Short Selling, Securities Lending - The Prequel, The Sequel & Then Some More

Well after two and a half year of screwing around, we are back at the table on Short Selling. Only this time, the "leadership" seems to have been taken over by Securities Commission instead of Bursa ... hmmm... wonder why??!! ; ) I searched through my older posts on Restricted Short Selling and its funny how the tone of my postings have changed (or mellowed rather). I was so much more vicious and angrier then... ; ) ... Let's look at the history for a while:

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as posted on 11th October 2006 ...

Regulated Short Selling Will Fail Dismally (Again)

Bursa will not like to hear me on this. They'd probably think I have a deep vendetta against them. First, Bursa is too greedy to try and act as the Central Lending Agency. Brokers, custodians and investors all have to go through Bursa to things done. This creates an unnecessary layer which adds to cost. Secondly, Bursa failed to appreciate why an OTC market would have been better. Not all lenders want to lend shares at 2%, some may only lend at 5% or even 10%. Take Google shares for example, at US$500, probably a lot of people would want to short it, hence the lenders could actually ask for a higher rate before lending out. A transparent and free-market OTC makes for real activity and better returns for both sides. I am not sure if Bursa even have the mechanism to change the lending rates?? (..what, change the rates... every now and then ... so much work la...). Thirdly, too much red tape, inteference, scrutiny... blah blah... Having said that, as long as people can make big money, they can withstand the trouble to invest, if they can make 30% in a month in Timbuktu exchange, you can betcha they will try to get there. But it probably won't happen in Bursa's RSS - limited shares for shorting, do you think there will be 1 million of a company's shares for shorting? Chances are, it will be sporadic and insignificant, which will turn people off. That is why an OTC would have stood a better chance to survive. Imagine the current scenario, with Genting jumping on the Macau news, I think its a good time to short Genting shares, but no one wants to lend at 2%, so I put up a willingness to borrow 50,000 shares at 4% or even 6%, I am sure someone will bite. The failure to allow for a free flowing capital markets. The shallow thinking that by being the Central Lending Agency, somehow that could prevent disasters needs to be re-examined. You mean, the 1997 implosion was due to short sellers??? Please grow up, that shows how naive the current crop of people in unthinkably high positions are... sigh... You cannot molly-coddle a capital market, it has to be relatively laissez-faire ... look at global best practices... please...

p/s btw, I totally agree there should be short selling, just do it better ... man...

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as posted on July 17, 2008 ....

RSS (restricted short selling)... it was expected to fail, it failed ... NO SHARES AVAILABLE FOR SHORTING!!! What does that tell you about the program? A learned friend disagreed with my negative assessment on RSS two years ago saying they have international consultants and exchanges helping on the product. Just because they are foreign, does not mean they are good. The Bursa is ladened with bureaucracy, red tape, nothing ever gets decided, in the end any decision will take two months to make, and the bulk of people never really touch securities before...

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Now to the present, the SC obviously said something to the effect of "I don't think you guys really know what you are doing" to Bursa... Anyway, why make more enemies? My comments in red.

Aug 4 (Bernama) — The Securities Commission (SC) and Bursa Malaysia today announced the introduction of securities borrowing and lending negotiated transaction (SBLNT), an enhanced securities borrowing and lending (SBL) model that offers an option to borrow and lend on an over-the-counter (OTC) basis. In a joint statement here today, the SC and Bursa Malaysia said the SBLNT model would be implemented on August 17 and relevant participants would be able to submit applications now.

They said the model would complement the existing SBL Central Lending Agency (SBL CLA) model which was introduced in January 2007 as the first phase of the securities borrowing and lending framework. ( Gee, this is b.s., what do you mean by "complement", it complements nothing, the existing SBL is crapufullacrap, obviously somebody devised a "better way to not lose face" by using the word "complement", just say it like it is... it IS a new way to replace the previous crap).

