Global Markets

senior vice president, Stream, SunGard's capital markets business

Does HKEx Have the Midas Touch?

Posted by

This blog post originally appeared on TabbFORUM.

The London Metals Exchange (LME) achieved record transactions in April, which may suggest the Hong Kong Exchange and Clearing (HKEx) was smart to acquire it in December. Still, the situation is complex. Although the HKEx has significantly boosted turnover in the wake of the acquisition, it anticipates contributions from the acquisition will be limited in the next two years as costs offset gains in trading fees. The acquisition came amidst fierce competition among Asian exchanges and represented Asia’s first completed international exchange acquisition.

Other exchanges have already shown interest in a shift of metals trading into the Asia-Pacific region. For example, in 2011, the Singapore Exchange (SGX) launched LME mini-contracts (20% of the standard contract size) on aluminum, copper and zinc. These proved successful on launch, yet the volumes plummeted from June 2011. During February 2013, trading volumes were zero on copper and aluminum contracts, and there was little movement on zinc. The future of the LME mini-contracts traded on the SGX now seems uncertain.

The HKEx has stolen a march on its rivals through acquiring the LME – which conducts more than 80% of the global non-ferrous metals on-exchange business. Indeed, the LME trading volumes often exceed world metal production by a factor of 40.

Although volumes are impressive and there is immense demand for metals in Asia, the HKEx’s strategic reasons for buying the LME were not based on metals alone.

As the exchange investigated the acquisition around late 2011/early 2012, the HKEx published a document revealing the less obvious “pot of gold.” While recent years had seen equities trading volumes going down and even trending lower, derivatives trading volumes broke records. The HKEx devised a strategy centering on expansion into commodities – which could help safeguard against peaks and troughs in other traditional asset classes.

Its LME acquisition seems to mark a key milestone in realizing this strategy, with the HKEx seeking to position itself as the international exchange of choice for China, and the area’s exchange of choice for international participants.

The acquisition will give Chinese traders increased access to the LME, which HKEx chairman Chow Chung Kong anticipates will boost trading volumes and share. The impact of the China market could be substantial, given that China currently consumes 42% and produces 32% of the world’s base metals.

The acquisition is also expected to lead to an upturn in China’s domestic market, especially through the Shanghai Metal Exchange. Overall, the new opportunities for Chinese brokers to trade new markets should spur growth of the metals business in Asia.

This growth should lower barriers for Asian and Chinese investors to access the LME. According to HKEx, the benefits will include: facilitating easier cross-border access, developing Asia time zone trading and clearing, offering RMB clearing services, and extending the LME’s warehouse network into the Mainland.

There is also a plan to build a London-based clearing house to achieve self-clearing for base metals. This will support Asian time zones, Asian products clearing (including RMB), and OTC clearing and trade repository services for commodity derivatives. Plus, HKEx intends to introduce a LME warehouse network in China.

In addition to representing a major step in the shift of commodities towards the Asia-Pacific region, the acquisition of the LME should help enable the HKEx to diversify its assets and maintain its growth, and perhaps help power Hong Kong towards becoming Asia’s top financial market hub.

Certainly the boost from recording Asia’s first international exchange acquisition and its optimal location at the doorway of China is giving the HKEx a major new advantage.  However the story doesn’t end here. With the continued growth in demand for commodities in the Asia-Pacific region, we can expect the regional commodities exchanges to become increasingly competitive both in terms of volume and of market participants. Perhaps other exchanges in the region will have the Midas touch as well.

global head of connectivity, SunGard’s global trading business

Come Trade with Me

Posted by

A version of this blog post was originally published by the Financial Times.

Recently, I traveled to Madrid. I booked a flight on British Airways and found myself flying… Iberia. Of course these days these two “national carriers” are part of the same company, listed primarily on the London Stock Exchange and Bolsa y Mercados Espanoles, the Madrid exchange.

The Madrid and London stock exchanges are both over 150 years old and fiercely independent. They used to be among scores of independent stock exchanges around the world, all existing to serve their local markets with listings of companies from their country or local area. But increasingly independence is the exception, not the norm, for stock markets.

