The Disintermediation of Securities Lending
tl;dr: Reimagining the world of securities lending when smart contracts work at scale and we all keep more of our money.
There was an article in the June 10th edition of the Wall Street Journal entitled, How Investing Giants Gave Away Voting Power Ahead of a Shareholder Fight.
The crux of the story was how Black Rock, Fidelity and others take the stock that they own in various companies and put them on loan to generate borrowing fees.
It seems that “short sellers often borrow those shares to bet against companies, paying fees to funds that supply them with those shares.”
The downside, according to the article, is that when it is time for a proxy vote, whoever has the shares is the one entitled to vote on the issue.
If the shares are recalled, Black Rock can vote in line with their long-term interests. If they are not recalled, the investors’ long-term interests are not represented since the shares belong to the short sellers at that time.
On the one hand, it’s a market and that is fine.
On the other, it feels weird that an investment firsm which is buying shares in a company (presumably for the long-term) are then loaning those shares out (for the fees) so short sellers can damage the company either via a bet or via their voting.
Anyway, I’m not concerned about that.
The Cost of Loaning Shares
The thing that caught my attention was the visual which accompanied the story.
In this graphic, I see at least 5 transactions.
- Original investor puts money into fund (e.g. Black Rock)
- Black Rock buys stock in companies
- Black Rock loans stock via broker
- Black Rock recalls shares
- Black Rock votes.
Now, I’m no expert on the securities industry, but if I had to guess, there are fees and costs at every step of this continuum.
All of that is money that is (one way or another) taken out of the pockets of the original investor.
Smart Contract Securities Lending
Now, let’s imagine for a moment that the stock in a company is actually a digital asset secured by a blockchain.
Let’s call it a token.
Perhaps you buy it directly and hold it in your wallet. Perhaps you use a service like TokenSets and build a portfolio based on the the recommendations of an algorithm or an individual trader you’d admire.
At all points, you retain control of the shares.
Which gives you choice.
You can choose to lend them out or not (something that Black Rock can’t offer).
But, if you want to lend them out and garner fees for it, you can. However, there’s an important difference.
You could loan out the share as a financial instrument but strip out the governance rights associated with the share.
So, a short seller who doesn’t care about voting on governance issues might borrow your “no voting rights share” for a slightly lower amount to you, while you retain the voting power.
Think of it as an “unbundling” of the rights associated with being a shareholder.
And here’s the best part, since all of this happens with smart contracts on a blockchain, the number of intermediaries drops to zero and the costs drop as well (though it’s not free).
And it comes with full transparency, so everyone knows who is loaning out shares.
You can still vote on a proxy issue, but everyone else knows that your vote (well, it’s pseudonymous, but you get the idea) is valid, yet you are someone who has loaned your shares out that were used by short sellers.
This may be fine and totally legal. Perhaps no one cares. But everyone knows.
How that works or how people might respond is also not of my concern right now.
The image was just a reminder of the things we take as a given (a lot of intermediaries generating fees that erode the value for the original investor) and the fact that there exists a technology today which is going to change the unit economics of this business.
More money in your and my pocket.
Sounds good.
Everyone wins…except for the intermediaries.