“Under the SBLNT framework, any eligible person who is approved by Bursa Malaysia Securities Clearing Sdn Bhd may borrow and lend securities. The lender and borrower are now given the flexibility to enter into SBL agreements, hence they can negotiate and agree on the terms of borrowing and lending directly,” they said.

These SBL transactions, they said, must be reported via onshore borrowing and lending representatives and facilitated through Bursa Malaysia Securities Clearing as the approved clearing house.

“This reporting is imperative for the movement of the loaned securities to take effect from the lender’s depository account to the borrower’s depository account. In addition, only securities that are specified by the approved clearing house are eligible for borrowing and lending transactions and the purposes for which the borrowing and lending have also been specified,” they said.

The statement said the SBLNT framework would also enable Bursa Malaysia Securities Clearing to ensure orderly and transparent borrowing and lending. Besides that, the SC also released the revised SBL Guidelines while Bursa Malaysia issued the relevant rules, procedures and guidelines to provide for SBLNT. (All things being equal, transparency is good, but in such a small market such as the Bursa, with an even smaller number of "players", the transparency rule actually inhibits, scares and restricts the players. A better rule would be, as long as the investor is "approved and has an account with an approved broker", if client borrows or lends, it should be referred to by a number, and not the actual client. The unique structure of short selling/ lending give rise to excessive spotlight and focus on these transactions - no clients will want to be shamed publicly by its fraternity for having shorted at the wrong levels or lent securities which have since collapsed in price.)

In the SBL CLA model, Bursa Malaysia Securities Clearing acts as the central lending agency for all SBL activities conducted in Malaysia and participants need to comply with the terms and conditions as directed by Bursa Malaysia Securities Clearing.

Both the current SBL CLA and the new SBLNT models will operate concurrently. The revised SBL Guidelines by SC also provide clarification on the tax treatment applicable to SBLNT. The revised SBL Guidelines and rules are available on the SC website at www.sc.com.my as well as Bursa Malaysia website at www.bursamalaysia.com.

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My Worthless Views: It is a better model in that it allows for negotiated terms of borrowing or lending. However, it will fail just as dismally as the earlier model because:

a) The model still requires investors to borrow the securities first before selling. In many places, the investor has the option of selling the shares first, and then having 3 days (in the US) to borrow the shares. Naturally that is risky as one might not be able to borrow the shares, but herein lies the shortcoming, there isn't sufficient liquidity on the lending side here. Chicken and egg thingy, no liquidity, smaller share caps, low free float ratios, and you cannot sell first then borrow later which is an important option.

b) The vast majority of stocks borrowed by brokers (in most markets) come from loans made by the leading custody banks and fund management companies. Depending on specific account agreements, brokers are able to borrow stocks from their customers who own "long" positions, particularly those in "margin" accounts. I don't think our custody banks and fund management companies are "up to speed" with the nature and benefits of short-selling. I don't think many of the trust deed of local fund management companies even allow them to do that.

c) It isn't clear to the borrowers that the lenders may ask for the return of shares, and the borrower will have to return them to the lender or borrow the shares from elsewhere. Its cumbersome and most participants are not savvy or patient enough to go through all the trouble. A successful short selling model requires a critical mass of institutional players, which we do not have. We need hedge funds players, we need astute local funds that trade and hedge, we need a lot of local funds that are willing to lend securities, we need... (fill in the blanks).

d) The only savvy short selling / lending players are the local brokers. Right now MOST LOCAL BROKERS are "lending shares" to cover short positions, many without even telling their clients - its a loophole the SC and Bursa must plug. My strong recommendation is for all brokers be required to get "expressed permission of the customer" before they can "deploy or lend" the securities belonging to the clients, and that the clients must be properly compensated for it.


p/s photos: Rita Rudani

Sovereign Wealth Funds Are Generally Sheeps In Wolves' Clothing

Just how have the track record been for sovereign wealth funds. Temasek and GIC were path leaders for the most of last 10 years with their aggressive investing strategies. The Gulf nations SWFs only started to adopt Singapore's aggressive tactics over the last 5 years - joining in at the wrong end of the trend.

