The securities lending event organised last night by iShares at the former Great Eastern Hotel in Liverpool Street was standing room-only, reflecting the keen interest in ETFs from those employed in this specialist subsector of the financial market.
The lending of exchange-traded funds is still a marginal activity in Europe when compared with the US. Len Welter of Data Explorers, the main compilers and analysts of securities lending sector information, produced a chart at last night’s event showing that the value of European ETFs on loan is less than US$1 billion, compared to around US$25 billion in the US.
However, the demand to borrow ETFs is steadily increasing, according to Stefan Kaiser of Barclays Global Investors, with many orders from willing borrowers unfulfilled. It seems that potential lenders are still not making the ETFs they hold in custody available to the market.
Unsurprisingly, the net result of this imbalance between demand and supply is that some pretty attractive lending fees are available. Data Explorers quoted an average fee of 1.56% for the top 20 European ETFs on loan by value. Two of the leading equity ETFs in Europe, the Lyxor ETF DJ Euro Stoxx 50 and the iShares DJ Euro Stoxx 50 ETF, currently command lending fees of 1.85% and 1.81%, respectively, whereas the cost of borrowing the underlying basket of stocks would be only 31 basis points, Welter pointed out.
Of course the familiar “plumbing” problems of the European ETF market probably don’t help; for example, different “lines” of ETF reflecting different listings across the region can cause confusion. But a lot of the inefficiencies in this market seem to reflect simple inertia among potential market participants, caused by a lack of familiarity with ETFs in general and the finer details of ETF structure in particular. And some risk managers have historically viewed ETFs as poor-quality collateral, according to Sadat Mannan of Barclays Capital’s prime brokerage team, a view that yesterday’s event was partly aimed at addressing.
For the time being, the markets team at iShares is aiming to connect the dots between potential borrowers and lenders of ETFs by matching the demand from the former with the supply from the latter on a voluntary, unpaid basis, using a network of Bloomberg chat rooms. It’s not entirely altruistic, as Keshava Shastry, head of markets at iShares, readily admits; the sooner the lending market for ETFs can be kick-started, the deeper and more liquid the secondary trading market in European ETFs will become, ultimately attracting more clients to invest in exchange-traded funds.
For investors, the development of an active ETF lending market in Europe would also help broaden the range of available options for those who want to generate short exposure. Selling ETFs short in the US market is easy by comparison. This is all with the caveat of “regulators permitting”, of course, given the various restrictions on shorting that were introduced last year and which have only partially been rescinded.
One final thought on current equity market levels: Data Explorers produced two charts showing that the ratio of global securities lending inventory (a proxy for stocks held “long”) to the value of global securities lent (a proxy for stocks sold “short”) is at its highest level since 2006. In other words, relatively few market participants are currently positioned for a sell-off. Does that mean that another market decline is overdue (looking at the chart as a contrarian investor might), or have the dynamics between short-sellers and the rest of the market been changed permanently as a result of the exit of many hedge funds and the regulators’ interventions over the last year?