At Barclays Global Investors we have supported the efforts of Robert Morris Associates (RMA) in the US in creating a benchmark for performance measurement in securities lending.
We believe open and active communication between lending agents and beneficial owners is long overdue. A benchmark provides an important framework within which to discuss return objectives and risk tolerances. It allows a context for lending clients to understand their lending agents’ performance relative to standardised and broadly understood performance metrics.
Benchmarking is not new, unknown or generally controversial. On the contrary, it is a tool that has become an indispensable part of the constructive dialogue between plan sponsors and their investment managers. One of the key benefits of establishing a benchmark is that it forces communication regarding any deviations in performance from what has been agreed. Ideally, any variation should be anticipated, attributed and appropriately compensated.
For a benchmark to be credible, it must satisfy three principal criteria. It must be achievable, representative and objective. The difficulties in constructing such a benchmark for securities lending should not be minimised. There is no publicly quoted market, the pricing of loans is not transparent, there is an important borrower relationship management aspect to any successful programme and lending income has been used by custodians to subsidise aggressive pricing in other areas.
We believe the results of the RMA initiative will satisfy the above criteria. By compiling the results of actual lending programmes in the US, the benchmark will be de facto achievable. If there is sufficient participation by the largest lending agents, it will also be representative of the current lending programmes and the risk profiles on the market.
To satisfy the third condition, that it be objective, we believe the survey results should be compiled and verified by an independent third party. This last point is still under consideration by RMA.
Value-at-risk (VAR) has been proposed by some as a more appropriate measure for risk-adjusted performance of securities lending. The results of a VAR analysis are completely dependent on the assumptions made. While we agree that VAR is an important and useful risk measurement tool, we are concerned that the increased number of variables and assumptions it introduces would actually reduce the comparability of programme results.
It is also important to note that neither VAR nor consensus return benchmarking cannot hope to incorporate some of the most important risk aspects of securities lending. Issues such as enforceable legal agreements, adequate operational controls, separation of duties, daylight/moonlight exposure and effective collateral monitoring defy quantitative analysis. Yet they need to be part of the beneficial owner’s checklist when evaluating a lending programme.
The RMA proposal offers the benefits of a benchmark in a reasonable time frame. We agree and hope that this is not the final word on performance measurement and risk management in securities lending. Rather, we see the development of this benchmark as an important first step.