Demystifying Stock Lending

Steve Sosnick, Interactive Brokers’ Chief Strategist, talks with Bill Pepe, the firm’s North American Stock Lending manager to discuss the key processes and pricing behind this opaque yet critical aspect of the securities business.

Summary – Traders’ Insight Radio Ep. 14: Demystifying Stock Lending

The following is a summary of a live audio recording and may contain errors in spelling or grammar.  Although IBKR has edited for clarity no material changes have been made.

Steve Sosnick

Hi everybody and welcome to Interactive Brokers Traders Insight radio. This is Steve Sosnick, chief strategist at Interactive Brokers.  I have with me today a colleague who I’ve worked with for over 20 years now.  He and I talk frequently, and we’ve done so for decades, literally.  It’s my colleague Bill Pepe, who manages our stock loan department.  We hope to miss demystify the topics of stock lending and short selling because these are continually of interest to our readers at tradersinsight.news.

Let’s get going Bill.  Why don’t you start by just giving a quick background?  I think I’ve given the basics, but if you could just flesh it out a little bit so the so the listeners know who you are.

Bill Pepe

Sure, first of all, I thank you for the opportunity to speak to you and our audience.  I think it’s probably best if we do a little stock loan 101 so we can get the basics down and then we can delve into other things.

First, as you said, I manage the stock loan desk in the US and in Canada for Interactive Brokers, and have done so for quite some time, as you alluded.

Second, in in terms of stock loan 101 in terms of terminology, I think one of the things that mystifies folks is that it often is stated under different names, so stock loan, stock lending, securities lending securities, finance it all sort of falls under the same umbrella.

So let’s talk a little bit about the key purposes of stock loan.  I just want to pin down the basics so we can dive into some other things.  You have several components of a stock loan deal.  For starters, none of it would happen if there wasn’t borrow demand.  The stock borrower is a firm that typically has a short sale obligation.  That is the primary driver of borrowing stock, although that’s not the only driver of borrowing stock.

Steve Sosnick

Let me just interrupt for one second just so we really get the basics.  If you sell a stock short, somebody is expecting that stock at the other end of the transaction.  Therefore, since you’re selling what you don’t have, your broker or the clearing firm behind your broker is required to borrow those shares to make delivery to whomever bought the stock from you.  They’re expecting stock, they don’t care that you’re a short seller.  The process of facilitating that delivery is what we’re discussing now.

And by the way, let me state for the record, this is a legal activity.  This is something that is routinely done in the in the markets.  I’m going to say this is a lubricant to some extent, like some motor oil that goes on behind the scenes in the marketplace to facilitate transactions.

Bill Pepe

Come settlement date — which is typically two days after the trade date — that short seller has an obligation to deliver shares to the buyer and that short seller’s broker has a couple of possible sources to satisfy that short sale obligation.  They may have shares internally — in other words, from another long customer, or perhaps a proprietary trading bucket that they may use.  If that’s not the case, they may look to borrow externally to satisfy the borrower’s obligation, and that’s where the lender comes in. So, what’s the lender’s primary motivation to engage in a stock loan deal? 

One reason is to generate revenue.  We have long stock, and I don’t want to say it’s collecting dust ’cause there are many uses for a long stock, but you can use it to lend it to a borrower and charge a particular rate in order to generate revenue.

There are secondary reasons for both borrow demand and lending supply or the inclination to borrow or less.

And we can touch upon those in a bit.  But let’s focus on this primary circumstance, if you will.  The components of a stock loan deal are the quantity that which the stock borrower wants to borrow.  The value is, generally speaking, the market value is the quantity times the market price. 

The duration is far more often than not, overnight.  In other words, the stock borrower has the right on any given day to return the shares.  The stock lender has the right on any given day to recall the shares and ask for them back. 

But let’s talk about the rate a little bit since that’s what steers the revenue or the costs associated with the deal.

So, generally speaking, the greater the borrow demand of a given stock relative to float — or more accurately the lendable supply — the greater the cost to borrow.

Steve Sosnick

Let me just interject here that float is something you can look up.  You can find that number relatively easily.  It’s public, it’s the shares outstanding, less those shares held by the company itself or insiders.

The lendable amount is not a number that’s known to people because not everyone either chooses to or is obligated to lend their shares.  And so, the availability of a borrow that lendable amount can be a bit opaque.

