Out of the Dark Ages
Clearing Quarterly and Directory, March 19, 2008
Pitt and others complain that the structure of the securities lending business retards growth. That's because would-be clients like hedge funds can't find objective or sufficient information to make informed choices. Therefore, whether looking for hard-to-get stock or lending out their own securities, they are fearful they will be overcharged or will not get the best rates.
Lendex officials will make the case that returns from special, or hard-to-borrow, securities offered through single-stock auctions will be improved because of their exchange (see sidebar with Lendex official). They also argue that utilization ratios will increase as many securities lending operations tap more stock because information is easier to obtain.
But while everyone agrees that securities lending is often illiquid, the issue of whether an exchange or some new electronic platform will work is this: Will custodians, agents, pension funds and others such as prime brokers, some of whom have a stake in things continuing as they are now, use a new system, be it Lendex or another?
Lendex will charge borrowers a transaction fee to use the platform. Those who upload their inventory themselves, who don't use the Lendex staff, will pay a smaller fee. Will it work?
"Their proposal," says the head of a large securities lending firm of the Lendex plan, "is based on the idea that beneficial owners can generate more money from lending their special, hard-to-get, stocks through Lendex than they would get out of their existing lending agent programs." But, he adds, since the exchange doesn't exist, how can one know if it can work? Some say the Lendex plan will fail because there won't be enough inventory. Some critics charge that Lendex is playing tough guy, implicitly threatening players to use the model or else.
A Closed Community
A broker-dealer, who says he is neither for nor against the Lendex plan, warns that "securities lending is a fairly closed community." To have success, "one must have the support of major holders of liquidity," says the official, who declined to be quoted by name.
The dealer doubts that major custodians such as State Street and Northern Trust, both of which declined comment for this story, will use Lendex. He also maintains that Lendex has been taking "a confrontational approach," trying to force asset holders to use its model. And he also questions whether the Lendex exchange will have a relationship with a CCP. At presstime, Lendex officials said they were about to establish such a relationship.
"We're going to sign the papers with a custodian very soon," said Tabacco as CQ&D was going to press (see news section).
Others simply question whether Lendex will work. "By adding Harvey Pitt," says another securities lending dealer who didn't want to be quoted by name, "what exactly are they adding?"
Pitt has legal arguments for critics of the Lendex plan. If custodians, agents and others don't explore the Lendex options, they will be possibly failing in their fiduciary/best- execution obligations to clients, he argues. But Lendex critics say that best execution rules are difficult to apply to securities lending.
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