Let the record show that when these fund outperform, its largely due to momentum and bull market rallies, rather than astute stock picking. The bulk of the gains were made from telco investing in Asia, banking investing in Asia, followed by the disastrous banking investing in developed nations. For most of the last 10 years, there had been a sharp demand to bid up telco assets in emerging nations as growth prospects struggled in developed countries, thus the higher prices. Same can be said for banking stakes in emerging countries. Temasek, thanks to its connections, got in early acquiring substantial stakes in Chinese banks before they were floated. Take that factor out and you would have seen Temasek figures down the drain, literally.

The Gulf nations SWF, thanks to the surge in petrodollars over the last few years, looked to acquire significant Western assets in exchange for the petrodollars in order to make the money work for them in the future. Alas! What it did was to give back the supernormal gains to the very people who bought the oil at silly prices in the first place.

So, what went wrong? Are SWFs incapable of investing wisely? Firstly, their size makes their strategy limited. They certainly won't be considering investments that have a market cap of less than $250m, because if they do, they would be looking at a portfolio of well over hundreds of companies, how to monitor - attend board meetings also die.

Secondly, they want a substantive stake, not so much to have board seats or board control, but that to be able to influence management somewhat, to be consulted over major investing and capital decisions.

Thirdly, they tend to overpay - when you have identified a good sector or a good company, the sellers will also know its SWFs who are behind the deal, the general feeling is that they will be willing to pay a premium to get that substantial stake because they do not come around too often.

Fourthly, SWFs never seem to "walk through the data and financials" - I have mentioned this before, maybe its the fact that they are always suited up in nice executive dressing, they don't do enough "dirty work" before going ahead with a purchase or disposal. Figures and research reports are all there, and if you stop there, you risk a lot in your investments especially when we are talking about billions of dollars and a substantial stake. Its easy to talk to management, but you need to walk through the financials with a fine comb - go behind the aggregation of data, the assumptions, talk to the mid level managers and their competitors and suppliers, check with their clients, see how satisfied they are, if its a bank thats been showing tremendous growth in certain units, verify why and how that came about, go through the processes that made they stand apart from the competition. If things look too good to be true, all the more reason to look deeper.

That to me are all the main reasons why SWFs are sheeps in wolves' clothing. SWFs need to get away from pure trend investing. They need to think clearly whether to buy something for solid dividend yield protection or organic growth or growth via acquisitions. They need to think 5 years or 10 years out, which sectors would be a lot more lucrative then - I don't think telcos would be, banks would be iffy still, but commodities and food would be great. Its really simple in the end, it when you have too many suits in the room, thats what causes problems.

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Sovereign wealth funds (SWFs) were much in the news last year. As the first wave of the financial crisis hit, Gulf and Asian funds such as the Kuwait Investment Authority (KIA) and Singapore’s Temasek, ploughed billions of dollars into recapitalising prominent Wall Street institutions such as Merrill Lynch and Citigroup. At the time, with oil riding high at more than US$100 a barrel, it seemed very much as if the balance of economic power was shifting rapidly eastward. Despite the fact that their combined value accounted for only a fraction of the size of other investor classes such as pension funds or insurers, there was a brief moment when sovereign wealth was seen by some western politicians as a considerable threat to their economic independence.

The steady steamroller of the global crunch has seen those fears substantially recede. A collapse in demand from manufacturing powerhouses such as China led to a slump in the price of oil last autumn, a downwards journey aided by the exit of speculators. Furthermore, as soon as it became apparent that the instability which began in financial institutions had infected other sectors of the economy, the size of the necessary fiscal response dwarfed the capacity of anything other than a government-led rescue. With the exception of Daimler, which received a $2.7 billion (Dh9.91bn) capital injection by selling a 9.1 per cent stake to Abu Dhabi’s Aabar Investments in March, none of the recent major corporate bailouts has seen sovereign wealth riding the white horse.

