Equity Financing/Securities Lending
I apologise for such a basic question but I have tried to wrap my head around this and still don't understand.
What does this desk actually do? I.e. how do they make money?
What affects this desk the most? E.g. is it more macro level stuff like Interest Rates.
I am based in Europe and will be talking to a Trader on desk tomorrow so I just wanted to get a basic understanding so I can ask more interesting follow up questions.
Any examples or useful links you may know would be much appreciated. Thank you.
Sec. lending means that a bank will lend the shares that it has in custody to other counterparties for whatever reason and charge a fee for that. Let's say bank A has a pension fund client that holds it's stock with that bank. Pension funds don't trade out of positions that often so the stock just sits there. Then a hedge fund client comes to bank A and says that it wants to short a chunk of Chemical Radio Alliance Partners $CRAP. Bank A checks its custody accounts and sees that its pension fund client holds just enough shares of CRAP for the hedge fund to short. So the bank takes those shares and lends them to the hedgefund for let's say 5% p.a. interest, that interest will depend on CRAPs liquidity, volatility, short float and all other reasons. Now the hedge fund can sell those shares short, the bank gets it's interest and the pension fund receives a part of that interest for doing nothing.
Everyone is happy, until the pension fund wants to sell it's shares, then the bank needs to get those shares back, it can either borrow from another client or in case it can't the bank will need to buy-in the hfs position, now that means that the hf will have to close it's short, i.e. buy the stock and deliver it back to the bank, which kinda sucks if the trade goes against you and your buying only makes it worse. You can do same thing with bonds ar any other asset.
Thank you so much for this! Really helpful.
How do they hedge the risk? E.g. say HF client wants short exposure to CRAP. Do you then borrow or buy more of CRAP? In-case prices don't go down.
Apologies again if this is plain stupid but I feel hopefully one day it will all click and make sense.
You do not need to manage directional risk, this is not your asset it's the pension funds asset and their problem if it goes up or down, you are just an intermediary that lends that asset to another counterparty who then assumes directional risk. You only collect interest, you don't care where the price goes.
Think one of the most interesting aspects of this is sourcing "borrow" in stocks that are heavily shorted. When a stock attracts a lot of short interest it becomes hard to borrow - both more expensive and all the usual sources of borrow eg. passive funds have already lent out their shares.
I'd imagine a good stock loan desk is managing this kind of situation and trying to maximize their revenue by preempting it somewhat getting fresh longs to lend.
Most of the time it's probably fairly dull but I bet there was plenty of money to be made when Tesla was in play and borrow was insanely high.
Thank you for this insight. Think I will ask around this a little bit to see if any interesting stories come up.
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