Like airlines, when countries from Austria to Zimbabwe took pride in having “national carriers,” having your own stock market was a calling card for a nation, even a region. Just as the economics of airlines have prompted alliances no-one could have conceived of – Air France KLM, for example – the economics of stock markets are increasingly leading to a shake-out of the industry.

And just like with airlines, the traditional players are being challenged by low cost entrants who are shaking up the perceived business model by stripping it back to the basics of what traders want from a market. For every Easyjet or SouthWest Airlines, there are multilateral trading facilities (MTFs) such as BATS-Chi X or hungry new entrants, like the Intercontinental Exchange (ICE).

Hardly a week goes by without another deal or alliance being struck among exchanges. The partnerships change all the time creating the most unlikely bedfellows. But in reality all they are doing is following the money.

We are often told that we live in a global world. What happens in Sao Paulo can move markets in Shanghai. This means that traders can be in any location they choose – and these choices are dictated by the availability of skilled labor, the nature of the tax regime, regulations and probably where hedge fund managers want to send their kids to school. From that location they want to trade in any security anywhere in the world. Their choice of market is not predicated on any national loyalty – they will go where there is the best opportunity, the most liquidity, the lowest costs and the least hassle.

As a result you have seen an increasing flow of companies listing on stock markets outside their home territory – from Israeli technology companies on NASDAQ to Kazakh miners on the LSE and Manchester United, an English football club with a Scottish manager, listing in New York where “soccer” is at best a minority sport. Even when a company has its primary listing in its home country, you will often find that the investor community and the majority of trading happen in other places.

Like airlines, national exchanges have had to adapt from being near monopolies in their home markets to being relatively small players in an increasingly global marketplace. They have had to invest in systems and infrastructure to compete and yet still see a large amount of their business being taken by rivals. Against this background it is not surprising that they want to huddle together or face being picked off by global consolidators, worse- altogether forgotten and obsolete.

Over the last few years we have seen multiple alliances in other parts of the world come to fruition. Euronext in Western Europe should regain some autonomy following from the very likely takeover of its parent company by ICE, while NASDAQ OMX in the Nordics, ASEAN in South East Asia, CEESEG in Central & Eastern Europe, and MILA in Latin America have all emerged as important trading blocks, each operating with a subtly different market model.

A fresh crop of new entrants are emerging who reflect the financial strength of markets previously not considered to be worthy of consideration. Moscow shows how, with government backing and strong momentum, a fragmented market can be consolidated to create a credible emerging financial center, fighting for Russian stocks listings that previously would have gone to London or New York. Both the Warsaw and Istanbul exchanges are emerging with similar ambitions.

Where will it end? I can see a few major groupings of markets emerging over time. It is hard to see more than two or three exchange groups in Europe.  The lessons from the airline industry are there to see.

market analyst, Astec Analytics, SunGard's capital markets business

It Started with Tulips, but is the Bond Market the Next Big Bubble?

Posted by

A version of this blog post originally appeared on Forbes.

It started with tulips, went through corn and technology, and most recently hit property and cheap money. I am of course talking about bubbles. Not the type children play with and people write songs about, but the kind that, when they burst, can cause financial havoc.

The word “bubble” is bandied about all too often. There seems to be a constant fear that any price rise could become a short-sharp-shock. The latest in this long line up are bonds. Junk bonds, investment-grade corporates and even U.S. Treasuries – the classic ‘no-risk’ investment option – all seem to be reaching new heights.

Low interest rates and stimulus efforts from the U.S. government and Federal Reserve have brought U.S. yields to record lows. Add to this a fast flow of cash away from riskier equities and into the perceived safe haven of bonds, and maybe there is a case to be made that these fixed income securities are starting to get overheated.

Is this a bubble? If prices slowly retreat rather than burst, overheating like this isn’t usually defined as a bubble. So then, does this increase in demand for bonds look set to pop?

Looking and analyzing securities lending data from SunGard’s Astec Analytics may offer us some insight. If people have started to increase short positions in bonds, this at the very least represents growing concerns that prices may not rise forever, nor yields keep on falling. But could the accumulation of short positions actually precipitate the collapse of the bubble? If people are betting it will burst, could these positions represent the pin that will do the popping?

