The Retail Securities Revolution

Hi, friends. Welcome back to another episode of Peer Connections, the podcast series brought to you by the Global Peer Financing Association, also known as GPFA. These podcasts offer our GPFA members and global beneficial owner friends a forum for information sharing and discussion on topics most important to them. And we hope you, our listeners, appreciate the insights, best practices, and transparency offered from our members and industry friends about securities, finance, or related investment areas. Now let's get into the episode. All right, listeners, well, welcome back. This is another episode of Peer Connections by the Global Peer Financing Association. We're back in partnership with the team from ISLA, which is the International Securities Lending Association in advance of their upcoming annual conference in June in Madrid this year. And I have with me some very exciting guests representing our industry at large, but also representing ISLA and GPFA as well. And so I'd like to first introduce you to our guests, and then maybe we can tell you what we're here to talk about. So with me today, I have Matt Burnett from Norges Bank Investment Management, and I have Karen Halperin from ShareGain. So welcome, Matt. Karen, how are you both? Thank you. Good. Matt, I know that you're a frequent voice on this podcast and other podcasts as well, and many know you and are familiar within the GPFA community, but you want to just give our listeners perspective on what role you sit in and what hats you're also wearing today? Absolutely. So for one, I think this is a super interesting topic. I think this is probably one of the biggest revolutions in our industry in the last couple of years. So I think even though I'm very active in GPFA, I'm on the board of ISLA. For me as a lender, retail liquidity and accessing retail liquidity isn't really relevant, but I think there's a lot of things to be learned here. But for the most part, I'll wear my hat as ISLA board member that wants to promote the development of the industry. But yeah, why is this interesting? So the story that I know is accessing retail inventory used to be really difficult. Retail investors had small positions. They were volatile. Their brokers or asset managers didn't have the technology nor the competence probably to access the market. But something in that has changed. I'm guessing it's products and technology that Karen and her colleagues have brought to the market, but it's made it, I think, a much more automated and palatable model for the borrowers or the primes to access. My questions are also, what can traditional lenders learn from this? What's going on in the space, et cetera. So maybe we can just kind of jump into it from there, but this is a segue to a much deeper dive within the conference in Madrid on the 17th of June, just FYI. Good. And I just want to do one preview in addition to this topic that we're discussing as a pre-education opportunity that Matt, you and Tommaso from GIC will be co-leading and hosting in partnership between GPFA and ISLA, the closed door beneficial owner session at this year's conference. And so we'd encourage any listeners that are qualified beneficial owners that if you're not already tuned in and attending the conference, you're welcome to attend the conference. We all encourage you to do that. But in addition, if you are attending, I know Matt and Tomasa would love to have you join for that closed door session. So with that, maybe Karen, can we turn it over to you and both to maybe just give perspective to our listeners, your role at ShareGain, your involvement with Isla in the industry, and then Matt gave you a pretty big topic to address. So we'll let you take it from there. I'll start with my background and then my role as I think it's all connected at the end. I started my career 35 years ago in tech, but quite quickly I moved into capital markets. I was a trader after the tech aspect. I loved capital markets. And then I joined an algo trading company. 25 years ago, algo trading wasn't a thing. There is an argument whether we were the first ones or the second ones, but we were doing high frequency trading and no one really understood what does that even mean back then. Then four years after I studied law and economics and I moved to the regulator side, which is the opposite of high frequency, as you can imagine. Everything is slow. Everything takes like the quickest is five years span, exactly the other side of that industry. And eight years ago, I joined Churgin as the second in command. What we do, and it's tied straight to my role as an ISLA board member, is we're not a newcomer anymore to the industry, but we were back then. We're a securities lending platform that enables every financial institution to offer securities lending to their clients. Simple as that. It's an end-to-end. You can do everything on our platform. I think the linkage between my background, what we do in Isla, and it's straight to Matt's point on the revolution, I would say, things are changing constantly. And we understand that if securities lending back in the days was, if we're going back like many years ago, if it started from an operational perspective and then becoming a P&L center. But the industry knew how to do that one-to-one trade. I'm a lender, there is a borrower, everyone benefits from that trade. We get it, this is the oil in the industry engine. And that was it. Today, as retail ourselves and with the capabilities that we have in the tip of our fingers, we want to know everything. We want to have full control on everything that we do. We want to understand why we're doing it. We want ChatGPT to come with the exact explanation for that. I think that with retail investors, and this is where COVID was a huge accelerator for retail as well, everyone understood that they don't need to only put some money in their pension funds, but they can also trade and make some decisions. And they had spare time and some spare money and started