Bill Pepe

You’re right on the money.  It can also be said that the short interest is also opaque. Yes, it’s reported twice a month, a month, but it’s not reported on a daily basis, so not everybody knows what the collective demand is to borrow stock.  And so, generally speaking, those are the supply and demand factors that weigh into the cost.

Steve Sosnick

Let’s go into that cost of the borrow because in a basic sense, there’s the concept of general collateral.  General collateral are shares where there’s no reason not to be able to borrow or lend them. They’re plentiful around the street.  They’re not in particularly high demand for short selling.  Effectively what goes on in stock loan is that it’s a secured loan, so there’s not really a ton of counterparty risk in here.  The shares are held in the depository.  The counterparties are usually members of the clearing house, and in the vast majority of cases where it is general collateral, think IBM. There’s nothing particularly special about borrowing or lending that stock, so that’s going to take place around Fed Funds rates, correct?

That rate should have gone up a little bit.  Which does increase some of the revenue to the lender to the lending firms because we’re after the most recent Fed rate hike.  There’s 25 basis points to it now, whereas before the transactions were more or less happening around 0, is that correct?

Bill Pepe

That’s right on the money, yes.

Steve Sosnick

Yeah, so this is just the basic economics.  The fun really comes in when we’re talking about things that are not general collateral.  And I’ll let you lead into that when you feel it’s appropriate.

Bill Pepe

And so, the fun, as you say, is especially felt on the loan side of course, because you have the opportunity to charge a market rate, at a rate that is a greater offset if you will.

I use the word offset to describe the difference between the benchmark, which is Fed Funds as you noted, and whatever the rate may be.  Let’s say we were charging negative 1% and the prevailing benchmark rate was zero spot 25 [0.25%] after the rate hike last week, then the offset would be 125 basis points that we would charge on the transaction.

Steve Sosnick

Spot 25 — that’s just a fancy way of saying 0.25, which is the prevailing rate of interest.  There is something that’s very specific to stock lending that doesn’t occur in the real world all that often: the numbers are quoted in negative.  It’s important to understand why there’s a negative [quoted rate]. 

It’s because effectively, when you borrow shares, you’re lending money and vice versa.  Why don’t you explain a little bit why stock lending tends to be expressed in negative numbers?

Bill Pepe

Sure, and I think it’s fair to start off with your example of IBM or any other highly liquid GC general collateral stock, so let’s imagine that Steve and I are our stock loan counterparts working at different firms, and I’m going to lend GC such as IBM or Microsoft.  Suppose I’m going to lend $1,000,000 worth of IBM to him.  He’s going to give me $1,000,000 simultaneously.  It’s one transaction that occurs versus payment so the $1,000,000 comes to me and that is Steve effectively investing his money.  Since this is totally available to borrow, there’s again no reason why there would be a shortage of supply.  He’s effectively investing his money at the opportunity for which any broker dealer would have to invest that money, which is somewhere around Fed Funds.  I think that’s a reasonable expectation.

OK, now let’s say that he has shorted and therefore is borrowing a stock that is highly in demand relative to supply.  He needs to make good on his delivery obligation associated with his short sale and it’s not readily available.  He can’t call up any number of however many firms are on his roster account.  He’s going to have to work hard to borrow the stock.

And as luck would have it, I do have it in house as lendable supply.  I am going to be able to charge more as you would with anything that is in scarce supply. I’m going to be able to charge more for that stock loan and the way we profit and process his payable or my receivable is in the form of a rate, and the sign convention would be negative on the deal in order for the stock loan post trade processing to handle that billing appropriately.

Steve Sosnick

Let me clarify.  In exchange for lending the shares, you get to borrow money, but you get to borrow that money at a negative rate.  Effectively for that $1,000,000 that we contract to you, when we unwind the transaction I give back the shares and I get back $990,000 or something to that effect. So effectively you’re lending the shares and getting the opportunity to borrow money at a negative rate.  Paying me back less than I would have received in a normal case.  In the example you gave, 1.25% less or whatever, but that’s why it’s negative.

Bill Pepe

Yeah, that’s fair.  I probably wouldn’t have otherwise stated it that way, but that’s a fair representation.

Steve Sosnick

Please tell me how you would state it because you’ve got much more experience with this.

