EUROPE - Pension funds could once again retract from securities lending if they are included in European proposals which would tag lenders as ‘short sellers’, according to the trade body for securities lenders.
Pensions have re-expanded their lending programmes to near pre-crisis levels, after a sharp pull-back at the height of the crisis.
However, But Kevin McNulty, chief executive of the International Securities Lending Association, said another contraction could occur if pensions find themselves defined in the eyes of regulators as short sellers, by lending out securities that they subsequently sell.
While this might be an unintentional by-product of the proposals currently under discussion in Brussels, it could expose lenders to stringent shorting rules, including disclosure, McNulty said.
"We want to make sure investors do not end up with a situation where, if you're a pension fund that has loaned and then sold shares, you are not held to have sold [them] short. If there is a risk pensions be seen as short selling, they may not lend anymore," he added.
The recent expansion in lending has accompanied a full replenishment in the number of lenders, after some halted programmes amid public opprobrium and shorting bans at the peak of the crisis in 2008.
However, McNulty said short sellers have more than halved borrowing, from $4trn pre-crisis to around $1.8trn now.
Although hedge fund assets have breached their pre-crisis peaks, he said "we are not seeing that translate into real demand to borrow. Compared to historical demand levels, levels now are very depressed".
ISLA cited fear over regulations, less use of leverage and long-bias as reasons.
Richard Thompson, ISLA chairman, said uncertainty over which European rules - including on disclosure - would take effect was a major contributor.
"Hedge funds like to have a level of certainty over their ability to execute and live with a trade over time. If there is a sense that a physical short sale will present a challenge in the near future, that does act to deter putting the trade on in the first place. Hedge funds may look for other ways [to sell short]."
European politicians are currently discussing the main proposals to regulate shorting more tightly.
McNulty said ISLA opposed one forcing hedge funds to reveal publicly significant net short positions.
"That can have very negative effects on the market and some the regulators would not want to see," he said. It could result in funds blindly copying large rivals' shorts, and artificial limiting shorting just below reporting thresholds.
It supports full disclosure, he said - but in private, to regulators.
"Regulators need to see this information, because politicians scream and shout at them that short selling is out of control and causing all sorts of problems, and regulators need the hard information."
He added academic studies have demonstrated shorting aids price discovery, and market liquidity.
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