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Securities lending – transparency for the sake of it?

From the desk of Roy Zimmerhansl,

Practice Lead, Pierpoint Financial

This past week has seen two moves by European regulators in the broader securities finance ecosystem that I’m sure on the face of it will seem sensible, nay necessary by many observers. Yet I look at these as two fundamentally different initiatives that underscore the views, hopes and fears I have held since the aftermath of the Global Financial Crisis. Europe continues to value bureaucracy and control over anything else, while the UK continues to work behind the scenes continuing in a central role in global financial markets despite the wider turmoil caused by Brexit. My move from London to Hong Kong early in 2015 was in part due to the frustration that been building in me for several years that Europe (including the UK) would spend the rest of the decade inwardly focused while the rest of the world focused on improving economic conditions post-Global Financial Crisis.

Before I get into that, some of the news items this year contribute to momentum that I’m not convinced is taking us in the right direction. They say that bad luck comes in threes so with Greensill, Archegos and GameStop behind us, maybe it will be quiet for the rest of 2021. But I wouldn’t count on it, and maybe that’s because I don’t view GameStop as a problem, so there’s still room for a third problem yet to come.

The solution everyone seems to be arriving at is that more transparency would make everything better.

This past week, newly minted SEC Chair Gary Gensler spoke at the FINRA Annual meeting where according to CNBC, he identified his three priorities. One of the three is that the SEC will concentrate on “transparency-enhancing initiatives” around short selling, stock lending and securities-based swap rules. That will be fun.

Interesting because, as I suggested earlier, I keep saying that I don’t think that GameStop is a problem. Retail investors that don’t have access to any of the securities lending data providers were able to discover, using publicly available information, that GameStop was over-traded and vulnerable to a short squeeze. Melvin Capital and others got squeezed and lost money. Some of the retail platforms, such as Robinhood (but not only them) were unable to meet the collateral calls, had to cut their services to customers and have suffered economic and reputation backlash.

There was no systemic risk, and no one went out of business; no one needed to be bailed out. Melvin got other investors in, Robinhood raised additional capital, and politicians got a new topic to wheel out and beat to death. If Melvin hadn’t got the money in or Robinhood had failed to bolster its capital, maybe they would have faced existential threats, but in the case of Robinhood, at least, I don’t think so. If I am not mistaken, all investing is about winners and losers, companies that succeed and others that fail, and if there was no risk to the wider community, I don’t get all the interest. The Robinhood app was no more gamified the day before GameStop exploded in January than in the first Congressional hearing.

Even without the “transparency-enhancing initiatives” the Redditors were able to figure it out – so where’s the beef?

Please stick with me through this next section. Despite the relatively small size of cryptocurrencies, they seem to always be in my face. According to the total market cap of the 7,463 coins listed on 474 exchanges is $1.387 trillion. That’s the figure showing on Sunday 23 May when I am writing this, so by the time it gets posted, it could be double that figure or half of it. Two days can be a long time - consider that CoinGecko’s calculations show a drop of almost 37% since 12 May and a similar percentage run-up from 25 April.

Two developments in digital assets this past week follow on with my broad theme here. First, China has banned financial institutions and payment companies from providing services related to cryptocurrency transactions and warned investors of their volatility. On top of that, they have reined in mining due to the energy costs. Apparently, even renewable energy-rich provinces don’t want to accept bitcoin mining projects. Of course, none of this is new (although we have to credit Elon for the incredible new discovery that bitcoin mining consumes huge energy), but it is very convenient given that China is well on its way to replacing cash with an e-CNY (officially called Digital Currency Electronic Payment - DCEP). Maybe they should be more transparent – or maybe they are.

In the US, the Office of Comptroller of the Currency recently approved two applications for national digital trust banks. These banks are now permitted to engage in many activities for digital assets, including lending. If crypto is considered a currency, then it is money lending; if considered assets, then it’s akin to securities lending. Acting Comptroller Michael Hsu announced on Wednesday that he had asked OCC staff to review the approvals. On Monday last week, the Federal Deposit Insurance Corporation issued a Request For Information on current and potential use cases for digital assets, including risk, compliance and deposit protections.

Transparency? Central Bank Digital Currencies are the ultimate tracking tool for governments, even better than credit/debit cards which also leave a digital trail.