Bill Pepe

No, I think that sort of captures it. I would say that’s what the borrower is willing to forgo.  It’s all baked in.  He’s willing to forgo the opportunity to earn a rate as if he were borrowing IBM to be able to borrow something that’s highly in demand and therefore willing to pay up for it.

 The steps that you just described that actually does capture it for the layman a little bit better.

Steve Sosnick

Thank you.  The logic here would be why would you ever do something that has a negative rate?  Well, you’re speculating, and again, this is legitimate.  This is legal ’cause these shares are all borrowed and subject to FINRA and SEC regulation done legally and appropriately.  You think the shares are going to go down by more than the amount that it’s going to cost you in terms of your stock loan.  That’s the rationale for it.  There’s a reason why people do it.  Sometimes there’s an arbitrage.  Sometimes it’s outright speculation.  We’ll get into some of that as we go on, but I wanted to get through the mechanics ’cause once we start talking negative rates that tends to baffle sometimes and for good reason.

Bill Pepe

Indeed, and I would like to add one other thing on the topic in terms of a firm’s inclination to borrow in in negative territory.  You and I can both recall a time when firms would not at all be inclined to borrow in negative territory.  In other words, to be inclined to pay up to borrow.  That was a time when there was no ramification, no legal ramification, for failing to deliver.  This was prior to 2008, if memory serves, and it’s at that time where the rule came to be that you had to close out a short position if you fail.

Steve Sosnick

Reg SHO [SHO commonly pronounced “show”] is the term you hear all the time.  Regulation “S-H-O” being “short sale.” Reg SHO is a common term.  Sorry, I just wanted to throw that out there.

Bill Pepe

Yeah, no, you’re right on the money and I’m glad you mentioned it by name.  But prior to this rule, firms would willingly fail, and it was a street-wide thing to which the regulators — and I’m glad they did — said, “whoa, what’s going on here?  You know, let’s prevent this activity,” and they instituted several rules.  One of them was if you fail, you have to close out that short obligation.

Steve Sosnick

I will say that a lot of the bad name that short selling got was from what I would call “the bad old days.”  You’ve heard about naked shorts and that’s what Bill’s referring to.  It’s when you shorted a stock without the ability to borrow, that creates failed transactions. The street used to sort of brush them under the rug and people would yell about it, sometimes fairly, sometimes not.

I think a lot of the worst of it got overblown, but there were some fairly nefarious situations and I think the SEC did us all a favor by codifying what is what is required and what is not.  This was a case — and I hope you agree — of sound regulation rather than regulation for the sake of regulation.

Bill Pepe

I do agree 100%.

Steve Sosnick

Let me also explain something else that I think mystifies people in some regard.

Well, I’ll let you explain, I should say. Stock loan is one of the few remaining opaque areas of the financial markets.  It’s really not visible to many people.  The transactions still tend to be broker-to-broker rather than exchange driven. Can you explain a bit more about to what extent it’s still kind of behind the scenes over the counter market?  How much transparency has come into the business since you’ve been a part of it? That sort of thing.

Bill Pepe

I’m glad you brought that up. It’s gotten better.  It’s not completely transparent to the public, but it has gotten better in a number of ways — automation being one of them.  There is better data, at least to insiders, at least to stock loan personnel and to a large extent to institutional traders.

There are a number of vendors that collect and distribute stock loan data.  Does the average retail trader, the moms and pops of the world have access to this information and should they?  No, they don’t, and they probably should.

In fact, Interactive Brokers does a very good job on its Trader Workstation of providing a lot of this information such that its customers have visibility to it there.

There is a proposed rule that is being discussed that is going to add some transparency to the general public, as you suggested, was insufficient, for lack of a better word.  That is being discussed at a high level, and it’s probably going to be something that comes to fruition in the next year.

Steve Sosnick

It does.  Can you go into some of the rules?  Because one of the things that I think caught a lot of people by surprise is that the basic amount of stock loan data is reported by the exchanges every two weeks, and even then, on a lag, and I think that that came to play early last year.  We’ll get into a lot of those mechanics.  Is there some talk about requiring the dissemination of short sale data on a shorter timeframe?

Bill Pepe

I wish that were the case. I haven’t heard about any regulation that is going to disseminate short sale data more than twice a month, and as you said, on a delay.  There are some stock loan specifics, and it’s important to distinguish the difference.