trading constantly. For us, that was a game changer. I think that when we're looking at that retail trading as a mega trend in the industry, and there are many researchers around that aspect specifically, and I think last month's research released that the forecast is that by 2030, it will be more than 51% in the New York Stock Exchange, if I'm not mistaken. So that trend is massive, and everyone wants to have more control and more education. I think that what we had in the past from a one-to-one trade, the industry realized that the other financial institutions like online brokers, like private banks, their clients are expecting to get the same services as these big financial institutions. And they were facing a huge challenge where they wanted to offer it. The systems were not equipped to actually be able to do it. If we think about, and from an ISLA board member perspective, I think this is part of that educational aspect of it as well. Because lending is not new, it's something that every investor has the right to actually lend out their securities. But from an operational perspective, to do that one-to-many was almost impossible back in the days. Trading, if you think about it, and give the Airbnb example, which I think it's just an easier analogy. If I'm buying an apartment, then I need to look at it. I'm going to buy it. We're going to agree on the terms, but that's it. Like we exchange hands, money, and assets, and that was the end of it. If I'm renting from Matt, now we have a long-term relationship. And you could let your apartment back before Airbnb as well. But then how will you find the place if you're looking to rent? How would you trust that owner? Or the other way around, how would you trust people that are coming into your house? How will you manage the cleaning and the day-to-day operation? Someone needs to own it, and the trust needs to be there. Airbnb came in, they solved it with tech. Because again, that's the long-term relationship and that scalable solution that was needed. It's a good learning in a way, it's quite similar. Sorry to interrupt you, Karen. Maybe we can back up. There's a lot of questions coming up from the story that you're telling here, but maybe we can back it up a little bit for myself and hopefully for the listeners as well. So traditionally there's very large barriers to entry of securities lending, right? It is a difficult, highly complex operational business, right? So you have, as you say, thousands of securities that need to be traded across, you know, 35 probably markets globally. so you have to have the infrastructure and the networks to make that happen so maybe you can talk about how have you enabled that for retail investors that probably even have a broader portfolio in aggregate than most institutional lenders and what is the operating model or the ecosystem that you've put in place that makes that possible yes with pleasure i think exactly as you mentioned that i think you need to have the tech in order to really offer it to these millions of underlying clients, but you need to have the operational infrastructure as well. Because at the end, there needs to be a borrower, there needs to be a collateral manager. There are other participants in that industry that needs to be part of that trade. And again, because the post-trade is the big part of the relationship between the borrower and the lender, that needs to be managed. The system that the financial institutions that are retail facing As today, usually not everyone, most of them are, again, not built for that service. What we've done is threefold. One was the tech infrastructure, which is a layer that is connected to the lender's systems in a very flexible way. So to only understand what do they hold, how do they hold it, and what do they need in order to manage their books and records. not to need to be relying on their systems. So we are getting all the information from them and sending it back however they need it. But the other aspect of the operational infrastructure is that they need to have the relationships with the borrowers. They need, again, to decide what is the collateral that they're going to receive. How do they manage it? All of that is completely transparent to both sides. So we understand that from, if you think about a private bank, It's not their investment decisions either, right? Like they have their clients. They need their clients to, first of all, understand what is securities lending. So we made sure to work with them and that's part of the tools that we have to simplify it to the core. At the end, it's not that complicated, but there are many details. So Matt Brunette and Brooke Gilman as retail investors in this example, you're just giving those individual retail investors sort of an access to the opportunity to participate in lending via the technology and the platforms that you've built and then make available to whomever the aggregator is. So whether that's a private bank, whether that's a larger bank, a broker, whoever is ultimately the investing platform that a retail person would access through, you're giving that technology and that platform support, either doing it directly yourselves or maybe the technology for them to do it for themselves. And so the retail investor isn't so much the one facing off. It's all of those retail investors being brought together in the aggregate at whatever that bank broker level is, correct? Yes. So it's aggregated to that financial institution level. At the end, there is one single financial institution that is facing the street. Right. So we are aggregating everything so that financial institution can face the street because no big or prime broker would want to and they cannot face that individual anyway. But moreover, and Matt mentioned it before, the way that retail are trading is different than the institutional investors. So in order to make sure that the trade will be beneficial to everyone, we are managing the pool and the allocation and reallocation according to their trading