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On January 19th a
blog titled "The Index-Fund Dilemma: An Empirical Study of the
Lending-Voting Tradeoff" was published, which along with the linked
academic
paper, makes claims about how the 2019 change in SEC guidance
impacted beneficial owners and the lending of shares over proxy
record dates. To support the arguments, the paper presents a broad
statistical analysis as well as a specific anecdote to illustrate.
The paper relies on the change in the ratio of lendable shares to
shares outstanding. If a firm's shares outstanding declined during
the observation period, potentially as the result of share
buybacks, that alone could increase the ratio without requiring any
action on the part of beneficial owners. With that being said, the
change in shares outstanding alone would not justify the observed
increase in borrow cost detailed in this note. It is also worth
noting that time trends do not fully explain the paper's findings,
which are based on a difference-in-difference design comparing
high-index and low-index ownership firms. Per the author's
description, "The paper generally seeks to advance the argument
that beneficial owners responded to last year's SEC guidance by
failing to recall a larger proportion of their holdings over proxy
dates, to the detriment of their ability to impact corporate
governance by voting."
The example presented in the paper is GameStop around the firm's
proxy record date in 2020, however the YoY increase in the
percentage of shares outstanding cited in the report, both in
lendable inventories and on-loan, was driven by GameStop
repurchasing shares, which reduced shares outstanding. Lendable
inventories and shares on loan also declined over that time,
however the decline in shares outstanding was greater so the ratios
increased. Over the proxy date on April 20th GameStop shares were
extremely difficult to borrow, partly the result of shares having
been steadily taken out of lending programs from September 2019
through the proxy record date.
GameStop Example:
On December 10, 2019 GameStop Corp announced third quarter
earnings and revealed the extent of their share repurchases in the
quarter, 22.6m shares, which immediately reduced the shares
outstanding by 27%. The repurchases occurred during the quarter, so
short sellers with open positions were already borrowing from the
remaining shares outstanding by the time the announcement was made,
which meant there was not a scramble to find new shares on that
date, it was just an occasion for data aggregators to reflect the
new shares outstanding figure. The result was that on a single day
the percentage of outstanding shares on-loan (or in lending pools)
increased by 27%.
The number of GameStop shares reported to IHS Markit as being in
lending programs peaked at 55m shares on August 30th, 2019. By the
time of the proxy vote the number of shares had been reduced to
just below 40m, a 28% decline. The scarcity of lendable shares
drove a substantial increase in the borrow cost, which made the
opportunity to lend shares more lucrative of an alternative to
voting. The fee for new borrows averaged more than 100% annualized
over the last week of April and first week of May with the average
for all open borrows being greater than 80%. That means a
beneficial owner who had refrained from lending prior to the proxy
record date on April 20th would have been able to lend faced with
the option to lend shares at a rate of more than 80% annualized, a
return of more than 20bps just for that single date. If they had
left the shares on loan until May 10th, when spot rates started to
decline, they would have earned 4%, under even the most
conservative assumption they would have only achieved the average
fee for all open loans (if shares had been on loan for the entire
year they would have earned more than 24% under this assumption).
The takeaway is that despite the improved economics for lenders,
with average borrow cost having roughly tripled from the start of
2020 to the proxy date, there were still far fewer shares being
made available by beneficial owners.
Part of the explanation the reduction in lendable shares is that
beneficial owners simply sold their holdings. From the 13F filing
on December 31st to the March 31st filing, non-hedge fund
institutional holders reduced their holdings by 12.8m shares,
however even if 100% of those shares had previously been made
available to lend it still wouldn't fully account for the 15.3m
shares taken out of lending programs over that time.
Looking at the hedge fund 13F holdings helps to clarify the
borrow dynamics in front of the vote. Between the December 31st and
March 31st 13F filing, the number of shares held by hedge funds
increased by 5m shares, to 17m shares in total. While some hedge
funds were adding to long positions others were covering shorts;
the bi-monthly short interest data published by NYSE declined by
6.7m shares over the course of Q1. Over the same time the gap
between the short interest and number of shares reported as on-loan
to IHS Markit increased by 9m shares. That gap is generally
indicative of the number of shares broker-dealers can source within
their own custody, typically hedge fund longs or delta-1 trading
desk positions, so an increase in the gap can be interpreted as
increasing broker-dealer supply. The implication is that over the
course of Q1, some hedge funds added to long positions in GameStop,
which in turn reduced the need for prime brokers to borrow shares
externally for the funds who were short, while the total number of
shares short declined.
For the borrow cost to increase as much as it did in late-April
and early-May, after the short interest declined, suggests that the
friction caused by the reduction of shares in lending pools was
manifest. That impact may have been exacerbated by hedge fund longs
who had previously lent their shares recalling them ahead of the
vote. The exchange short interest declined by 1.8m shares from
April 15th to April 30th, which included the proxy record date,
however borrowed shares only declined by 269k shares. The decline
in the gap between the short interest and borrowed shares reflected
a reduction in dealer inventory available for borrow, which may
have been the result of hedge fund longs recalling shares. Over the
next month borrows declined by 4m shares while short interest only
declined by 700k shares, suggesting that brokers had reverted to
sourcing a greater portion of the borrow internally.
Equity derivative exposures, and related trading in common
shares, may have also contributed to the challenge of borrowing
GameStop shares over the 2020 proxy. That topic is beyond the scope
of this note but would need to be considered for a full analysis of
the trading dynamics for GameStop shares.
Conclusion:
The decision to lend an equity over a proxy date means passing
voting rights on to the borrower, typically a short seller, who in
turn passes the voting right to the ultimate purchaser. This
decision is made weighing the impact of the vote against the value
to be garnered by lending. Academic research utilizing IHS Markit
Securities Finance data has provided empirical evidence to suggest
that making these decisions is, and has long been, an important
priority for beneficial owners. Lenders have tools which allow them
to understand record dates and materiality of votes which - along
with securities finance data- supports a thoughtful decision-making
process regarding the decision to lend or recall. While the ESG
acronym is new, the consideration of corporate governance and
stewardship for beneficial owners in securities lending is not. The
need for many market participants in 2021 may not be so much
putting into place relevant policies regarding governance but
rather illuminating those policies for interested stakeholders. For
the shareholders of GameStop, the recent increase in the share
price has been spectacular regardless of the decision to lend, but
the additional return was surely welcomed by those who did.
Posted 22 January 2021 by Sam Pierson, Director of Securities Finance, IHS Markit
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