There has also been a growing sentiment that the U.S. Fed may start to rein in its stimulus efforts, when, and if the economy recovers. Any such move would likely see interest rates rise and demand for bonds, particularly Treasuries, fall. An unexpected announcement from Ben Bernanke, or even a European Central Bank or the UK’s MPC, would most likely act as a ‘pin.’

So what does the Astec Analytics securities lending data show? Are traders taking bets against bonds? Does this mean a burst is on the cards, or does it suggest selling pressure (both short and closing longs) may exert an influence at a more gradual pace?

Looking at the number of borrowed securities over the past year, we can see a distinct difference between implied shorting activity on U.S. corporate bonds, Treasuries and U.S. equities.

While the cash U.S. equity markets made steady gains during 2012 and early 2013, the number of shares borrowed saw only mild increases and generally held at fairly steady levels – a pattern we often observe when the short side of the market believes the price gains are ‘appropriate,’ or have the potential to continue.

The bond market on the other hands shows two fairly distinct patterns – corporates undergo increased borrowing in the first half of 2012, up around 25%, falling back and then bouncing once again in 2013; Treasuries see almost the exact reverse, with borrowing levels declining in the first months of last year, then climbing higher only to pull back again during the start of 2013.

Comparing corporate bonds and equities in the cash market, we have already observed a similar pattern. Both have been gaining over the past 12 months as some confidence surrounding the economy and prospects of individual firms has begun to build.

Companies have found it ever easier to issue debt at low interest rates as demand for their bonds has been strong. Likewise the very real threat of junk-graded companies defaulting on their debt has started to subside from the levels feared last year.

The one difference then is what has been happening recently; while both corporate bonds and equities have continued to climb in 2013, the increase in short interest in bonds has started to outstrip that of the stock market. An increase in short interest in line with climbing prices (when other factors are not an influence) is a pattern we see when short sellers are skeptical of the price move, and believe the securities to be overbought. Here, those on the short side seem to be making bets that corporate bonds will fall in a way shares will not. Is this a bubble?

Moving to Treasuries, their borrowing volumes seem to suggest a pattern all their own. As U.S. sovereign yields fell lower on bond buying and low interest rates, Astec Analytics’s data suggests short selling the bonds began to climb as early as May of 2012. Although at that point, the idea that Treasuries were in a bubble saw little speculation, the perceived pessimism probably began to surface thanks to an improving economic situation and increasing likelihood that the Fed would eventually curb its enthusiasm for stimulus measures.

In this case then, the lending data for the past few months suggest the exact opposite with regard to corporates – short positions may have been building over the previous year, but most recently those on the short side seem to be more skeptical that a bubble has formed, or at least that a bubble would pop any time soon.

Unlike corporates, this also fits in with the long side for U.S. sovereigns. While it is true that Treasuries are holding near record-low yield levels, the second half of last year saw rates creep slowly higher. The yield on the benchmark U.S. 10-year, for example, was as low as 1.4% in June 2012, and so it could be argued the current 2% level actually represents a fairly significant increase.

This easing of demand for Treasuries may be the key point. Rather than the short-sharp-shock needed to burst any bubble, Treasuries have seemingly been undergoing a slowing of demand, a release of air if you will, that may reduce the risk of any actual pop.

So then, is the bond market experiencing a bubble? This may be a matter of opinion, and depends mostly on what one defines as a bubble. A bubble is generally only called a bubble after it bursts, in which case the lending data seems to suggest that short sellers believe corporate bonds may be ready for such a hit.

With Treasuries on the other hand, the story may not be as clear cut. Although any move by the U.S. government to ease stimulus measures would certainly have a massive impact on sovereigns. Astec Analytics’s data seems to suggest much of this turnaround in policy is already being “priced in” to one extent or another.

One should also consider how far ‘ahead’ on the long side short sellers are. If each side is offering fair value, then the risk of the bubble bursting is reduced. If, however, the short side is overly cautious (or optimistic, depending on the perspective), then Treasuries may still be set for a deeper drop than one might think. As of yet, though, the lending data seems to suggest this may at least not lead to a burst to the extent many now fear.

senior product specialist, SunGard's capital markets business

For a Competitive Advantage, Firms Require Integrated Compliance and Surveillance Systems

Posted by

In the wake of a long series of high-profile international failings in market conduct and outright fraud, the Hong Kong capital markets are today under increased scrutiny to ensure trading in the region remains fair, transparent and orderly. The key overarching objective in Hong Kong – and around the world – is to ensure investor trust remains high.