while the trade is alive. So there are many mechanisms and algorithms and machine learning in the back of it to make sure that the fact that they're trading will have the minimal impact on that trade back to the street as well. So is the aggregator then doing the lifecycle events? So the asset servicing, the corporate actions, and the collateral management, presumably? We are managing it for them. They have full control on everything and full transparency. So they can choose and they can decide what are the limits that they want to have if it's on specific events and even on credit lines to borrowers, for example, or collateral that you want to hold and how do you want to hold it? And so they can manage it throughout platform real time constantly. So one thing that listeners to this podcast at least would be interested in knowing that many would be institutions, right? an institutional investor similar to a mat would be the comparison between a large institutional investor, whether that be sovereign pension, mutual fund insurance versus the retail side. And so, Karen, could you maybe give us that perspective to the extent that you're willing to step into the shoes of the borrowing community on how they would compare and contrast, how they would prioritize supply, recognizing that you just mentioned, and I think that as of late, it's been pushing near 50%, but you just made the prediction based upon that data set or research that the NYSE could go 51% retail assets versus institutions at some point near. So a huge part of the market, whether it's under or at or above 50% is now becoming retail money and accessing that side of the market is obviously important for overall market liquidity and opportunity. But how is a borrowing counterpart perhaps going to see borrowing from Norges Bank versus borrowing from the pool of retail assets? A few things to mention around the borrowing perspective of it. First of all, because the retail aggregators are joining the market, but their capacity within the securities lending industry is not as big as their capacity in trading. So that's something that is happening, but we're not there yet. Some of the borrowers, it's not easy for them to even face these retail aggregators. This is a process that they're doing in order to get used to what does that mean to onboard these type of clients. So that's another process. If we think about education, and this is where we're in my ISLA hat, there is the education to the retail, what is securities lending, and the education to the borrowers community to say, what does that mean to face these financial institutions? Because they're different. the type of supply and the type of trades that will be behind the retail supply and the pension fund and the big financial institution or the institutional aspect will be usually a bit different. The things that they hold is completely different. They will many times, and it's by the way, and if you will take an online broker and a private bank, again, it's how the distribution of securities is very different as well. So usually they will face this financial institution, the retail aggregators, for the specials only, or mainly. Because for the GC or the long-term trades, this is where I think Matt and the institutional market have the supply. They know exactly how long they can rely on that trade and it's different. What the retailers are bringing to the industry is more liquidity and securities that many times weren't there. And I think that In a way, I'm going back to like an Airbnb analogy, it's growing the pie as a whole. I think that they're looking at trades that weren't an option before. Even if you think about Algo, for example, in order to build some kind of a strategy, you need to know that you can source the supply. If you never see the supply, then that theme won't be on your strategy even. So I think that it's new for many of the borrowers as well. There are the trades that everyone expects, like Pacific Shorts, or if it's MC and things like that. But the value and the interesting part is these things that weren't even on their plate before. And we see, for example, and this is where I think it's a nuance, the ETF that we're bring to the table because it's not a single stock, but sometimes it's things that were never in lending quotes. Just thinking out loud based on what you just said. So there's also a very large growth and this may take some speculation on your side if we're comfortable with that, but there's been massive growth in new market makers, hedge funds being market makers in the retail space, pay for order flows. Is that some of the demand possibly to hedge their own positions for that same type of retail inventory, thinking the end demand for some of those transactions? From a market-making perspective, I believe so. On our platform, the borrowers are the big BBs. So we don't have any hedge funds on our platform. And by the way, it's because if you think about newcomers to an industry, and again, the fact that the retail aggregators' clients as a retail aggregator, they're heavily regulated, and whoever is taking the counterparty risk, that risk and credit needs to be well managed. So everyone feel more comfortable facing the big banks and not the hedge funds. So that's to begin with. Whoever is trading down the line, my assumption will be similar to yours. I think that from a market making perspective, when we see the new demand coming in, then and we don't know what drives the demand, but we have our speculation. Yeah. Okay. That's interesting. You mentioned AI, everyone's favorite topic and algorithms is there a simplified pricing model behind the technology or are these negotiated transactions or is there some secret sauce in there somewhere i won't say ai although everyone likes to say i but it is machine learning now everything is automated on the platform i mean our operations team is still four people for the last six seven years The growth didn't change the operational needs and the demand gen, the one that