "yes" to both, so I applied, was interviewed, hired, and started as a messenger the following Monday – 7 April 1980.

I've been through the transformation from physically certificated settlements through to the application of Artificial Intelligence to securities lending, survived multiple market crashes, and been part of numerous bull markets. So, for what it's worth, today I am going to share some thoughts from my career.


My Greatest Surprise

For some reason lost to the mists of time, from at least the age of ten I had found the stock market interesting and dreamed of being part of it. I created a game using dice and stock names I picked at random from a newspaper listing. When I entered "the market" some years later, I saw for the first time the people and infrastructure required to support that marketplace which was incredible. All of a sudden I knew that many of the people I saw traversing the streets of Toronto included messengers delivering securities and picking up certified checks for deposit into banks later in the day and I had become one of these people. Relevance for today: despite the shift away from certificated securities and an incredible investment in technology, there are still armies of people required to drive the investment markets machine.


Dramatic growth in world stock market capitalisation over past 40 years

Least Surprising Conclusion

The chart above shows the growth in the global stock market capitalisation going back to the year I entered the market. The chart only goes to the end of 2012, so consider this - the Institute for International Finance wrote in its weekly report on 2 April 2020 that stock market capitalisation had fallen to under $70 trillion. In other words, despite the huge fall in stock market capitalisation, it was still more than 20X the global market size in 1980.


Imagine the number of changes required to adapt to that growth. In 1984, I was in the custody department of Canada's largest bank custodian and trialed the first PC purchase for cost-effectiveness. I had an estimated 11 weeks for payback, in reality, it was six weeks.


Not long after, we bought a jigsaw machine to more efficiently "clip the coupons" on bonds in the vault and that was a huge time saver. Not long before I left my last bank employer in 2018, we had robotics providing the traders with information as to which stocks required re-rates up or down. There will be a time when people laugh at that as much as readers may have laughed at the jigsaw coupon application.


Investment in and application of technology and automation is a pre-requisite, not an option.


Biggest Disappointment

I left a relationship management role at the depository in Canada to join my largest client as they were transitioning their post-trade process to take advantage of the trade matching and reconciliation services offered by the depository. The biggest challenge then was the slow take-up of banks and brokers in the market reluctantly conforming to our requirements rather than embracing the benefits of investment. More often than not, the market takes the path of least resistance to change rather than using change to drive forward progress. It is generally forced evolution rather than revolution. Revolutions can cause the most pain but are transformative and can position a firm for success in the future. My colleague John Arnesen's recent posts are worth (re-) reading as they deal with change and decision-making at times of stress.


Change is constant so apply it constructively not reluctantly. Is SFTR only a reporting burden or does it represent an opportunity? If change doesn't come from within the industry, will it be forced by a new entrant?


Greatest Concern

In my view, the scars of the Global Financial Crisis continue to run deep and have an ongoing impact on the securities finance business today. In their efforts to make banks safer, regulators have created an environment where risk-taking is to be avoided. To be fair, I think that recent months have made the regulators' case and banks have shown themselves to be more resilient than in the past. However, risk-avoidance has extended beyond clamping down on the provision of excessive leverage, practical elimination of proprietary trading, and over-extended acquisition sprees.


While I often read firms extolling their focus on innovation, what I observe is more often 'latervation'.

First movers are increasingly rare these days, with most waiting on others to lead, hoping for imitators to follow and after that, they will join in – or latervate. When I started working, there was a catchphrase – 'no one ever got fired for buying IBM' – intended to mean that people don't get fired for making safe decisions, even if it may not be the optimal one.


Decisions have always been taken with imperfect knowledge, and of course, none of us can see the future.


My feeling is that there is general insecurity with respect to taking difficult decisions. Being judged as having taken a decision that didn't work is penalised whereas making no decisions is often tolerated or subtly encouraged. Change is hard and usually forced from the top as cost-cutting or by regulators and therefore mandatory. One phrase as true today as it was when I first heard it: 'tell me how someone gets paid and I'll tell you how they will act'.


Our former partner Raymond Blokland wrote optimistically in December 2019 that he was expecting 2020 to mark the return of the securities lending entrepreneur. I hope he is right, but I suspect the revenue challenges for many firms over the remainder of 2020 may dampen enthusiasm people had as recently as a couple of months ago.


Most Encouraging Observation

Even someone filled with as many stories from the past has never seen the combination of a huge market sell-off combined with a pandemic. The graph below shows the MSCI World Index with recent epidemics marked.


Of course, the chart is dated January 21, 2020, so it doesn't include events since March.

World stock market performance overlaid with epidemic outbreaks

Nevertheless, what we see are functioning markets, banks able to withstand the turmoil and only a handful of mostly small markets implementing short-selling bans. I also don't hear any calls for further regulation which contrasts with past sell-offs of this scale.


That says to me that with the right sense of progressive investment and approach, the securities finance business can continue to grow and is an embedded part of capital markets activity.


Closing Comments

Over the past forty years, I have been fortunate to have worked for several different firms on three continents. I have been lucky to have worked alongside a huge array of knowledgeable people who have taught me a lot and I continue to learn today. However, no one builds experience when everything runs smoothly.


I'd like to close with a couple of references to Samuel Smiles, a Scottish author, and reformer who believed that more progress would come from new attitudes than from new laws [or regulations] and is credited as having said:


"We learn wisdom from failure much more than from success. We often discover what will do, by finding out what will not do; and probably he who never made a mistake never made a discovery."


Experience is the accumulated knowledge of previous errors and is only gained during difficult times like those we are living through today. Resilience is the key to being able to apply that experience and my final comment is that "the first forty years are always the toughest".


Final Note: Although this blog post mentions the pandemic, I have only looked at the business side. I recognise that there has been a huge and tragic personal cost for so many resulting from the COVID-19 pandemic and our thoughts are with all those directly and indirectly impacted.

#securitieslending #proprietarytrading #coronavirus #shortselling #innovation

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