LOCAL customers of the United States giant State Street Bank are being prepared for a new market era, when short selling opens opportunities to develop another sector for banks: stock lending. In Europe, stock lending became controversial because of its connection with Robert Maxwell's use of the technique to plunder his employees' pension fund of millions of pounds. State Street, as one of the world's biggest lenders of international securities, will be stressing the additional returns that securities lending can produce for institutional portfolios. Ralph Vitale, senior vice-president of the bank's global securities lending, said that among Hong Kong companies there was a growing awareness of security lending - especially among foreign companies. ''Once a market is attracting significant outside investment, with a good settlement system and well-regulated participants, the market will become more liquid and efficient. Security lending will form a piece of that development,'' Mr Vitale said. With the extension of the legal maximum stock lending term before stamp duty from two weeks to one year, the market should take off soon. Apart from having the appropriate tax and security laws in place, greater awareness is needed before security lending can achieve wide acceptance. ''People here panic when they hear about security lending. We want to educate them so they know this alternative investment is an important part of what they should be getting from their custodian bank,'' Mr Vitale said. The return on security lending ranges from 20 basis points to 200 basis points on the value of the security, depending on the supply and demand condition of the stock. The mechanics of lending involves the placing of collateral at the agent bank by the borrower, usually in the form of cash. Income is derived from the difference between the rate earned on investing the cash and the rate paid to the borrower for use of the collateral. ''When borrowers place sovereign bonds, or letters of credit, as collateral they will have to pay a fee on borrowing the stock,'' he said. Understanding and managing the risk are key to security lending. The risk of borrower default is covered in two ways: a credit review process and the monitoring of collateral. ''Extensive credit reviews are conducted on borrowers and we lend only to creditworthy customers,'' Mr Vitale said. Monitoring of collateral includes receiving the collateral, setting a cushion margin and daily marking of the collateral market value. Security lending has only become common in the United States in the past 15 years, a result of the development of the derivatives market which involves bulk hedging and arbitraging of stocks, bonds and warrants. ''Various derivatives create opportunities for people to buy or sell something they don't own. The need for security trading will grow,'' he said. The bank is finding that demand for Hong Kong shares is on the rise. But because of the stamp duty restriction it is encouraging its customers to lend their non-Hong Kong securities.
