Stock lending agents and prime brokers were challenged with a once-in-a-career opportunity after the December 3rd, 2019 announcement that Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, had decided to ban the lending of their offshore stocks -- nearly half of their holdings. That bold decision by the fund's CIO will reportedly cost as much as $300 million in lost annual income and “could prove hugely disruptive to equity markets if others follow its lead,” according to the Financial Times.
To justify the ban, the GPIF cited lending’s effect on its governance duties and concerns that foreign borrowers were using their shares in schemes to evade taxes. Regarding governance, the GPIF said that by giving up votes on loaned shares, the fund could not comply with its own principles of Environmental, Social and Governance (ESG) based investing. However, the fund’s announcement also left open the door if a new service provider could resolve its concerns.
If no solution is found and other funds start to ban stock lending, layoffs may well start to begin at the service provider firms. However, the firms are already on the case. Any provider who lands and restores an ESG-compliant lending account to activity will earn a resume credential worth millions of dollars in future earnings. Yet, it won’t be the sales department alone that lands that kind of account in the 2020's. It will take team-based coordination with the Information Technology department at the heart of any proposal. The new GPIF lending contract, when it is won, will harness the ability of new distributed ledger technologies (DLT) to control the links to its ultimate borrowers.
DLT AS THE SOLUTION
Unlike today’s blind lending to prime brokers, DLT will give the agents of the GPIF and other concerned lenders the ability to screen their ultimate borrowers by limiting their trades, giving assurances that borrowed shares are not being used to evade taxes. And, if the borrower is a broker-dealer, then non-directed and unvoted shares in the firm’s depository account can be assigned to the ESG-compliant lenders, either for a fee or for preferential access to deep and desirable stock pools.
Industry-level and DLT-standardized technologies, such as blockchains, shared ledgers and smart contracts can make all these services possible ... and necessary. The risk for inaction by a service provider is that of being left out of the supply chain, i.e., disintermediation.
- If a lending agent controls the shared ledger in the DLT system, then loans may be routed by smart contracts so as to bypass the prime brokers who usually finance the final borrowers.
- If a prime broker wins, the agent could be disintermediated.
The shared savings (and the value of that new edge to the winning contractor) should more than justify the cost of making the service providers’ existing cloud-based lending systems more transparent.
The starting gun has already fired. From now on, many believe, DLT systems will be the agents of change in a new order of stock lenders and their service providers.
The Financial Times offered its own view of the challenge. "Asset owners also typically have little to say over what happens with their securities once they are lent out. … The GPIF said it was concerned that lending stocks out stopped it exercising proper stewardship over the underlying investments. This included a lack of transparency over the final borrower and how it was using GPIF shares. Should these concerns be addressed, said the fund, it will consider lending stocks again."
It may not take long. There are DLT projects already underway that can be adapted to address the GPIF's concerns and new hi-tech DLT initiatives that can be justified based on economics alone.
The merits of DLT cannot be overstated when viewing the proven success of global projects to organize the supply chains of hundreds of produce importers and their shippers, as well as to connect the end-buyers to the distribution networks of corporate farms. Products tracked from field to shelf are less likely to contaminate the supermarkets of America.
The use of DLT in the supply and distribution channels of the stock lending markets is inevitable. And, just as Walmart can now see through to its farmers, so also will the GPIF and other large ESG-compliant lenders be able to gain “transparency over the final borrower and how it was using GPIF shares.”
The agent or broker who can deliver the best DLT-based and ESG-compliant solution will win the competition … and help to prevent disruptions to the market and to careers.
Author Ed Blount wrote the industry’s 2010 rebuttal against allegations of empty voting and has testified before the U.S. Senate, the Securities and Exchange Commission, and more than a dozen state and federal courts.