A few incidents that have touched the region recently are high-profile anti-money laundering failings at international levels, suspected collusion in the process of setting interbank interest rates, and identified failings of monitoring and reporting positions.

Whether the resulting regulatory action is a fine or a criminal prosecution, individuals, firms associated with those individuals, and the firms themselves that are found guilty are subject to not only financial damage but reputational damage as well. The press is increasingly monitoring and reporting any suspected and confirmed misconduct within the industry. Ultimately, they also provide fuel to the movement to clamp down and excessively regulate the whole industry.

Another trend is also emerging: customers are increasingly asking a firm about its compliance policy and processes before deciding to commit to long-term and/or large-scale investment services. After all, you don’t want to find that your investments are involved in scandalous insider trading or used by the firm to finance expensive fines.

FIND OUT: What is effective surveillance?

Clearly, there is now a business case for actors within capital markets to invest in efficient surveillance systems.

Compliance solutions must be able to analyze a firm’s trading activity and the effectiveness of its trading strategies, ensure that trading activity falls within regulatory frameworks, and comply with corporate ethics of the company. The system also needs to be integrated with other compliance tools – such as pre-trade risk, social media surveillance, staff dealing and customer due diligence – to give a complete picture of regulatory risk and the ability to demonstrate a comprehensive approach. Finally, firms need a strong compliance and regulatory function. This will also help them demonstrate their corporate responsibility to employees, regulators and the public.

Compliance systems must demonstrate enough flexibility, performance and capacity to cater for future regulatory changes and business requirements, including the anticipated growth in the amount of data that needs to be processed in real time.

For the visionary organization, a well-functioning and integrated compliance and surveillance solution is becoming an important opportunity to get ahead of the competition and – perhaps even more importantly in today’s climate – also a way to demonstrate a company’s full commitment to corporate responsibility and engagement in the evolving regulatory landscape.

After all, how can anyone properly participate in the regulatory legislative process if they don’t fully understand market activities and trends, including their own firm’s contributions? This is true for participants, market venues and regulatory authorities alike.

senior product specialist, SunGard's capital markets business

Brazilian Capital Markets: Evolution Demands Automated Compliance Solutions

Posted by

A version of this blog post was originally published by Brasil Econômico.

The Brazilian capital markets are continuing their exciting evolution into a high-liquidity, low-entry trading and investment space.

To date, Brazil’s BM&FBOVESPA has not shared its in-house clearing services with rivals, preventing the emergence of a competitive exchange landscape similar to what we see in the U.S. and Europe. In addition, buying equities is still a novelty for most individual investors in the country.

With trading largely focused on large-cap companies and executed by institutional traders, the emphasis on active, automated and near real-time market abuse and insider trading detection is just emerging on the Brazilian scene.

The above scenario clearly paints a picture where there is huge room for growth over the coming years, and to follow is an increased focus on market conduct from Brazil’s Commisão de Valores Mobiliários (CVM) and local exchanges. To tap into this growth potential, the CVM is seeking ways to increase the participation of individual investors in the nation’s capital markets.  This will be achieved by making it easier for small and mid-cap companies to enter primary and secondary markets through changes to regulation.

At a board meeting held in November 2012, CVM decided to communicate that it will assess on a case-by-case basis the possibility to grant an exemption (waiver) from the requirements of CVM Instruction No. 400, of December 29, 2003 (CVM Instr. 400/2003), which regulates the public offers for distribution of securities in the primary and secondary markets. This waiver intends to facilitate the access of small and medium-size companies to raise funds through the placement of shares with the investors in the Brazilian securities market.

With these developments inevitably follows the need to more closely govern and monitor market activity. This requirement spans the entire spectrum of investor protection, anti-money laundering, conflict management and staff dealing, as well as active monitoring and surveillance for potential market abuse at different levels in the transaction chain. Indeed, CVM and local exchanges are becoming much more active in their review of trading activities and have a clear message to market participants that improper trading activities will be fined appropriately.

