New Sec-Lending Platform Aims to Give Beneficial Owners Bigger Piece of the Pie
LendEx prepares to launch, lines up central counterparty
March 24, 2008
A pair of industry heavyweights--former Securities and Exchange Commission chairman Harvey Pitt and LocateStock.com founder and CEO John Tabacco--are backing a new electronic securities lending platform. The system, LendEx, will cater to beneficial owners and is the first to offer what it calls central counterparty (CCP) services.
Jersey City, N.J.-based LendEx is set to be pilot-tested on April 2 with two broker-dealers, two trust companies and a self-clearing hedge fund. It anticipates becoming operational in May.
The goal of the new platform, according to Tabacco, is to promote greater transparency and dynamic price discovery in a historically opaque market and to enable beneficial owners to claim a bigger share of the fees paid by end users. LendEx is jointly owned by Kalorama Partners, the Washington, D.C.-based consultancy founded and headed by Pitt, and LocateStock.com, created five years ago to service hedge funds looking for securities to meet their short-selling requirements.
"We are focusing on getting a better deal for the beneficial owners and retirement systems because they really are the underserved segment of this market," said Tabacco. "They lend a tremendous amount of their portfolios, but due to the nature of the market they don't see how much the end users are actually prepared to pay for those assets."
Pension funds and other beneficial owners of securities will be able to list their inventory on LendEx at no cost and will receive e-mail alerts when shares are borrowed. The platform will remain separate from LocateStock.com, Tabacco said, disputing rumors that LendEx is intended to replace it. However, the new market will leverage Jersey City-based LocateStock's user base.
Large custodian banks generate significant income by lending their clients' assets to broker-dealers or prime brokerages, who in turn lend them to hedge funds and other firms. Regulation SHO, adopted by the SEC in 2004, mandates that brokers must first locate and borrow a stock if they want to short that security, to reduce fail-to-delivers. Hedge funds typically rely on their prime brokers to perform this action and market makers that do not self-clear depend on their correspondent clearers. Self-clearing market makers must cover themselves from inventory or borrow from a custodian bank.
The large custodians split fees received from borrowers with their underlying clients--large pension funds and other institutional investors. Prime brokerages share their fees with their hedge fund clients. To some industry observers, LendEx effectively disintermediates custodian banks and broker-dealers.
"In principal LendEx is a good idea," says Josh Galper, managing director of Concord, Mass.-based research firm Vodia Group. "But there are real questions about whether beneficial asset holders and their lending agents will adopt the platform."
Special Securities
LendEx will charge borrowers a transaction fee of one to 20 basis points, based on the type of securities; special stocks will often command more than general collateral.
John Sampson, managing director of Kalorama, said that beneficial owners could generate higher revenues through LendEx because it will let them loan their most in-demand securities--known as specials--to the highest bidder on an individual basis. Custodians usually package specials with less attractive general collateral stock to improve overall utilization rates.
Perceived inefficiencies in the model used by custodian banks have given rise to a number of third-party securities lending platforms, including EquiLend, Quadriserv, Icap's i-Sec, SecFinex and eSecLending. Of those Quadriserv and eSecLending deal in U.S. equities, while EquiLend retains the current custodian bank agency model.