As if to confirm the retreat of sovereign wealth from the basic international economic agenda, no mention of it was made in the concluding statement at the end of the Group of 20 (G20) summit of leading and emerging economies in London last month. According to German government sources, the omission was intentional.

SWFs may no longer be in the spotlight but they have not gone away; moreover, the chain of events established by last year’s backlash against sovereign wealth continues to play out. Following a degree of pressure from the US Congress and the EU, an International Working Group (IWG) of SWFs was established last October, under the auspices of the IMF. This group, which includes fund-holders such as the UAE as well as concerned inbound nations such as the US, published a series of investment guidelines called the “Generally Accepted Principles and Practices” (GAPP) – better known as the Santiago Principles after the city in which they were drawn up. The principles call for SWF investments to be based on “economic and financial grounds”, and if not, for the alternative rationale to be clearly stated.

The wording of the accompanying statement to the principles claims they are intended to ensure transparency and accountability. Yet the decision to call the document a “voluntary code of principles”, as opposed to a more binding code of conduct, is telling. According to Dr Sven Behrendt of the Carnegie Middle East Centre, a specialist in SWFs, the Santiago Principles “enable signatories to adhere to a standard, but without any monitoring or enforcement mechanisms”. The result is what Dr Behrendt calls an “unsecure document” – an agreement which is not yet sufficient to prevent unilateral action further down the line from concerned governments of nations receiving inbound investments, if and when SWFs become a political issue once more.

While the Santiago Principles may, thus far, fall short of providing countries such as the US with the guarantees they would like, according to Dr Behrendt the procedure involved to agree upon them marks an innovative concept in global governance. “The IWG reflects a bottom-up approach towards regulation, and is one of the rare occasions when industrial and industrialising nations have come together on an equal footing to agree on a set of principles”, he says. The contrast between the IWG and, for example, the Group of Seven (G7) or the Doha round of world trade talks is stark. Like SWFs themselves, the IWG represents an element of structural transition in the global economic system – one whereby the traditional power centres of the West are having to make room at the table for the growing financial clout of the East – a trend notably repeated at the G20 summit.

As if to confirm the permanence of this structural transition, the IWG is itself evolving into a permanent institution. Following the conclusion of its fourth meeting in Kuwait last month, the body announced it would form a permanent representative forum, with a secretariat to be staffed by the IMF. The forum will be chaired by David Murray, the head of Australia’s Future Fund Board of Guardians, while Bader al Sa’ad of the KIA and Jin Liqun of the China Investment Corporation will serve as deputy chairmen. Its first meeting is planned to be held in Baku this October.

If early 2008 marked the high-water point of sovereign wealth in the media eye, what will be its ultimate long-term significance as a structural element in the global financial system? For example, does it represent as fundamental a shift in the balance of power as the creation of OPEC in the 1970s?

Dr Behrendt presents three possible scenarios: first – and most pessimistic – oil prices remain so severe that funds are forced to liquidate their assets to inject liquidity domestically. This scenario would in effect mark the end of sovereign wealth as a market phenomenon. The second possibility is that SWFs remain essentially where they are, as smaller players compared with pension funds, but with the potential to create the occasional headline in sensitive markets. In this case, the permanent forum will be of most importance as a capacity building institution for the less-experienced SWFs.

The third possibility, however, is that economic recovery, and especially a recovery in the demand for commodities, results in SWFs becoming “super strong”. It is in this final scenario where the Santiago Principles, and the permanent forum, will play a significant role in reconciling the concerns of inbound nations with the demands of investors. As it currently stands, achieving such a role still requires a considerable amount of work.

Oliver Cornock is regional editor of the Oxford Business Group

p/s photo: Rita Rudani