Participants:

Alastair O’Dell, Global Investor/ISF, chair
Craig Starble, chief executive, eSecLending
John Griffin, senior risk manager and head of derivatives & trading counterparties, Himco
Tred McIntire, managing director, Goldman Sachs Agency Lending
Doug Brown, managing director, Americas sales and relationship management, State Street
Mike McAuley , managing director and global head of product and strategy, BNY Mellon


Chair: Are US beneficial owners actively looking for lending opportunities in other markets around the world?

McAuley: Brazil is a market that most lenders are developing. There is very little, if any, offshore lending taking place currently. As a result it presents opportunities for clients that can participate. One of the main issues in Brazil is the lack of collateral – neither the client nor the lender has a security interest in the collateral. There are alternative solutions such as indemnification, offshore collateral and other arrangements but the clients who can participate may be limited.

McIntire: People have been talking about tax harmonisation for years, but now it is beginning to take hold. France is an interesting example. Technically, there is no longer a withholding tax for many investors. However, the process for reclaiming tax has been murky for such investors. As a result, many taxable accounts have to make a judgment call as to whether to continue to lend and capture less than 100% with certainty versus the possibility of receiving the 100% to which they are theoretically entitled.

As these types of trades fade, it provides some impetus for lenders to look more closely at opportunities in newer markets. So there is more focus in Asia. Taiwan and Hong Kong have received a lot attention in the past few years. There is still a lot of work to be done in China before that becomes a big opportunity, then there are Malaysia, Indonesia and the Philippines. There is even interest in certain markets in Africa that are pretty far from the traditional model.

Starble: The involvement of the portfolio manager is critical for markets such as Brazil. It is no longer just about talking to the person in charge of securities lending. You really have to get the buy-in of the portfolio manager as they are going to have to play an integral role in approving the risk profile of the structure as it is a very different model from what they are used to.

Brown: We have always considered this as an investment product. It was miscategorised for many years, but getting more portfolio managers involved means we are bringing it to the person most focused on returns. We are seeing interest especially from mutual funds for these incremental return opportunities.

If you are not participating in lending and you are underperforming, maybe that is part of the reason. More broadly, like others we think there are largely untapped opportunities around the world for lenders, including a 400-basis-point or more opportunity in Brazil for those eligible to enter the market.

Chair: Are you concerned or optimistic about the level of hedge fund demand?

Starble: It depends on macro issues. Will QE tapering and interest rates create more volatility in the equity market? If so, you are going to see better demand. In general there needs to be a better macro environment for hedge funds to have the conviction to be bigger borrowers. That drives our business.

Griffin: Yes, with equity markets at record levels in the midst of a questionable recovery, hedge fund managers stand aside because they got killed on shorts throughout the year. But there is going to be a time when they are willing to put their chips back on the table. When there is a reason to question current levels — and there always is whether the market is too low or too high — people will start to act. Indeed, some already have.

Personally, I thought to myself a year and a half ago that a 1,600 S&P felt high, but I was obviously way too early. The present 1,800 level is higher. At some point, hedge funds are going to think they have identified the opportunity they have been looking for and rush back in.

Brown: Some companies will not perform well when rates go up. Investors have their eyes on those companies already, and in a different environment they would be executing trades. We are already seeing new players in the market, such as alternative registered funds. Many new registered funds have a long-short strategy as the managers are saying there is not a need for another S&P 500 fund — so let us think outside the box.

McIntire: M&A transactions have been a traditional driver of short demand, and many have said the environment is ripe for a pick-up in activity. Corporations have record levels of cash on their balance sheets, interest rates are low and corporations have lacked organic growth. An important missing element is stability. Cash M&A transactions really do not help short demand. However, some believe they are a cyclical precurser to a wave of stock transactions.

Brown: The market is pointing towards a better 2014. That is what it looks like today.