To use stock loan data as a proxy for what the short interest is out there is a misleading thing. What it misses is the component of internalization. I want to revert back to what I said at the beginning of the call, which is when you are a short seller, when a clearing firm has a short sale obligation, generally the first thing that they do is they look to tap into what shares they have on hand to satisfy that obligation, and it’s only after that they absorb that sourcing before they go out and they borrow the shares externally.

So, the first piece of that is not and will not be contained in this Exchange Act that is that is being proposed.  There’s a significant portion of the short sale quantity that is not captured in this stock loan data that they’re going to require to be reported.  And so, I fear that it’ll be misleading in a sense.

Steve Sosnick

That’s important because I think that is lost, and I think that actually plays into the fact that depending on which brokerage firm you’re dealing with, you can get vastly different answers as to what is shortable or what a rate is at any given time.  Your broker has what they call a “big box” in that security, which is the amount of lendable shares.  It can be relatively easier for them to fulfill a short sale obligation.  Either the fact that they can versus can’t, or the price to you may be better.  I would say without being overly promotional that there are certain brokerage firms I could think of — that you and I work for [IBKR] — that tend to have a large box of available shares and tend to be transparent with the rates.

But I think at firms that don’t have that [big box] you can get into some nasty surprises because they are more likely to need to go out to the street to fulfill their customers’ short sale obligations than one that can do so in house.  Is that a fair approximation?

Bill Pepe

Yeah, that is 100% accurate and what I what I like about Interactive Brokers’ platform is not only do you get a good indication of the shares available that you may short — which, by the way, are decremented per short sale, so it’s not like IB shows X amount and then short sales occur and they’re not reduced. They’re reduced to the degree that there are short selling going on, but also the indication of the rate for as much as we can possibly know now. We can’t predict the future, but you know, it’s a real-time rate based on what we know now.

Steve Sosnick

Those rates could be very fluid.

Bill Pepe

They certainly can be fluid, and I don’t deny that, but we’re not in the crystal ball business and so we can only present what we know at this moment. The other things come that I kind of like and I’ll take my promotional hat off in in a moment, but there are other statistics presented, such as utilization. And utilization can be a very good indicator of an expected rate.   Not only what to pay on a short, but if you were involved in in the stock yield enhancement program, which is a revenue sharing program where IB would have a documented relationship with a customer to allow IB to lend those shares and then the revenue is shared per those loans.

So again, the ability to say “All right well, what’s the expected utilization here you know? Is it 90%? Is it 2% and what’s the expected rate?”  I think that’s the kind of transparency that you alluded to when we started to veer towards this topic.

Steve Sosnick

It’s important also to remember the distinction between margin accounts and cash accounts. If you have a margin account, which the vast majority of customers at Interactive Brokers do, those shares are pretty much free to lend — not free to lend that’s the wrong term — available to lend because they’re held in street name as opposed to your own name. Whereas in a cash account, though you can opt out of letting your broker lend the shares.

I don’t think that’s available in a margin account. Is that correct?

Bill Pepe

Yeah, in a margin account any broker dealer has the right and the opportunity to hypothecate 140% of the debit balance. And so, perhaps that means pledging, or more likely it means the opportunity to lend stocks that are in the accounts associated with debit balances.

Steve Sosnick

Yeah, so sometimes you hear a whole bunch of misinformation out there, like “I don’t want to lend my shares”, or, “you know if I use a market order, the shares won’t get lent” or the same if you use a limit order. First of all, let me state for the record that stock loan has no idea whether you placed a market order, a limit order, a good-till-canceled order, a day order.  That’s all irrelevant ’cause they don’t see the transaction until it’s in the settlement process. Not during the trading process.

So let me just clarify the misinformation that got out there. Sometime in 2021 there were all kinds of crazy theories. That’s not one of them, but also what it means is there are situations where people want to squeeze the shorts by not lending their shares.  Yet if you hold those shorts, if you’re the person who doesn’t want their shares lent, you have to move them to a cash account, because if they’re in a margin account, it’s not up to you.

 And this is, again, this is not our rule. This is system wide. So that’s an important distinction, and the stock yield enhancement program to me is a great benefit, because if you have a margin account and your shares are getting lent, you might as well see some of the benefit, which I think is an important feature.