The example I always give about transparency without context is the occasion when the CEO of one of the largest US banks publicly recommended that President Obama should ban short selling in his company’s stock. His comments were based on his assertion the bank’s falling share price was caused by short sellers, it was now the most shorted stock in the US and that was causing it operating difficulties. Factually it was indeed the most shorted stock at the time if calculated as the value of the short positions was the largest of any US company. However, the context was that it was less than one day’s trading volume, so the impact of short-sellers was negligible, and it was being used as a swerve to avoid accountability. For comparison Market Beat shows current short days to cover as follows: J P Morgan at 1.2 days, Citibank 1.3, Bank of America 1.5 and Wells Fargo at 1.6 days.

Getting back to the beginning of this post … three things to add.

According to a story in the FT, the Australian regulators were warned about Greensill by Bronte Capital’s John Hempton three months before it collapsed. Although Hempton describes the regulator as professional and said they precise questions, one must wonder what APRA did with the allegations and information. Was there transparency with other regulators?

ESMA this week recommended that the short-selling regulatory disclosure limit be permanently reduced to 0.1% of outstanding share capital. Apparently, they have concluded that when they dropped the limit to 0.1% in the immediate aftermath of the market crash last year, the amount of information they received increased. Who would have thought? The reason that there was a lot of information between 0.1% and 0.2% is that many funds purposely stay below the reporting limit to avoid the reporting obligations and to avoid unwarranted scrutiny from European regulators. Paranoia perhaps? Ask the short sellers involved with Wirecard and Casino about regulatory scrutiny on them rather than the companies they were short and called out. Europe has created a friendly environment for fraudulent companies by placing onerous requirements on short sellers.

I don’t have an issue with regulators asking for any information they like at whatever threshold they like. My expectation is that it will be symmetrical and unbiased. Given that the long investor threshold is 15 times larger for long investors (shifting to 30 X if the 0.1% rule is made permanent), it clearly demonstrates the anti-short bias at ESMA. Indeed Steven Maijoor, ESMA Chair, proudly related to an EU committee not long ago about how low the short interest was in European companies. Rather than be proud of it, he should be worried as short-sellers aren’t as actively policing companies in Europe. Given that I accept it’s impossible for any regulator to discover every bad actor, short sellers play an important role, and while I am not suggesting they should get favourable treatment, they should at least be treated the same as they are when taking long positions.

In other words, in my opinion, the EU ‘transparency’ requirement provides protective air cover for fraudulent activity by the few (but not zero) companies and individuals that inevitably are out there today with significant investor money in them.

ESMA short-selling rules protect frauds, not investors

Finally, the UK’s Prudential Regulation Authority has started a probe into the collapse of Archegos and the impact on banks. According to this Bloomberg article, the PRA is taking the lead on positions held by UK entities in the Archegos affair. That makes sense as for many banks, where transactions for alternative managers involve higher degrees of leverage, the transactions tend to be booked in the UK entity. It makes sense to investigate the use of leverage, the work that banks carry out for their clients – hedge funds, family offices and others. This cannot be a UK only exercise, and the Bloomberg article suggests the PRA is working alongside other regulators. Given the dearth of regulations applying to family offices, it seems inevitable that Archegos will have repercussions for family offices everywhere, including … you guessed it … increased transparency. Given that there is a very low threshold, in this case, increasing transparency seems sensible.

The difference between the two issues from the start of this post? ESMA’s approach is masking its anti-free markets discrimination against short-sellers as shining the light of transparency in dark corners; whereas the PRA initiative will consider whether there are risks arising from the lack of transparency, use of swaps and the various banks’ risk management in the presumed absence of disclosure and transparency from Archegos.

One is paperwork and virtue-signalling whereas the other is a legitimate inquiry into an area that could have systemic consequences if left unaltered.

Chair Gensler is a considered individual, and my own conversations with people at the SEC have given me comfort that they will be thorough and measured in their approach. The test for any new requirements should be that they solve a problem and that the cost for implementation is commensurate with the benefit to the ecosystem.

Transparency can be a powerful tool when used selectively, but when it is applied just for the sake of it, it benefits no one (except maybe politicians).


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