Pressure is growing on industry and government to respond to 2021’s extreme stock market volatility. Following on the controversy around the GameStop retail buy-side suspensions, one of the remedies being discussed is shortening of the settlement cycle and, perhaps, even a shift to real-time settlement in the US equity markets.
Interest in ESG investing and the broader area of sustainable finance has exploded over the past few years. Both institutional and retail investors are clamoring for ESG investment options. According to one recent Morgan Stanley survey, 95% of millennials and 85% of all investors are now interested in sustainable investing strategies. Consequently, the highly competitive mutual fund industry has gone into overdrive, creating ESG mutual funds to attract these investors. Given the high demand and the growth of new mutual funds aimed at these ESG-conscious investors, it was only a matter of time before the regulators noticed. Over the past year, the SEC has been unfolding a larger plan to police and regulate sustainable and ESG finance.
The European Union has embarked on an aggressive legislative push to make environmental, social, and governance (ESG) considerations as a focus of financial services industry regulation. The first salvo in the EU push, the Regulation on Sustainability-Related Disclosures in the Financial Services Sector (SFDR), was finalized in December of 2019, with an implementation deadline for key provisions (Level 1) on March 10, 2021.
On February 4th, 2021, the Securities and Exchange Commission called for a “robust public discussion” about whether online brokers’ late January suspensions of retail trading should lead to changes in the market infrastructure. In the view of attorneys for the aggrieved retail traders, there will be a lot for the SEC to consider. More than 50 lawsuits have been filed as of today, creating another form of discussion. Our blog series on the potential infrastructure changes continues with a few of the likely discussion topics.
A large class-action lawsuit has cited, as evidence of an anti-trust conspiracy, the alleged wave of selling by hedge funds and institutions in the overnight markets of January 27th, 2021. Plaintiffs allege that the hedge funds, their brokers and the institutional investors conspired to prevent further increases in the prices for the contested issues, which would have deepened their already-substantial losses.
The trading suspensions set by online brokers in late January 2021 reminded many industry veterans of the systemic circuit breakers that were first deployed during the Black Monday crash of October 1987. In both instances, a loose band of derivatives traders was prevented by the capital rules of the equity clearing and settlement system from continuing to crush exposed short sellers and risk a systemwide collapse.
Securities lending has proven the most challenging aspect of shadow banking for regulators to bring under a regulatory rubric. One of the most vexing aspects for regulators has to be how to make securities lenders’ decision processes about whether to recall lent securities to vote proxies more transparent to investors and the regulators themselves.
Feb 1, 2021: The social controversy over Gamestop’s (GME) battle of wills — r/wallstreetbets v ‘The Shorts’ — may well harden the scrutiny of regulators and litigators toward the US$2.4 trillion global equity finance ecosystem that supports hedge fund strategies. This is a pivotal moment, not only for GME and The Shorts, but also for the clearing systems that their lenders and agents use to secure the funds’ trade settlements and financings.
Ignorance of clearing house rules, coupled with uneven disclosures had clearly inflamed social tensions over the GME short squeeze. These tensions were exacerbated when risk managers at clearing houses were portrayed in the media as fighting the popular uprising of legions of day traders.
On Friday, December 11, the Department of Labor (DOL) issued its final rules on proxy voting by ERISA fiduciaries. As proposed last August 30, the draft rules drew hundreds of responses by the ESG-directed investing community, many of which criticized the proposal as unworkable. The final version of the rules eliminates the proposal’s rigid requirements for plan sponsors to weigh the economic vs. non-economic effects before casting their proxy votes.
Sustainable investing is becoming more important to investors when creating portfolios. As a result, institutions often follow policies with formal environmental, social, and governance (ESG) factors to guide their investments. They commit substantial resources to ESG research and produce comprehensive reports about their compliance. But then the same institutions give away their proxy votes when they lend securities for fees to cover their bank charges. And the loans of those securities – and their proxies – go to borrowers with unknown intentions, and often with unknown identities.
One market veteran asked if there is any other space in capitalist finance where the lender knows neither the specifics of the borrower nor the purpose of the loan? Given this opacity, can ESG factors really be squared with securities lending strategies?