Bill Pepe

Yeah, it’s aptly named stock yield enhancement. It’s a very good program for many, and certainly if one opted to not execute what’s called a Master Securities Lending Agreement with Interactive Brokers, it’s their right not to, but I view it as a very good program.

Steve Sosnick

From an interest rate point of view, unless you have hard to borrow names, you’re not missing out on all that much, with rates being set zero – 25 basis points.

If we start to see a higher rate cycle, as many people predict and Fed Funds rates start to get into numbers that are actually like integers, then that becomes that becomes a meaningful help to your performance*. So, it does behoove you to consider this if you haven’t already.

* The proceeds generated by the Stock Yield Enhancement Program are dependent upon the differential between the rate at which the shares are lent and the prevailing market interest rate.  Customers participating in the program do not see a benefit simply if prevailing rates rise.  For more information: Stock Yield Enhancement Program | Interactive Brokers LLC

I’m going to get to the elephant in the room when people really started to think about short selling when it came to the fore, and that was the meme stock craze of early 2021. Let me preface it by saying that thanks to you and your colleagues, whom I really didn’t credit as much as I should have, we got to explain something that was fascinating.

I wrote something that got a good pick up — again as a result of long conversations with you and your team — about how there could be a bigger short interest in GameStop than there was actually a float and that was a particularly extreme example. And we won’t get into that right away, but that whole meme stock craze put short selling into the fore and to the point where it was in my in my thinking, it was the mother of all short squeezes. 

I could explain the trading mechanics of a short squeeze, and that is when some people realize that there are short sellers who need to cover because they’re facing margin calls or because their stuff gets too hard to borrow. There was an old saying “He who sells what isn’t his’n buys it back or goes to prison” which is interesting ’cause it actually came about before there was Reg SHO. That came about 100 years ago or so.

But if you could explain some of the mechanics of what you see when we get into these short squeezes, it doesn’t have to be a meme stock. They happen with distressing regularity. There’s always something that’s getting squeezed.

Bill Pepe

So that was as interesting a time as any of us can recollect and by the way it sure seems like there’s some ratcheting up on those same stocks in the last several days, so you know we’ll see what happens going forward.

To touch on one of the things that you mentioned, how could it be that there are greater shorts than shares that are out there, namely the float?

So, let’s use a very simple example.  Let’s say the float is a grand total of 1000 shares, to make the numbers easy. And somebody sells short 500 and borrows it. Let’s call the original long, Firm A, if you will, and then the firm that shorted will be Firm B. They short 500 shares and then they borrow the shares from Firm A to deliver to Firm C. At that moment we have total shares outstanding or the float if you will of 1000 shares, we have a collective short of 500 shares. Everything seems reasonable and intuitive at that moment.

OK, so let’s say Firm B says, “I like my short exposure here.  Let me go ahead and short another 500 shares.” And they do so, and now they borrow another 500 shares from counterparty A. I said counterparty but I meant firm. They [Firm B] borrow it from Firm A, they deliver it to Firm C per their short sale obligation.  Now we have a collective float of 1000 shares still — that hasn’t changed — and a total short amount of 1000 shares, so they’re equal at that moment.

And then on let’s say day three hypothetically, he [Firm B] says, “I really, really like my short position here and I would like to short additional shares” so he shorts another 500 shares, and he turns around and he borrows it from let’s say, Firm C, who loaned it to somebody else. And so, what I’m describing here is kind of a circle where the short is ratcheting up. The total float remains the same. No new shares were introduced to the market, and that’s how you have that dynamic that you kind of lead with.

Steve Sosnick

Yeah, in the case of Firm C, he gets delivered the shares, but he has no way of knowing whether those shares are in fact borrowed shares or owned shares.

Bill Pepe

Indeed.

Steve Sosnick

And so, he can then turn around because they’re not flagged, they’re not tagged. There’s no distinction once he receives them, he can then turn around and lend them himself. And so, you could find the stuff getting rehypothecated — if we want to use a bigger word– around the street and because in that situation Firm C is free to lend the shares that he received as a result of Firm B’s short sale, which were facilitated by Firm A. He can then lend them to firm D, who wants to short the stock, and there you have it. So, you could end up in that situation where you have 1000 or 2000 shares, 1500 or 2000 shares shorted, despite the [float] only being 1000 shares.

