quadriserv, inc. futures and options expo november 2003
TRANSCRIPT
Quadriserv, Inc.
Futures and Options Expo
November 2003
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Pension fund/Plan sponsor is the “beneficial owner” of the securities.The securities have additional value as collateral to borrow cash at low rates.Beneficial owner lends assets through custodial bank.The cash collateral is invested at a rate above the borrow cost.Revenue is shared between the owner and the lender
What is Stock Loan?
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Agent lender sends portfolio availability to prime brokers.Hedge fund determines his PB can provide the security he wants to sell short.After canvassing lenders by telephone, the PB borrows security then re-lends it to the hedge fund.The PB re-lend “mark up” can be substantial depending on how “hot” the stock is.
The Current Process
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Stock loan can be effected synthetically using an EFP
The basis between stock and futures is comprised of dividends, transaction fees and carry costs
The IR component reflects the implied financing rate for a long position or rebate rate for a short position
Long stock holders can use futures to lend their position
Borrowers can achieve short exposure through the future
Synthetic Lending through Futures
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A customer who is long stock could synthetically lend their stock using an EFP transaction
The customer would sell their stock and buy the equivalent number of futures at a basis which implies incremental net lending income
The customer now has long exposure to the stock through the futures market
Synthetic Lending (long stock)
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“GC” financing for shorts is generally Fed Funds less 20-30 bps (the interest received on cash from short sales)
Industry participants are able to finance long stock at Fed Funds plus 10-15 bps
The result is a spread differential of 30-45 bps
Thus, in absolute terms, the customer should be able to get short exposure through the futures market at better short rates
Synthetic Lending (GC short stock)
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Customers are charged a rebate rate to borrow “special” stock (they pay interest in order to borrow the shares)
The cost to borrow special stocks can be as high as a few hundred bps, depending on the issue, the broker,etc.
Given a broader base of potential “synthetic” lenders, the costs of borrowing special stocks could be reduced
The potential new revenue to customers long special stock can be realized
Synthetic Lending (special short stock)
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The financing spread differential between cash securities lending and synthetic lending (using futures) is reduced by the transaction fees associated with futures clearing
For example, if short stock can be financed 35 bps cheaper using futures, then total transaction costs need to be less than $.35 per contract (per 100 shares)
Synthetic Lending (cost structure)
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Problems with synthetic lending:
Active traders (stat arb hedge funds) may not want long exposure to the market in the form of futures.
Prime brokers may simply reduce short rates below competitive market rates, and kill the trade.
Long exposure through futures is a term loan.
Additional costs are incurred to either take delivery of the stock at expiry or cover the long prior to expiry.
Synthetic Lending (problems)