Trading Workflows in Securities Lending - The Fundamentals explained

this is securities lending fundamentals and today we're going to be talking about trading workflows we'll be working through how you go from locating stock to doing that trade execution so if securities lending is something you're interested in then this is the place so let's get to it [Music] hello everyone as i said roy zimmer hansel here let me just get my slides up with my handy dandy slide pack which i always have ready if you are interested in downloading the slides for this session or any of the previous ones just go to the link that i'm actually showing on the screen right now register and in the next couple of days we'll send them all through to you the ones that we've done so far plus weekly updates so hope you enjoy that so what we're going to be talking about today as i said are the trading process workflows let me just go into the next slide okay so these are the previous weeks the sessions that we've done from everything why does securities learning exist to last week when we talked about the imp of lehman brothers on securities funding today as i said is trading process flows so logically you would expect next week to be on uh post-trade flows and that's what we'll be looking at and let's get to it so what are we going to be talking about today in uh this week which is part 15 we'll be looking at the pre-trade flow the locate process executing trades and the actual borrow at the end of it so those are the methodologies right this is as i said week 15 we've done 15 of them we get a lot of positive feedback the subscribers have been going the interaction has been picking up and i've had some great suggestions like today's session on episodes that you want to see that's what we're here for is to give you information you want to learn about securities learning that's what it's about today so if you if the videos are helpful this one or any of them please give us a thumbs up that'll help it get out to more people and help us educate the world on securities landing it's a global business so if you touch it in any way it's better to have more people involved than few okay if you also think that it adds value please subscribe and ring the bell so you can find out every time we put up a video now i am going to say hello first to always one of our first viewers jean-pierre great to see you again thanks very much for tuning in this week and every week and the man from down under david really appreciate you being here again but it's always an honor to have viewers here and linkedin is letting me down linkedin hardly ever lets me see who it is i don't understand how it works because i can see david having said hello and i've seen a great thumbs up from someone unfortunately i can't see who you are so thank you in any case right let me get to it so the pre-trade process really starts with someone wanting to put a short sale on they have an idea they have a strategy and the regulations in almost every country require you to make sure you can borrow securities before you put on a short sale and so i've given some examples there and these extract slides came from an earlier session i think on june 5th i'll put a link uh now how does that go either here or here i'll put a a little link into it after i do the editing it'll be one of those places it'll be news to both of us when you see this but both of those slides are are taken from that session one of them talks about reg show which is a us regulation which mandates that locates done before a short sale is put on and an equivalent similar but there are slight nuances to the european regulation but also hong kong and other markets have similar rules so why is that first of all when you're short selling you are selling something that you don't and whoever buys it from you needs to be confident that you'll be able to deliver it to them and if you don't have it and it turns out you can't borrow it well they'll never get their securities and that's a problem for the market so part of it is to make certain that there's a good likelihood that you'll be able to borrow those securities before putting on that short sale so that's one objective the other objective is that it's an indirect soft limit on how big a short sale you can put on in the market so what do i mean by that imagine a stock trades a million shares a day and stock market prices in fact every market prices is really driven by supply and demand and so if it normally trades about a million shares a day that means there's a million buyers a million sellers a million shares worth of buyers and sellers and if that's disrupted if that if there are more sellers than buyers the price is likely to go down just in the same way that if there's more buyers than sellers the price is likely to rise so if you had a short seller wanting to put in a short sale so increasing the supply of sellers and it was distorted it was 10 million shares versus a normal 1 million trading market of course that would have a negative impact on the market and the thing is they probably can't ever deliver that so it's a phantom trade and it could be argued that's market abuse so by requiring a short seller or a would-be short seller at this stage to locate shares they need to find someone for multiple people that will sell them enough shares or lend them enough shares so that they can execute the short sale in the market and what that means is practically speaking if you look at the total float available from a company that total shares in issuance and then you whittle that down to the number of investors that make their shares available for loan that's a much smaller figure that's often in the neighborhood of 20 so if you start with a hundred shares in float maybe only 20 of them are actually available for low and then if you look at the number of shares that are on loan let's say five of them are on loan so 25 of the supply and that's a little bit hot that's higher than average