Reported by Financial News
September 20, 2012
The ratio of securities available to lend versus those actually out on loan has reached an all-time high of nearly nine times, suggesting that regulatory uncertainty and market volatility are continuing to spook hedge funds.
The biggest long/short
The ratio, known as the “long-short” ratio and shown in this chart from data provider Markit, is often viewed as being a measure of investor sentiment, and the all-time high indicates that factors including short selling regulations and volatility may still be unnerving parts of the market.
The value of stocks on loan has fallen to $1.5 trillion as of this week, far below the figures seen prior to the credit crunch. In late 2007, this hovered around the $3 trillion mark. The fall in the number of securities out on loan comes as the amount of securities available to lend reaches close to levels seen prior to the financial crisis.
The fall in the value of stocks on loan can be attributed to a number of reasons. Following the financial crisis, a number of hedge funds pulled out of the market: thereby strangling the demand for securities for short selling.
Regulatory uncertainty is another factor. While there is no regulation directly levelled at securities lending, the European Markets and Securities Authority’s short selling regulations are set to come into play on November 1. These rules require that a hedge fund or other borrower discloses its short position on any company: it must notify the regulator of any position of 0.2% or above of the total shares available of a certain firm; and must publicly declare positions of 0.5% or above.
One source close to the securities lending industry said that because markets remain volatile, it is more difficult for short sellers to choose the companies they want to short.
One asset manager told Financial News that liquidity has also been weak, which has made closing positions riskier and further discouraging hedge funds from taking short positions in the first place.
The ratio was buoyed by a rise in the amount of securities that long-term holders of assets – principally pension funds – are willing to lend. The figure now stands at $13.1 trillion, after dropping from a healthy high of about $15 trillion at the end of 2007 to $7.9 trillion in March 2009, as securities lending suffered in the aftermath of the financial crisis.
Blamed for facilitating short selling – which was accused of exacerbating the crisis by causing panic in the markets – securities lending programmes were suspended by many pension schemes after the financial crisis.
However, the supply side has made a comeback. Custodians say about 90% of the pension schemes that had suspended the activity have returned to the market. The rebound in the value of securities worldwide, driven by a more positive sentiment in the markets following European Central Bank President Mario Draghi’s efforts to lessen the threat of a eurozone break-up, also contributes to this figure.