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March 19, 2008

Out of the Dark Ages

By Gregory Bresiger

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.

The securities lending dealer disputes Pitt's claim. He says, say you are an agent or a custodian lender and you want to lend out a small state's entire portfolio. If a dealer goes to an exchange to loan out some of the hard-to-get securities, it may be true that one is getting the best price on the securities.

"But if they're getting the best price on one-tenth of the securities that they could lend through another model, another model in which they might earn more revenue, then just getting best execution on a small part of the model doesn't really equate to best execution," he says.

Still, Pitt disagrees. He predicts that the regulators will impose new securities lending rules this year. This is based on the belief that "there is a need for higher legal standards in securities lending," Pitt says.

Modernization Needed

A hedge fund manager, who declined to be quoted by name, agrees that an exchange or more electronic trading-like platforms are needed, especially for those using new 130/30 strategies, strategies in which precise shorting is critical in generating alpha. Electronic securities lending will eventually happen, the manager says. But he also concedes that big prime brokers, such as Goldman Sachs, and big custodians, such as State Street, understand that someday there will eventually widespread electronic securities lending.

"But they'll wait until the last possible moment" the manager contends. Both Goldman Sachs, along with the other two biggest prime brokers, Morgan Stanley and Bear Stearns, declined to comment for this story.

An official with securities lender Quadriserv says it's human nature that most firms want to go slow. However, he adds, the "vested interests" of securities lending aren't against progress.

"It's just that they want a voice in the direction and pace of progress," says Gregory DePetris, one of the co-founders of Quadriserv. Operationally and technologically, he says, many firms are behind the times in securities lending. DePetris says he is interested in investigating every new securities lending model. But he believes "no one solution is going to be the right solution for everyone in this market."

Clients will have different needs, he says. For example, he says, for a pension fund with "only hard-to-borrow stock, the idea of centralized price discovery sounds like a really good deal." Others, he explains, will only be interested in widely available stock. They could use a very different model, he adds. So DePetris also says that the notion of best execution' in securities lending means different things to different people.

Looking at Lendex

DePetris adds that he will be watching Lendex and other developing securities lending operations very closely. That's a sentiment echoed by an analyst who has championed the idea of electronic securities lending.