It’s ultimately about risk mitigation. The increase of client trading activity not only brings a larger population of active traders to the markets (which means increased risk of market abuse), but banks and brokers also have a vested interest to ensure trading is conducted fairly and that markets remain transparent. Globally, we see a trend where a solid reputation is increasingly important in order to attract and retain private and retail customer flow.

The good news is that solutions and services providing market surveillance and monitoring are well developed and available as a result from lessons learned in the capital markets of the U.S. and Europe, placing Brazil’s market actors in a coveted position of being able to get things right from the start.

senior vice president, Astec Analytics, SunGard’s capital markets business

Is “Shadow Banking” All Bad?

Posted by

This blog post was taken from the Astec Analytics Securities Lending Focus for February 2013.

Shadow banking is one of those terms that will never be heard in a positive tone, it seems. However, there has been an angle which has been slowly growing – in the shadows you might say – that could be a positive note for the industry and even certain economies.

Shadow banking is a term applied to non-bank organizations (who are not, therefore, regulated as banks) undertaking bank-like activities – in this case, the lending of money. The scarcity of high-quality reinvestment opportunities that yield worthwhile returns has money managers scratching around for new places to invest. This has led to an increase in direct lending to corporations looking for investments that they cannot obtain from the more traditional banks.

An additional source of funds will always help companies seeking finance to grow, and this activity may, in a small way, be part of the answer for the borrowers and the securities lending industry who can supply the cash collateral. Who would have thought that “shadowy lending practices” could be a good thing?

While you’re here…

senior vice president, Stream, SunGard's capital markets business

Key Theme for Asian Middle Office: Automation

Posted by

This blog post was originally published on TabbFORUM.

It is well known that Asia is leading the world in the proportion of trades achieving same-day affirmation (SDA); most Asian trading venues comfortably exceed SDA rates of 90%, whereas the U.S. trading venues currently achieve 70%, on average. The automation of middle-office processes in Asia’s securities markets continues to be implemented with great vigor. This trend is undoubtedly being propelled by forthcoming regulatory requirements; yet there are other factors also driving the development.

Clients are demanding ever greater efficiency, with SDA being seen as not only best practice but an essential requirement of broker-dealer service level commitments. It is evident that error rates and the operational costs associated with them could be radically reduced, and general settlement efficiency could be significantly improved, if all details of a trade are agreed to on the day it is executed.

Of course, automation gives other benefits to broker-dealers besides merely reducing trade failure. Other examples include more reliable trade allocation, the ability to accurately monitor one’s securities lending, and the automatic alerting of corporate actions.

Recently, broker-dealers have found their clients demanding SDA, electronic confirmations and the streamlining of the settlement lifecycle. Accordingly, the relative efficiency of middle-office processing has become a means by which brokers can differentiate themselves from their competitors. A sell-side provider that proves its ability to handle increased volumes efficiently would likely attract further increasing volumes. With error mitigation, the provider can also help to keep costs down.

For brokers, the automation of post-trade processes is a no-brainer: It makes smart sense operationally and financially, and it is essential to compete and to comply with regulations. It also enables brokers to be better prepared in their processes for the inevitable future contraction of trade settlement periods.

Many Asian sell-side providers with automated middle-office processes not yet in place are urgently striving to implement them to gain a competitive advantage. Based on industry news, Australian market participants and Chinese firms are rapidly signing with system providers offering automated middle-office suites that can be implemented around existing processes.

With Asian capital markets participants seemingly leading the way in post-trade efficiency, it may only be a matter of time before electronic same-day affirmation and confirmation nears 100 percent, as would befit one of the world’s fastest growing regions.

While you’re here…

global head of connectivity, SunGard’s global trading business

Back to the Future

Posted by

This blog post was originally published on DerivSource.

The news that NASDAQ OMX is investing into Dutch alternative venue TOM MTF proves once again how much the European trading landscape has changed recently, with the focus increasingly shifting from equities to derivatives, given the paucity of trading volumes in equities and unsustainability of a lot of the venues that appeared on the scene after MiFID.