Now, taken to a grander scale, you would expect to see the rate increase — or in stock loan terminology, get more negative — and so eventually there is a self-limiting factor to it. I think what happened in the meme stock craze was it got taken to the extreme. It became a war, not just an economic event.

The winners in this case were the were the people who seized upon the short selling but, over time these situations do tend to abate, and you see the ebb and flow. Eventually they got the big short, which was Melvin Capital, to cover his short in GameStop and some of the air came out of both the stock and the lending cost.

Explain some of how you see the mechanics going. When they get too extreme, what sometimes causes them to contract back to something more normal?

Bill Pepe

I was thinking about this, in advance of this discussion, so the interesting thing about this dynamic is we take something like GameStop.  I think it’s fair to speculate that the reason why the short interest had been increasing was the whole prevailing wisdom or theory that brick-and-mortar stores were going away. And how is GameStop going to survive that and what have you?  And then what we saw is what you described and that generally pointed the price, as a result of the buying pressure, up significantly.

So, what I would say is, interestingly enough, when the short demand is greater, in other words, prior to what happened in GameStop, a lot of times the rate is at its apex. And after a short squeeze, when shorts have been either forced or because they’re panicked a little bit to come out of their shorts because they fear that exposure. Now what that does in effect is, it reduces the borrow demand and therefore reduces the price to borrow.

But there’s a process that doesn’t happen instantaneously.  The pressure on the rate is elevated temporarily, but then afterwards the collective short interest is decreased because of people coming out.  Then what you see is a very quick 180* back to normal rate territory. So, I don’t want to say it’s as volatile as what we saw with the actual price during those times, but there is a volatility based on that collective borrowed demand.

Steve Sosnick

That was extreme in every circumstance. I mean, ’cause during normal trading over the years we’ve talked countless times about things like “What’s the rate on this. Is it easing? Is it not easing?” Anytime you deal with a product that involves forward pricing, derivatives specifically, the stock lending rate is an important factor of that.

Right now with interest rates around zero, the forward value is basically whatever the [current] value is less dividends. As you start to get positive interest rates, the forward value will be something greater than the present value. Again, plus or minus dividends, unless the stock is hard to borrow, in which case see that the forward value is less than the current value because instead of there being a positive interest rate applied, there’s a negative interest rate applied. It can be a very interesting situation, particularly for people who trade derivative products.

Bill Pepe

Right, and I think you know what’s common in in your world, trading, versus my world, stock loan, is that there’s an emotional component to the pricing and so you see people making trading or stock loan trading decisions based on the extreme volatility of a given stock.

And so, you can wild pricing, again in your world, and rates in in the stock loan world that tend to calm down over time. Oftentimes during the chaos, things are not as intuitive as they might otherwise be.

Steve Sosnick

That’s an important consideration.

There’s another thing what I’m going to call “normal special situations”, getting away from the meme stock craziness. There are plenty of what I would call “standard situations”, when you find that stocks become hard to borrow, some of them being M&A transactions. If Company A is being acquired by Company B, and rather than paying cash, the holders of Company A receive Company B shares. There’s a natural trade there which would be buy A, short B.

If there are warrant deals, you start to see the people buy the warrant and sell the stock against it. What are some of the ones that are on your radar these days?  A lot of it I imagine is SPAC arbitrage where there are warrants that are exercisable, or after a “de-SPAC-ing”, for lack of a better word, there are warrants out there.

Bill Pepe

“SPAC-ing” was probably elevated the most during 2021. I suppose to a degree in 2020, but far more in ‘21. It has largely calmed down in recent months, but I think the general big picture thing that you’re describing is whatever the corporate action event, be it M&A or any other — we saw a recent ADR that was that was taken off the books. — that’s the catalyst. That’s the front-end thing that we deal with two days later come settlement date. Whatever that catalyst was is going to sort of dictate the supply and demand within the stock loan market.

We’re certainly aware of things that happen on the front end, and that’s not limited to corporate actions. That includes what we call pre-market movers or fast-moving stocks, due to some news or maybe not a lot of news. We just see wild and wacky activity in terms of the price of a given stock. It certainly hits our radar a couple of days later here when this thing impacts the stock loan market. It’s something that we want to be very aware of.

Steve Sosnick

So, it’s important for listeners to realize that the stock loan traders are just as sensitive to news, fast moving stocks, corporate actions, as are any other traders on the street. And in many ways their business is more dictated by that because many of the market comings and goings that create news or movement don’t get reflected in stock loan, but the ones that do get reflected in stock loan, really get reflected in stock loan.