is managing the relationship with the boss as well. Everything is led by the system and the algorithm. We have a pricing algorithm with machine learning that takes learn from what's going on in the market, what we see now, internal pools, what we see that is coming, different trends and learn from that perspective and to bring the right price. We are not negotiating. It's different. That's probably a separate conversation that could be longer, and there's probably some proprietary information in there. But I think that's also quite interesting because where the industry probably needs to go someday is a bit more automation and pricing. You kind of have that in GC has been automated, but the real pricing and experimentation with that pricing, I think, is an interesting topic. But we could probably skip that now due to time. I agree. And I think if you think about, again, AI automation and user experience as a whole, the fact, and I just read this morning about someone, I think there was like a lawsuit and someone was mentioning some laws and then they realized that it was a mistake. They're not existing. So I think that in a way, everyone feels very comfortable in relying on something that is digital or AI or these buzzwords. But at the end of it, it's coming from the same need of us as users. You want to know that the information that you're getting is as reliable and as objective as possible. So if you think about pricing, I think this is where you're going at. In a way, you want to know that this is the price because of A, B, C, and not because someone had lunch or didn't. Yeah, well, I mean, this is a difficult part of our industry. It's quite a bespoke industry. It is OTC. There's not a lot published. We have some data sources now that are backward looking, that are great, that have taken us a long way. But you can't really use AI on it because there's nothing written about securities lending. There's nothing to learn from the AI, right? So besides the fact that AI comes up with some really weird solutions, as you've alluded to, yeah, I would agree with you. It's probably best to stick to machine learning for the time being. But I think the concept of machine learning and being willing to say, if I raise the price, do I lose the trade? If I lower the price, do I get more trades, et cetera? And how does that pricing dynamic work in an OTC market? But you did also touch on one of my other favorite subjects, which is risk. And I'm very interested in, well, one, hopefully we agree that there is risk in these transactions. Where does the risk lie in a retail agreement? Does it lie with the investor themselves that ticks a box that says, I want to lend my securities out of my E-Trade account or whatever it is? Does it lie with the aggregator? Does it lie with their broker, et cetera? And how do you educate them to where they're making conscious decisions about that risk? I think, first of all, I will mention that although all regulators have the same mindset as a whole, where you need to provide transparency about the risks and you need to make sure that people fully understand what they're doing. And when it's retail, everyone wants to make sure that it's well-protected. But different regulators in terms of how do you manage risk and how do you showcase from books and records and other aspects, this is where you have some different views sometimes. But what we're doing is supporting how our clients, are lenders. When it comes to the educational path, that's the first stage. If you think about the client tomorrow morning, Brooke will have that announcement in her, give you a private bank and not a Robinhood account. I appreciate that. I feel private bank. I'm happy to take the Robinhood account. Matt, you get the Robinhood account. That's fine. So your private banker is calling and saying, Brooke, my dear, I have a great offer because private bank won't send you a great offer for you. I've seen that you hold this security and that thing. And actually, you can get a new revenue stream from securities lending. What do you mean? What is securities lending? And then they will need to send you some materials to read and to understand better. This is where we come to play and support as well. So from very simple FAQs to how do you evaluate the risk? What does that mean if your private bank is taking that principal risk? So if you're facing your private bank, then it means that they're taking the other side of that trade. But at the same time, you have collateral and how the collateral is being managed. Because the risk is you have that chain, if you will, and who is carrying the actual end risk, usually the collateral manager. The securities that the online broker or private bank choose to have in their collateral schedule is well-defined, and some of them are very detailed about it, and some not necessarily. It depends, again, on the client type, but to make sure that the retail clients fully understand who is the principal, which is usually the dealer or private bank, and how do they manage their risk. They will name the borrowers, for example, which is an option. They were facing only the five biggest or 10 biggest PBs. That gives you some comfort. The fact that the collateral doesn't sit with your private bank or with the borrower, but with a tri-party collateral manager, that gives them more comfort. think this is part of it. But the principles in the transaction is the private bank and the prime broker, not the underlying beneficial owner, I guess. Exactly. Yeah. Okay. So you mentioned some documentation and FAQs. Do you do like YouTube videos on what is securities lending and why it's good for your portfolio? Are you looking for another gig, Matt? Are you offering your services? Well, when I look for this, because I did prepare a bit for this and I looked through even some of the local Scandinavian brokers now offer, you can tick that box to lend your securities. And I looked through there and I couldn't find anything. So I searched for some YouTube