TOM MTF, short for The Order Machine, counts the largest Dutch institutions as shareholders (Optiver, Binck Bank, ABN, IMC) and has been working largely under the radar for a little while, first launching an equities MTF with a lit order book specialized on Dutch stock. Then followed, after a long and protracted battle; the launch of the relatively novel idea of a competing MTF listing and trading single stock equity options on Dutch stocks, which put in direct competition with NYSE Liffe Europe’s Amsterdam business.

With strong backing in the Dutch financial community and a market quite used to trading derivatives, TOM MTF is one of the very few trading venues to have chosen derivatives as their main focus, introducing competition in an area typically considered a duopoly in Europe between NYSE Liffe Europe and EUREX. With a market share around 15% in equities options for a trading platform launched little more than a year ago and with the usual difficulties with regards to clearing and settlement that have affected other alternative venues in Europe, such as Turquoise Derivatives, they are today one of the few credible derivatives alternative market – albeit operating on a small niche.

NASDAQ seems determined to get back into the thick of it in Europe, after the unfortunate experience of NASDAQ OMX Europe (remember them?), one of the first pan-European MTFs which failed to garner enough traction against Chi-X, Turquoise and BATS, and ultimately closed a few years’ back. The combined launch of NASDAQ NLX, competing in the rates business with the exchanges mentioned above, and now with the possibility to spread the battle to the listed equity options world through the TOM MTF “franchise” is definitely an interesting combination, showing the strength of the trading platform operator.

Interestingly, NASDAQ OMX through the TOM MTF investment has also acquired the opportunity to go back to equities trading competition, as the Nordics equities landscape increasingly fragments, no longer being a “chasse gardée.” We may be closer to seeing Europe finally turning into a single market, no longer a series of individual markets linked through technology. It may also be that we will see new life breathed into some of the market consolidation brutally curtailed by the successive failures of the LSE/TMX and Deutsche Boerse/NYSE Liffe Europe tie-ups.

Many of the current alternative venues are not viable, and the larger operators need to prove to their shareholders they have a strategy, and one that works: diversifying, buying market share or integrating new ideas could very well be the way forward.

While you’re here…

trading and client connectivity, SunGard’s global trading business

European Equity Trading: Research and Regulation Collide

Posted by

This blog post originally appeared on TabbFORUM.

Tabb Group’s new report, “European Equity Trading 2012/2013: Changing the Rules of Engagement,” highlights some issues that we must hope politicians will note during their review of the MiFID regulations.

It’s no exaggeration to say that Tabb’s research profiles an equity market in crisis ─ arguably one that is dysfunctional in some important respects. “Lit book” trading volumes have again fallen sharply in 2012, and there has not been a correspondingly large increase in dark pool trading. So the predicament, as it appears to most buy-side firms, is one of vanishing liquidity. And the buy-side’s primary concern – as reported to Tabb – is how and where to find what liquidity is left.

There are worrying signs of a self-reinforcing downward spiral, so one objective of regulatory change should be to stop or even reverse this trend. Good liquidity, after all, usually implies tight price spreads and the best results for end investors – the people whose interests the MiFID regulations are intended to serve.

The market fragmentation unleashed in 2007 hasn’t helped in this respect, as it has spread the thin post-crisis trading across an increasing number of platforms. In the absence of a consolidated tape of traded prices, fragmentation has also posed another challenge to the buy side: a serious lack of market transparency. This, at least, looks likely to be rectified with MiFID II.

But can MiFID II help with the liquidity crisis?

At the moment, it does not look likely. Even if we put aside the threat of a minimum resting time for orders ─ which may not appear in the final regulation ─ MiFID II has worrying implications for liquidity. A central finding in the new Tabb research is that block trading is in decline, with traders instead choosing to slice large orders via algorithms and then trade many of those small slices in dark pools. It’s clear that asset managers are increasingly finding this the safest and most efficient way of implementing buy and sell decisions in major portfolio adjustments.

But the broker crossing networks and dark multilateral trading facilities (MTFs) that support this mode of trading will not be allowed to do so after the implementation of MiFID II as it’s currently drafted – MTFs and “systematic internalisers” will have pre-trade transparency waivers only for “large in size” orders. So, who knows where those fugitive smaller orders will get executed? When we consider this factor alongside the constraints on market-making activity implied by the MiFID II drafts, it seems clear there is potential for a further downturn in liquidity.