European commissioners are reviewing a study from their securities and market authority (ESMA) that includes a recommendation for new laws to combat unfair trading practices and an extended remit for National Competent Authorities (NCAs) to conduct snap audits of securities loans and transactors. Loans deemed to be suspicious would prompt an inquiry to determine penalties for unfair strategies and inappropriate beneficiaries.
The European Securities and Markets Authority (ESMA) has recommended that the market regulators in EU Member States combine trade data generated from the Securities Finance Transaction Regulation (SFTR) with local surveillance data so as to empower tax authorities to catch and indict tax abusers. To the abusers, that is like saying that the Sheriff and Posse are closing in on their SFTR trails.
(No kidding. What did they think? And if the abusers haven’t created defenses by this time, it’s already too late.)
In the coming corporate bankruptcy crisis, banks and companies perceived as bad actors in society will find their resolution terms to be very harsh. To avoid being diluted or even wiped out, large shareholders and corporate boards of directors must be constantly vigilant in exercising their oversight duties. Stakeholders must enforce policies which require company management to act in a socially responsible fashion.
Stock lending agents and prime brokers were challenged with a once-in-a-career opportunity after the December 3rd, 2019 announcement that Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, had decided to ban the lending of their offshore stocks — nearly half of their holdings. That bold decision by the fund’s CIO will reportedly cost as much as $300 million in lost annual income and “could prove hugely disruptive to equity markets if others follow its lead,” according to the Financial Times.
The early torrent of media hyperbole about distributed ledger technologies (DLT), such as blockchain and shared ledgers, has now been supplanted by reflection on lessons learned. Scaling concerns were allayed to some degree by DTCC’s November 2018 report that its study of throughput capacity for DLT was sufficient to handle massive U.S. equity trading volumes.
The most powerful Distributed Ledger Technologies (DLT) for securities finance will be cloud-based data lakes in which blockchains and shared ledgers form the currents and eddies. Smart contracts will power the mills that channel the data flows to provide services to their participants. In their potential, DLTs can reengineer current securities processes in the same way that central securities depositories (CSD) did in the 1970s … so long as the looming limitations can be overcome.
The nature of the securities business has changed dramatically in the last decade. A full understanding of those changes is necessary in order to appreciate the challenges facing the industry in the Eighties. Impressive strides have been made since the days of the back-office disaster scenes in the late Sixties and early Seventies that forced over 100 brokerage firms to go “belly up.”
February 6, 2019 —Systems entrepreneurs – Armeet Sandhu, Sal Giglio, and Ed Blount – engaged in a lively brainstorming session with Chris Ferris, IBM’s Distinguished Engineer for Open Source Technologies, at IMN’s 25th Annual International Securities Finance and Collateral Management Conference.
Announced on November 6, 2018, the addition of Barclays brings to 15 the number of dealers in the main blockchain project of The Depository Trust & Clearing Corporation (DTCC). By recoding the DTCC’s Trade Information Warehouse (TIW) for bilateral credit derivatives in only 18 months, the securities depository and its team of IT consultants – IBM, Axoni and R3 – hope to show that distributed ledger technology and cloud platforms are feasible options for high volume transaction processing and recordkeeping systems — initially for those services with similar data architectures on a permissioned platform.
On October 16, 2018, the Depository Trust & Clearing Corporation (DTCC) reported that “distributed ledger technology (DLT) is capable of supporting average daily trading volumes in the US equity market of more than 100 million trades per day.” Based on a cooperative study by Accenture, Digital Asset and R3, the clearing and settlement service provider said that DLT can process daily trading volume at peak rates of 6,300 trades per second for five continuous hours. Past benchmarks were based on cryptocurrency blockchains that now operate at fewer than 100 trades per second.
The Bank of England’s Securities Lending Committee took up the question of distributed ledger technologies (DLT) in its September 24 meeting. Three vendors were invited to present their concepts to the group of nearly two dozen UK bankers and their regulators. The presentations and the Committee members’ reactions were summarized in the minutes of the meeting. Each vendor approached the market from a different perspective, using a different aspect of DLT. Members found some value in the proposed solutions, yet were generally disappointed in the market impact of the innovative approaches.