videos, but I have to say most of them have a negative tilt to it. So we maybe have to play some defense on this one. All right. I agree. So we do have some videos and making sure that there is collateral that is out there. We have clients that we work with them on videos that they send through their platform to their clients. I'm not sure you will see it in YouTube, but this is another way. We are also tracking, if you think about not necessarily the private banks, but the more trendy online brokers, what's going on in Reddit and how do their clients look at the cash lending? What do they care about? So when a newcomer will come and launch, they will be able to address exactly what their clients are looking for. So it's part of the research and work that our team is doing exactly because of that. And we've seen a few years ago, I think one of the biggest challenges was exactly that educational piece where, as I mentioned, during COVID, the whole retail trading became a massive macro trend. And today, I think that many clients are looking for it. I was in a meeting a month ago where someone that heard us talking and was like, why can't I lend my securities? This is not fair. when will you offer and people are just waking up to that thing as a basic right so i think from being something that not necessarily they want to support they don't fully understand we had a private banker that received a bouquet for the first time from a client because of a check that yeah that's the bouquet i sent so that makes sense so you're happy yes exactly very happy so karen this has been really helpful matt i wonder if you could help close us out by again And recognizing that you sit in a seat that is very much an institutional seat in this market as a lender participant, but you also sit on the ISLA board. And so from all of what Karen shared, I wonder if you could just give a closing thought or two on where you see this market evolving in terms of the benefits to the institutional lender market. Because maybe there are some, maybe there are technology advancements and data advancements and some of these other things that Karen spoke about that lenders like yourselves really also benefit from. But maybe there's also some supply competitive aspects to this where some of the most lucrative securities are really being driven more by the retail space. So I'm just curious if you have much of a thought now here to help wrap us up and close us out. Yeah, I'll do my best. So whenever large institutional investors like us that are very active and very vested in the securities lending market hear about new supply, we kind of suck air through our teeth, right, and roll our eyes a bit. But in all honesty, I'm a huge believer in just the evolution of the industry when it evolves in the right way and investors and beneficial owners and their facilitators are conscious of what's actually going on. And my favorite topic that there is risk in these transactions and that's managed in the right way. And my guess is that Karen's company is doing that in a very thoughtful way. So I think there's lots to be learned here. We desperately need continued technology advances in this industry. It's coming, but it's kind of behind everything else. Equity trading was automated 20 years ago, in the most part. Everybody has direct market access on their desktop. The biggest gripe in securities lending is you have a huge portfolio of lots of different assets that you don't have enough resources to make competent decisions on a stock-by-stock basis. But if you can do that in a smart and thoughtful way in aggregate, and you're managing your total risk and your total P&L on those transactions, and you have access to machine learning, etc., or you have a reasonable pricing model, I think that's great. And I think that's the direction we need to go. And ultimately, I think there's still hope for almost a bid and offer process within securities lending rather than I just want to get a yield on my assets. I think beneficial owners are moving from being price takers to having a conscious view on risk and return decisions, but they need technology to help facilitate that. Absolutely. I think there's a lot to come in this market. I think that we also have a lot of opportunity and more education that will be needed along the way. And hopefully we can all get together in Madrid, discuss this further, maybe even be brave enough to record a YouTube educational video for the retail space. We'll see if we have success on that. If not, it can be a lifelong goal of ours to get a YouTube educational video done for you, Karen. But otherwise, we will see the industry. We will see beneficial owners, perhaps even maybe we'll see some retail advisors and wealth managers, maybe some private banks attending ISLA. And those dates are June 17th through the 19th in Madrid. So again, we look forward to seeing you soon and we'll be in touch. Thank you again to Matt. Thank you to Karen. Thank you to ISLA and GPFA for the collaboration and partnership in bringing both this education, but also in the discussions that will occur in person in Madrid. And yeah, thanks, Matt. Thanks, Karen. Thank you, Brooke. And this is another episode of GPFA Peer Connections. Thank you, listeners. We'll talk soon. Thanks for listening to another episode of Peer Connections by GPFA. We hope you found the information shared in this podcast interesting and beneficial. And as always, please feel free to reach out to GPFA with ideas or interest for future episodes. And if you liked what you heard today, don't forget to subscribe wherever you get your podcasts. Now for the disclaimer, The opinions expressed in this podcast are those of the presenters and do not necessarily reflect the views or opinions of their respective employer organizations. This material is for your private information and does not constitute legal, tax, or investment advice. There's no representation or warranty as to the current accuracy of nor liability for decisions based on this information.