but it's not a crazy figure so now you're down to 15 shares out of that original free float of 100 and then there are limits so some investors have limits regulatory wise or self-imposed as to how much they can lend out and sometimes they also have limits on how much any one individual borrower can borrow and they exclude some borrowers so let's say that 15 shares actually gets down to 10. now all of a sudden you can only borrow 10 but it looks like at the beginning there's 100 shares that in theory can be borrowed actually no there's only 20. in fact no there's only 10 available so you can see that just almost by natural selection there's a limitation that makes it much more of a tradable and deliverable market size so those are the kind of two reasons why regulators put in these pre-trade requirements to locate shares before you put on the short sale as always i hope this stuff makes sense if it doesn't feel free to put a question into the into the slides so here i'm going to talk about the locate process and that i'll explain that funnel in a minute because that's a practical illustration of what this process is so imagine all of the lenders and the lender intermediaries like the agent lenders they send all of their available stock to the borrowers every day this is how much we have available and these are the number of shares that we have available in the market so now the prime broker which is usually the borrower they now have these files that say look all of this supply is there what they do is they aggregate all of that up many of them put filters on it based on their experience with the lenders based on their size of their client base based on the availability of the positions there's lots of different reasons why they might filter that information then what they do is they have this file at the end they go we're pretty confident that this number of shares is really available to trade and we don't really have to worry about it because those are liquid stock there's lots of supply there and they are good to actually trade what they do is they give that file to their clients so that their clients can have a starting position themselves that say look all of these shares are available to borrow and i don't need to ask that's what good to trade means these are good for hedge funds and other traders that might be short sellers to execute short sales without having to contact their prime brokers now the final point there says as the hedge funds or the whoever the n short seller is as they execute positions they decrease the amount available so let me give you in that diagram here a practical example of what that means so at the top we have the lenders all the different files coming into the prime broker showing there's a million shares of a given stock and of course these files typically have hundreds or thousands of different securities listed in them so the prime broker receives all of these files shows a million shares of abc stock are available they decide well of that we're pretty confident that 500 000 of it is very stable they have 10 clients and they send out in their file 50 000 shares to each of the clients and they say you can trade up to 50 000 shares of stock abc without having to get in contact with me now the record-keeping obligation is for the short seller so the hedge fund for instance here has to keep a record and they say look we got a file from our prime broker it showed 50 000 shares i've done a short sale of 25 000 shares and it has a reference number one two three four five and they have to keep that record often for as long as seven years in case regulators come in and say show me evidence that you were able to do one of these locates so they have that of course that means that they take that 50 000 share position down to 25 000 shares and they can trade up to 25 000 shares with the residual amount but they can't trade 25 000 and one because there's insufficient there okay now realistically i've shown it as the prime broker showing 10 10 clients all with 50 000 shares it's likely that in many cases that's that gets skewed relative to the size or importance of those hedge fund clients so they aren't necessarily going to show exactly the same file to everyone but in any case it has to all add up uh correctly so that they don't over commit what is available okay so hopefully that makes sense so you now have a number of short sales that have been done and you have some would-be trades so for example this green box green words here that actually shows those short sales that were executed in the market so the prime broker is going to have to go borrow that so it's gone from theoretical to a real short sale and the prime broker needs to borrow but in my example where there's 25 000 shares left and the short seller wants to short 25 000 and one shares or 26 or 30 or whatever it is is if it's more than the amount and the good to trade files so it exceeds the good to trade file or if there's stocks that are not on that good to trade file so these are called i would call these harder to borrow but not necessarily hard to borrow they just aren't on the freely executable good to trade position so for all of those different types of transactions the hedge fund contacts are prime broker here's some that are traded you need to borrow those here's some where i need feedback from you some of which are stocks that are on the good to trade file those will probably get covered pretty easily and then there's the other stocks and that's really what the prime brokers are trying to then go out and find so those are the three types of trades now when the prime broker is trying to determine where to go for those securities i've done a little bit of green amber red to show the priorities or the sequences so the first thing a prime broker is going to do is if a client wants to borrow shares and it's not on the good to trade file or has exceeded the availability the first thing a prime broker would do was see if they