Stock Exchanges and the Growth of Securities Lending: A Report for the World Federation of Exchanges

Finadium Research Report

Stock Exchanges and the Growth of Securities Lending:
A Report for the World Federation of Exchanges

November 2007

Finadium, formerly Vodia Group, has released a new report with the World Federation of Exchanges on how securities lending is impacting the business of stock exchanges. The report details three key issues facing exchanges:

• Corporate Governance
• Market Surveillance
• Central Credit Counterparties

Stock exchanges have taken multiple approaches in their relationships, control and oversight towards securities lending. In some countries, exchanges and their central securities depositories operate a formal and regulated marketplace. In others the business of exchanges and lending is nearly entirely separate.

In corporate governance, there have been reports by researchers and the press that securities loans can be used, intentionally and unintentionally, as a means of distorting corporate votes, at times with serious consequences for the targeted company. We review the mechanics of how this might occur and discuss how exchanges can best respond.

In price discovery and market surveillance, we found that while a direct correlation between securities lending rates and underlying cash price movements is impossible to prove, there are occasions where rates can be leading indicators of change in underlying cash equity prices. Exchanges responsible for surveillance should be aware of this possible connection for investigations on insider trading.

Each regulatory regime must make its own decision about whether to centralize securities lending market activity. Benefits include strong controls over lending practices leading to increased market surveillance. Disadvantages include greater regulation and costs for all parties, as well as potentially reduced opportunities for investors to express their sentiments in the market.

This report is 23 pages with eight Exhibits and Figures.

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■ Executive Summary
■ Stock Exchanges and the Securities Lending Market
■ The Business of Securities Lending
– Pricing in the Lending Market
■ Securities Lending, Corporate Governance and Exchange Listings
– Dividend Stripping/Recapture
– Empty Voting and Decoupling
– Major Initiatives in Voting and Securities Lending
■ Securities Lending, Price Discovery and Market Surveillance
■ Exchange Participation in the Market
– To Central Credit Counterparty or Not to Central Credit
■ About the Author
■ About Finadium


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