Monday, February 1, 2021

An Existential Moment for Securities Finance

Gamestop and the Storming of the Hedge Funds' Bastille

Feb 1, 2021: The social controversy over Gamestop’s (GME) battle of wills — r/wallstreetbets v 'The Shorts' — will harden the scrutiny of regulators and litigators toward the US$2.4 trillion global ecosystem that supports hedge fund strategies. This is a pivotal moment, not only for GME and The Shorts, but also for the Bastille-walled clearing markets that their lenders and agents use to secure the funds' trade settlements and financings. 

Ignorance of clearing house rules, coupled with uneven disclosures had clearly inflamed social tensions over the GME short squeeze. These tensions were exacerbated when risk managers at clearing houses were portrayed in the media as fighting the popular uprising of legions of day traders.  

Any image of industry heavy-weights circling the financial wagons to protect anti-social billionaires will always provoke critics of the status quo. When the antagonists are seen as trading desks at allegedly front-running hedge funds, it may be the final negative headline needed to incite strong regulatory reform movements.  The storms of reform have already been gathering, as evidenced by several well-publicized developments:

Changing social views of complex finance ...

* South Korea repeatedly extended its covid-ban on short selling and threatened jail terms for uncovered short sellers. More than 200,000 investors signed a letter to make the shorting ban permanent.

* The Japanese Government Pension Investment Fund banned the lending of its foreign securities, citing lack of transparency to assure ESG social compliance.

* The European Securities & Markets Agency called for EU in-scope securities loans to be audited for dividend tax frauds, using filings from the new Securities Finance Transaction Regulation.  

Add to this pandemic-day-traders' hostility to their brokers' platform slowdowns and it's clear that Main Street's historic distrust of Wall Street is taking on a global focus, partly driven by social media sites such as Reddit. In effect, internet-savvy day traders are saying that their 'crowd' in the global pit has imposed a popular brake on negative leverage in the market, but that their brake is being undermined by the hedge funds' conflicted protectors. That is not a good take-away for the careers of rising executives in the securities finance markets.

Will today's executives find their resumes downgraded by transformational shifts in finance, as has dislocated the careers of many others in our cloud-centric world? At this point, nothing is certain, but the challenge is obvious.  Executives at firms in securities finance must make it clear that the trading strategies of their client hedge funds are not just profitable for investors, but that those strategies can also convey great benefits to society -- and not just to market liquidity and price discovery, but also to universal norms of social justice and harmony.


Ed Blount