have any excess inventory from maybe one of their own proprietary trading positions or from a client position where the prime broker has either agreed that they can access those shares or the prime broker is financing the position sufficiently so that the prime broker is legally allowed to use that client's long position for its own purposes either as collateral or in this case to lend out because the prime broker is sourcing this internally economically it's the best source that's why i've got a green that's the first place they will go to try and find shares now if that doesn't uh arise then of course they'll go to their lending community and three types of lending arrangements they might have custody lenders or banks and dealers that are custody holders of the assets for their clients and they lend them out or non-custody where again they're just lending the securities but they aren't necessarily custodian and then the green box is the exclusive ranges now an exclusive is where an investor decides that rather than make those trade or those securities available to the entire community of borrowers they've struck a separate deal with one or more prime brokers that have allocated parts or the whole portfolio on an exclusive arrangement so only one counterparty can access those securities and there's pros and cons for doing that and i'll probably do that in another video because otherwise we'll get distracted but look the bottom line is the borrower is already paying for that whether they use the securities or don't use the securities they're paying for it so in that sense from a fee perspective it's free but of course there is still collateralization cost so it's not entirely free but that's going to be their priority because they're paying for it whether they use it or not so if there's an opportunity to use it of course they're going to use it and then there's no difference between custodians or non-custodians at a macro level there might be differences at the individual relationship level but that's not what we're showing now of course at the end of the day the prime broker is trying to service their clients and as much as they don't want to do this a red box here that's other banks and securities firms and in some cases those firms are competitors and so that's going to be bottom of their list but they're there to service their customers so they may in fact borrow securities from a competitor now they probably are going to go back to their client and say i've tried to get the securities you're looking for the only place i can find them is somewhere where i don't think the securities are necessarily stable right there's not necessarily going to be continuity of those but if you want to take a flyer if you want to take a punt if you are in urgent need of these securities or desks i can borrow those for you please give me some guidance because they have to recognize that there's a good probability that that one those securities won't necessarily be available for the full life of their trade okay so they may do that okay so that's how you prioritize things that either you don't have to pay for like the internal loans there's also no collateral costs there there might be some internal money so the prime broker might have to pay a fee to the internal desk that owns it but that's funny money out of one pocket into another pocket within the same firm but there's certainly no collateral cost there if there's nothing internal then they go to exclusives because they're already paying for it they just have to pay the additional collateral cost then they go to their lending relationships and if all else fails they go to sort of their peers and competitors okay hope that sequencing makes sense to you guys muhammad thanks very much for joining appreciate you being here thanks for saying hello okay now again this slide comes from the june 5th session on the trading side of things but just as a reminder there's a number of different ways that trades can happen the first way is direct messaging so i might just send you a message i'm looking to borrow this stock i could do that over my bloomberg terminal i could do an email believe it or not people actually use the telephone a new invention or not okay so any different way just a direct mess method there the majority of trades get done electronically so these figures uh for example are taken from the equiland website and this from their ngt platform but you can see here in this example for that month which might have been june but i don't remember two million trades were done electronically and it breaks it down that's equities fixed income and really global assets and with pretty huge values as well so 2.2 trillion so you can see probably the vast majority of trades by value get executed electronically because the harder to borrow ones tend to be not in the biggest capitalized stocks smaller transactions smaller cap companies and so they are by value probably a lower figure and then of course there is also direct bilateral trading and that bilateral trading can also be automated there are mechanisms that firms have individually or again for instance echoland has another platform where you're trading and directing trades at exactly the counter parties you want customized for what they need so three different ways that they actually get executed but how do you get to the stage of executing because this is still just communicating i'd like to borrow i'm just gonna walk you through this process first i'm gonna get another drink okay so here we go through the arranging a manual trade that little sound if you heard that was my telephone giving me a weather alert because yet again in summer we have a deluge of rain that's going to be coming and that was a weather warning so it's in the low 20s and about to rain yet don't get me distracted right now we've got let's go through this locate process so the end short seller the end borrower or the would be short seller has identified a security