Elsewhere in the Tabb Group report, it’s positive to see the increasing focus on execution quality and the rising usage of transaction cost analysis (TCA) in measuring it – often with multiple systems now being used for cross-checking. But the liquidity concern remains: if new regulation causes further volume reductions, then the market impact of larger orders will grow and those detailed TCA reports could make for depressing reading.

So let’s hope that MiFID’s apparent mantra of “transparency at all costs” is moderated, before the costs become too high.

market analyst, Astec Analytics, SunGard's capital markets business

Is Fresh Blood on the Cards for Groupon?

Posted by

The last six months have seen a growing trend; so-called second-tier technology start-ups such as Netflix (NFLX) and Zynga (ZNGA), which in a very similar fashion to the tech-boom of 2000 have been heralded by some as sure things with almost infinite potential, have been disappointing all round. An easily copied unique selling point (USP) has seen an influx of larger rival firms, with more money and bigger brands, hit revenues and profits while the ‘original’ company had to sit back and watch their good idea make someone else money. The latest in this series of firms is the online bargain site Groupon (GRPN), which has generally been considered one of the most promising.

As with others of its ilk, and just one year after going public, Groupon reported disappointing revenue and profit numbers at the start of November; missing out on even its own conservative estimates. Its share price has been on a steady decline ever since topping a $26 high in its first weeks of trade, now trading at less than one-fifth of this price. The company has been making efforts to halt this tide of declines though, diversifying its revenue streams and more notably, implementing a strategy of international expansion. The problem with this however, is that it has seen only fairly limited results, with initial growth from its foreign business soon succumbing to another key headwind the company faces – the European debt crisis.

Most recently pressure has started to surface at the top, with CEO and founder Andrew Mason admitting that the board has started to question his ability to run the company, with a potential leadership change now on the cards. With all this uncertainty, and with its share price trading near an all-time low, action by short sellers is becoming more and more significant. Securities lending data from SunGard’s Astec Analytics would certainly suggest that there is a large number of traders short selling Groupon’s stock, no doubt both a symptom and cause of the share price pressure. But with high levels such as these, there is always the potential for a strong turnaround on positive news to spark a surge of covering that may just bring Groupon shares some support.

In the summer of this year, around the time Facebook’s IPO disappointed and following lackluster results for Groupon itself, the cost of borrowing the company’s shares surged to almost 90% on an annualized basis – meaning that any trader who wanted to hold a short position for 12 months would in effect be paying 90% interest.

As we can see in the chart however, this trend with the cost of borrowing did not last. In fact the rate saw a massive drop-off over the subsequent months, followed by a rapid increase in the number of shares borrowed. This move tells us two stories: Firstly, that as Groupon’s share price continued to plummet, some of those with short position started to run away and take profits. A number of more optimistic and contrarian opinions at the time no doubt helped seed the idea that the company’s shares may not fall forever.

Secondly, and one that has most likely been played out in the company’s share price in the months since, is that the increased demand to short sell Groupon led to more if its shares being made available in the market on loan. As with anything, increased supply results in reduced price and the rapid rise in the number of shares borrowed shows us that these new loans were snapped up. In fact our data shows that throughout this time the utilization rate, the percentage of shares on loan that are actually being borrowed, was almost always 100%. Simply put, summer this year seems to be when most people started to realize that Groupon’s prospects were not as clear-cut as originally expected.

November’s results disappointed and both share price and short selling reflected this; the number of shares borrowed climbed 30% during the month while the cost of borrowing more than doubled. Mason’s announcement and his seemingly willingness to resign, has offered investors a ray of hope.

The chance of an easy transition if one is needed, and the idea of fresh blood leading the company forward, have helped sure up some mild support in the share price and have resulted in an immediate mild reduction in short interest. Whether or not this is sustained is of course a different matter. This small piece of positive news has a long way to go before it can turn around the more fundamental issues facing Groupon, but if it does spark some interest, there is a lot of room on the short side for long, sustained, squeeze.

While you’re here…