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The first-of-its-kind digital dividend issued by Overstock.com earlier this year has revealed that the securities lending industry is not yet ready for widespread adoption of digital assets, according to the Risk Management Association (RMA) in a new whitepaper.
The trade body’s financial technology and automation committee has used Overstock’s first issuance of a ‘digital voting series A-1 preferred stock’ in May as a case study to measure the securities lending industry readiness for widespread adoption of digital assets and other emerging technologies.
Overstock.com is seeking to disrupt the established order of publicly-traded shares being freely available across exchanges by limiting holders of its shares to trading exclusively on its venue: tZero.
The paper explains that securities lending was able to weather this corporate event by “over-communicating with market participants and hand-holding during the transaction lifecycle”.
In hindsight, it states, “considering the resulting actions by securities lending market participants, the approach to handling this type of issuance may need to evolve and become more deliberate”.
“Orchestrating a one-off mini-close-out, restricting lending, selling off entire positions, and opening accounts at the tZero alternative trading system worked as backstops, but the industry must come together to provide a strategic and consistent solution for the future,” the paper continues.
Currently, the industry could not replicate its Overstock.com response, the paper concludes.
The novelty of this form of corporate action was at the core of much of the concerns for securities lending participants highlighted by the RMA’s paper.
For example, a short squeeze during the dividend period occurred, in part, as a result of many agent lenders being uncomfortable with lending until they were completely clear with how they would receive their dividend.
A market survey conducted by the RMA alongside the case study gathered feedback from 31 participants involved in the digital dividend event.
Fifty-four percent of agent lenders that owned Overstock.com shares decided to recall outstanding loans and restrict lending over the record date.
The RMA’s paper concludes that in most cases the decision to recall was “driven by concerns over the operational processing of such a distribution far exceeding its inherent value”.
Of those that did lend during the period, some accepted the digital dividend but 82 percent preferred to receive an equivalent value in cash.
Market participants must learn from this corporate action and prepare to adapt for the possibility of others, the paper says.
The study and supplementary survey and report represent the committee’s first steps in creating a roadmap and industry playbook on how to tackle new issues as they “inevitably occur in this ever-disruptive industry”.
The full whitepaper is avaliable here.
