11 May 2011
SLT: What do you think about the short selling restrictions we
have seen over the past couple of years?
Neville:
I think it's just nonsense. I always use the example of selling
the Mona Lisa; it's a long price, you can't sell it short, it can
only go up in value. Likewise, house prices always trend upwards
because you can't sell them short. And because you can't sell them
short there is no genuine price discovery process. If you sell, you
do so because you need the cash - you don't sell because it's the
wrong price. For price discovery, selling short is crucial.
Nelson:
There seems to be a lack of understanding of the markets by
governments and regulators. Enormous media pressure encouraged them
to be seen to act, and restricting short-selling was an easy target
- it feels like it was a knee-jerk response to the market situation
at the time.
Neville:
Poland introduced short selling when everyone else was taking it
away and it had no negative effect on the market. Their stock
exchange saw that short-selling is a key part of creating liquidity
- it facilitates derivatives hedging, which in turn should enable
and encourage more futures and options business, new products and
more market makers.
SLT: What about the introduction of Central Counterparties
(CCPs)?
Nelson:
At the moment I'm fairly neutral about them. They will add
another set of costs to the equation. I understand the pros, in
terms of better balance sheet treatment, standardised clearing and
settlement, theoretically no counterparty risk and so on. But I
think they will reduce flexibility, especially with collateral, and
I wonder about the level of trades that will still be completed
outside of the CCPs.
Neville:
You put equity trades through the exchange, but if you want
decent volume in equity trades, you do that OTC, through a broker.
Name me a market and I'll show you a very large voice market - FX
is $2 billion on exchange and $200 billion on voice so there's
always an OTC market. But with most asset classes the reporting
goes through the exchange so there is a certain visibility.
With securities lending, there is no clear visibility of what
goes on - it generally means that if you can't see the information
then the price is skewed. And things like custodial services get
offered for free because the custodian has the inventory and makes
up the difference. So I think clearing fees will increase the cost,
but it will also mean that custodial fees and the like, will also
be charged. And I think that is right - the granularity of charging
gets spread out over the classes of services.
SLT: Can an exchange-traded system work well with
specials?
Neville:
There are loads of specials that go on all the time in other
markets - you get Notifications of Interest. There was one stock on
the FTSE, DMGT, that never traded. So if you wanted it, you'd have
to put a note up on Bloomberg asking if anyone had any of them. So
it was exchange traded, but it was a special. I don't see any
reason why this can't be the case in securities lending.
Nelson:
I think one of the challenges about trading specials are the
terms that are negotiated on them. Terms for trades in non-special
General Collateral (GC) securities are largely consistent across
the market, so they are well suited to the standardisation that
comes with trading on an exchange. But trading in specials requires
more negotiation and "special" terms - the limited trade-terms
available on an exchange could limit the negotiation process,
making it preferable to trade the special off-exchange.
SLT: Where do you think more growth will come from?
Neville:
The Koreas of this world, the Philippines, China and India is
where the growth will come from, and to an extent is already coming
from. I don't believe there will be phenomenal growth in the UK
because as you increase high frequency algo trading, you're just as
likely to get in and out of a stock quickly as you are to stay in
it. M&A activity is likely to increase and that will be great,
but it's South and East Asia where the opportunities lie.
China is a whole different ballgame. At some point that will
open and the beneficial owners will have some fun there, as there
is real investment potential; and if there's real investment, there
are real opportunities for shorts as well.
Nelson:
You also need to consider that securities lending growth will
depend on how easily the securities in those local markets can be
accessed - if the brokers can't physically borrow the securities,
they cannot on-lend (physically or synthetically) to the investors.
Volatile markets have traditionally been good for speculators and
therefore securities lending; but there are so many variables it is
difficult to predict.
SLT: Is there anything that could kick start the market, or is
it slow and steady growth?
Nelson:
There still seems to be a lot of caution and conservatism at the
moment, with the markets still seeming to lack any particular
direction. World events and media hysteria, rather than
fundamentals still seem to have too big an impact on stock markets.
Until the global economy settles down and recovery is more fully on
its way, I think markets will remain fairly steady. There are also
some significant events coming that will have an unknown impact -
I'm thinking of looming regulations such as Dodd-Frank and Basel
III, and the introduction of central clearing counterparties
(CCP's) to the OTC derivatives world. If nothing else, these
changes are all likely to affect the availability of assets used as
collateral by the securities lending world.
Neville:
Convertibles are on their way up, causing a bit of a stir. It
looks like the environment is improving for corporates to go out
and raise a bit of money and often they will do that through
convertibles. Trading is cyclical anyway, so at any one time there
are particular fund areas to be in and areas where investors are
less interested. As stock borrowing and lending is dependent on a
certain type of trade, you have to wait for that type of trade to
become flavour of the month.