they want to uh borrow pride broker's given the the the security name it now has to go out it now finds a lender that has a supply so they confirm that the lender has that availability and that lender is willing to lend it to the borrower because as i said earlier not every beneficial owner not every end investor has approved every firm as a borrower not every prime broker is approved by every investor not every broker improves every investor to borrow from because remember a borrower has real exposure to the beneficial owner because they're giving more collateral than the securities they're borrowing so it's a two-way street each has to approve each other so just finding the securities isn't enough you need to make certain that the investor that's lending their securities can lend it to the borrower borrower goes great you've now got the share you've confirmed that i can borrow them now i need to go back to my client to see if they're just looking for this stock or they're ready to execute a trade and they can so they the prime broker will go back to the client and say are i found some shares are you interested in borrowing them these are the terms and conditions if there's anything unusual and the fees that are involved then borrower says yep yep definitely interested in borrowing those then the goes back to the brokers definitely want to have those the prime broker then goes back to the lender and say yeah we're ready to borrow let's go and they negotiate the final terms and conditions of that trade execute the trade and then you initiate the trade flow so that's the process so there's quite a lot of back and forth because just looking for stock doesn't commit a borrower to actually borrowing and a lender or its agent saying yes i have it available isn't committing them to lending it so imagine in between the lender telling the prime broker over here that yes i've got shares available and the prime broker then going back to their borrowing client and saying we can we found you some shares you're interested and them saying yes and then the prime broker going back to the lender the lender might say oh actually my client sold it and those shares are no longer available so bowser have a lot of flexibility here because even if the borrower says look i'm interested in borrowing it before they borrowed it they can always change their mind say no what and why might they do that it could be many different reasons maybe some news has come out that changed their mind maybe the price isn't trading where they want to execute the short sale at there could be all kinds of different reasons and as i said the lender might decide no they don't want to lend it anymore or they might sell it so lots of different reasons so you execute the trade and you get into the trade flow but if both sides want it you execute it and off you go to the races boom you've got a trade that's it hi nick i really appreciate you joining thanks very much for that i sent you an email earlier to so hopefully you got lots of reading material there thanks for joining us so that's a trade that's how you get a trade done just as i've been going through this as you can see there's a lot of levels of complexity to this we go through some of in the primer that's free to sign up we have people signing up for that every day that just gives you an overview of the business from beginning to end doesn't go into a huge amount of depth lasts about 50 minutes i think and just gives you a perspective on the business the other one is the paid for course the introduction to securities lending course that goes into a lot more detail i'm in the midst of updating that now so people that sign up today will get access to the updated course and that's online on demand so it's whenever it's convenient for you you can find out more about this stuff at our website peerpoint.info under course okay so have a look at that so look we're at half an hour so let me just do a summary of the trading workflows so on a pre-trade basis so before anyone's committed a good to trade file gets sent out to the would-be short sellers those would be short sellers know that they can trade to their heart's content they can short sell those positions up to the size that their prime broker has given them for anything more than that or anything not listed on there they have to go to their prime broker who will then go through the locate process as well to contact their con their relationships to actually source other supply that are beyond that the trade execution look as i said this is a complex back and forth process if it's being done manually not if it's being done electronically if it's electronically then that's a trade but the manual ones a lot of back and forth confirming are you interested in shorting it do you have it will you lend it to me will you still lend it to me are you really still interested in shorting it and then it all comes together and people go yeah i'm interested and they might actually borrow it without shorting because they might actually be trying to build up a position so let's say i want to do a thousand shares i may not be able to get 1000 in one piece so i might borrow 300 today and 200 tomorrow 400 the next day and then 100 the following day and then when i've accumulated the position i want then i'll go execute the short sale in the market even though i before then okay so there's lots of nuances to that and then once the negotiation has been completed and the trades are confirmed the trade flow process kicks in and that's what we're going to be talking about next week the actual settlement of the trade and the post trade flows so this has been the quickest session that i've done so far very focused on the trading flows i hope that was of interest to you that's what we're doing next that's it that's me over and out have a great saturday have a great weekend have a great week and i'll see you next week

2021-08-27 23:25

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