Top players in the short game get a pass


It is asset managers, pension plans and sovereign wealth funds that provide the vast majority of securities used to take bearish positions. Without BlackRock Inc. and State Street Corp., the California Public Employees’ Retirement System and the Kuwait Investment Authority fulfilling such a basic role, investors such as Gabe Plotkin, whose Melvin Capital Management has become a piñata for day traders in GameStop Corp ., would not have any stocks to sell short.

“Every time we sell a stock, we locate a loan,” Plotkin said on Feb. 18 during the House Financial Services Committee hearing on GameStop’s short-term squeeze.

There are plenty of choices. By mid-2020, some $ 24 trillion in stocks and bonds were available for such borrowing, with $ 1.2 trillion in stocks – a third of all hedge fund assets – in fact on loan. , according to the International Securities Lending Association. .

This is a situation that, on the surface, defies logic. Given the popular belief that short sellers create unwarranted losses in certain stocks, why would shareholders want to provide the ammunition to attack their investments? The explanation is quite simple: by lending securities for a small fee plus interest, they can generate additional income that increases returns. This is essential in an industry where fund managers are paid to beat benchmarks and especially valuable in a world of low returns.

The trade-off is simple: For investors with large and diversified portfolios, a single stock that collapses under the weight of a short sale campaign has little impact in the long term. And in the shorter term, the higher the number of overall bets against a stock – the so-called short interest -, the higher the fees a lender can charge.

In GameStop’s case, short interest rates were unusually high and the stocks on loan generated an annualized return of 25% to 30%, testified Ken Griffin, whose Citadel operates a market maker as well as one of the most. major hedge funds in the world. Hearing of February 18.

“Securities lending is a way for long-time holders to generate additional alpha,” said Nancy Allen of DataLend, who compiles data on securities financing. “Originally it was a way to cover costs, but over the last 10 to 15 years it has become an investment function. “

Not everyone is comfortable with the inherent conflict. In December 2019, Japan’s $ 1.6 trillion government pension fund stopped lending its international shares to short sellers, calling the practice inconsistent with its responsibilities as a trustee. At the time, the decision was costing GPIF around $ 100 million per year in lost revenue.

The United States Securities and Exchange Commission has regulated short selling since the 1930s and monitors the market for abuses such as naked shorting, which involves taking a short position without borrowing shares. Advocates of legal shorting argue that its use increases liquidity, improves prices, and plays a vital role as a bulwark against fraud and hype.

CEOs, whose compensation often depends on stock performance, regularly decry short sellers as vultures. More recently, the short has been criticized in the emotionally charged jokes on Reddit’s WallStreetBets forum. Some speculators jacked up the prices of GameStock, AMC Entertainment Holdings Inc. and other stocks even in January to punish hedge funds that bet against them, and they rejoiced when the frantic buying led to deadly losses at Melvin, Maplelane Capital and Citron Research.

Many key players in the GameStop frenzy testified at the February 18 hearing. Plotkin was toasted by committee members on Melvin’s short position. Citadel’s Griffin and others have faced broader questions about short selling. Yet no one asked about the offering of the borrowed shares and no witnesses from the securities lending industry were called.

There is a symbiotic relationship between hedge funds and the blue chip brokerage units of Wall Street companies, much of it relying on securities lending. Prime brokers act as intermediaries, procuring stocks and bonds for borrowers who wish to sell them short and facilitate transactions. According to DataLend, securities lending generated $ 2.9 billion in broker-to-brokerage revenue in 2020, almost the same as in 2019.

Demand for short positions was already expected to decline as stock prices hit all-time highs. Now, with the threat of retaliation from the Reddit mob, he could weaken even further. Griffin said he has “no doubt” that there will be fewer short sales due to GameStop compression.

“I think the whole industry will have to adapt,” Plotkin said at the hearing. “I don’t think investors like me want to be sensitive to these kinds of dynamics.”

This could threaten not only the brokers who negotiate securities lending, but also the holders who provide the securities and share the income. They raised $ 7.7 billion worldwide in 2020, up from a record high of nearly $ 10 billion in 2018, according to DataLend.

While securities lending accounted for $ 652 million, or just 4%, of BlackRock’s revenue in the fourth quarter of 2020, costs are low and risks are low as borrowers must provide collateral equal to or greater than value. of the loan. At BlackRock and State Street Corp., the second-largest depository bank, the value of securities loaned as of December 31 jumped at least 20% from the previous year, to $ 352 billion and $ 441 billion , respectively.

“Every little bit counts with indexes,” said John Rekenthaler, vice president of research at Morningstar. “You scratch nickels from the street, but there are a lot of nickels.”

Others might take a hit as well. Just as Robinhood Markets is able to offer commission-free transactions by selling its order flow to Citadel and other market makers, asset managers typically pass on a portion of their securities lending income as a type of customer discount.

“It is very important to remember that institutional investors derive substantial benefits from their participation in the securities lending market,” Citadel Griffin said during the GameStop hearing. participate in the securities lending market. “

This story was posted from an agency feed with no text editing. Only the title has been changed.

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