Bill Pepe

And I think the speed and efficiency of being proactive in advance of that first settlement date when things start to happen, as opposed to reactive is really one of the facets that makes a good stock loan trader. The ability to be ahead of the curve and not totally reactive to it.

Steve Sosnick

What else makes a good stock loan trader? What else goes into success in the stock loan side of the business?

Bill Pepe

It’s an interesting role because you need to have good relationships within the firm, be it the Clearing Department, the Corporate Actions Department, the Treasury Department.  You have to be able to maintain good relationships with street counterparts because after all, that’s who you’re transacting with on a daily basis. You have to be able to consume news as efficiently as possible to shape your decisions.

It’s interesting, there’s an analytical aspect to it, but there’s also a salesy-type aspect to it that’s unique to a lot of back-office jobs or roles. And traditionally, stock loan has been a back-office or at least defined as a back-office role.

Steve Sosnick

I would call it more middle office as much as anything.

Bill Pepe

Yeah, that’s fair, that’s fair.

But I think it’s all of those things. So, it takes a diverse skillset if you will, to succeed and at Interactive Brokers we have an outstanding group that I’m very proud of. So, I think we’re approaching our jobs in each day in the right way.

Steve Sosnick

That’s awesome, and I think that’s actually a great place, — ‘cause you and I have been talking for a long time — to sort of finalize where we are.

I just have a couple of notes here. We talked about the rule changes that are coming. It’s actually Exchange Act Rule 10-C1 which I have thanks to your notes to me. So, for people who want to learn more, that would be something to look at on the SEC’s websites. And one other thing which we didn’t touch on was the upcoming change to T + 1 which is being talked about as opposed to T + 2. That was another thing people were screaming about in the meme stock era.

I am a firm believer that every day you shorten the settlement cycle, you remove a not insignificant, large element of risk from the system because there’s one day less that something bad can go on between trade and settlement. How will that affect you?

Bill Pepe

Well, I think you hit on the most important component, which is cutting in half literally, the systematic risk at the clearing houses and you know that price volatility that can occur between trading and settlement date. So that is critical.

In terms of stock loan, it’s really going to move all the time periods. In other words, a time period like if you send a recall — which is asking for a stock loan back if it were to come to a buy-in situation. Currently it’s two days from the day that you recall it that would be reduced to one day. It would reduce all the Reg SHO time periods.

All of that would just kind of fall in lockstep with the change going from two to one as it did with the change from three to two a couple of years ago. We are still two years away from moving to T + 1, so there’s nothing right around the corner per se, but we look forward to it when it is implemented.

Steve Sosnick

Does it add efficiency to your side of the business or does it just speed things up by a day? Obviously systemic risk aside, which I think we’re in complete agreement that is a good thing.

Bill Pepe

I know that Interactive Brokers will handle it well. We’re extremely automated, so I think we will react well to it.  I do have a little bit of concern about some firms’ ability to turn around the prior days trading into stock loan recommendations the following day. That seems like it’s a challenge that that perhaps some other firms might struggle with.

I don’t want to speak for them, but in the back of my mind I do wonder about that. For us frankly, it’s mostly a flip of a switch and we’re ready overnight, but I do wonder about the Street’s collective ability to handle the change. Now the fact that everybody is getting two years lead time to build up to that? Maybe that challenge is not something to be concerned about.

Steve Sosnick

I guess we’ll find out in two years.

Bill Pepe

Indeed.

Steve Sosnick

We’re going to wrap it up here. I’ve been talking to my friend and colleague, Bill Pepe, manager of Interactive Brokers’ stock loan for North America.

You’ve been listening to Interactive Brokers Traders’ Insight Radio. You can find our stuff regularly published on tradersinsight.news. One of the most popular features, typically is the most interesting stock loan names that Bill and his team puts on there.

I strongly urge you to keep an eye on that when they come out, and I strongly urge you to stay in touch with us via Traders’ Insight and I want to thank you once again, Bill for taking the time to join me.

Bill Pepe

Yeah, my pleasure. I appreciate the opportunity.

Steve Sosnick

Alright, I think we’ll leave it there. Thank you.

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• Short Sale Cost

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