Investment banks have enormous positions to fund on a daily basis. This will include not only its own proprietary positions but also those of its clients who make use of the bank’s market capabilities and its ability to maximise collateral to get the best possible deal. By making good use of the soup to nuts banking facility the investing client hopes to gain the best possible financial outcome. Please note this does not necessarily mean profit, just financing.

This was the set up banks hoped for after deregulation of the markets in 1986 and the anticipated explosion of business and massive profits that quickly followed all the way until today. Banks being able to supply their clients with a complete range of services has also created a double edged sword.

First, it is great for investing clients during a bull market but not so great during a bear market where there is a contradiction between what’s good for the bank and what’s good for its investing client. We have seen plenty of evidence in recent times how this confused ‘one size fits all’ can seriously breakdown and damage the health of all in the markets.

One of the major reasons why Investment banks are able to supply their clients with such massive benefits (well in the good times anyway) is to utilise their short positions to fund the bull positions of both their proprietary trading accounts and their clients investment accounts (were clients are also allowed to sell short).

This funding is achieved by borrowing a large amount of stock from the vaults of institutional lenders to deliver against their short position trades. The borrowed stock gains the investment bank added revenue by way of interest from the lending agent who in turn also pays the lender. The interest received by the Investment bank is able to be offset against the financing interest of the long positions of both proprietary and investing client accounts.

This is one of the few transactions in the market where no one loses. The Institutional lender gains interest from assets lying in the vaults, the lending agent takes a fee for managing the transaction and the Investing banks and their clients gain interest to reduce financing costs.  

This type of transaction will be presented and discussed at the next Post Trade Forum debate “Should Short Selling be banned?” on the 22nd February at the London Stock Exchange.