Securities Lending: More work to be done
Brian Bollen examines the resilience of securities lending as it evolves to meet new challenges and demands in the financial industry
Reports of the death of securities lending have been greatly exaggerated down the years. Some predicted that the near disappearance of dividend arbitrage (also known euphemistically as yield enhancement or seasonal trading) would mark the end. Others have been more upbeat and predict that new driving forces mean it will keep growing.
As one market shuts, another begins to creak open, says Roelof van der Struik, investment manager at the Dutch pension advisory specialist and pension fund manager PGGM. The word sustainability has taken on great importance in this brave new world. “We like stability and we only lend out equities that have an intrinsic value,” he says. “This is sustainable.”
PGGM has lent out securities for nearly 15 years. In that time, securities lending has brought in a steady stream of revenue without any serious incidents or losses, says Roelof van der Struik. Although these revenues are only several basis points on lendable assets, when measured against on-loan positions, they are consistently above the 1% mark. This is a significant return on a collateralised investment with virtually no risk and minimal loss of liquidity, he adds.
For NBIM, the manager of the Norwegian wealth fund, efficient use of its holdings through securities lending is an integrated part of its asset management. Its spokesperson Marthe Skaar, formally reiterating published information in the 2015 annual report, says: “We use both direct internal lending and external lending through an agency established with our custodian. The custodian has access to the securities holdings of the fund and may lend these to other market participants. The borrowers used are approved by Norges Bank and are, for the most part, large international financial institutions. Both equities and bonds are lent.”
The report shows that at the end of 2015, Norges Bank Investments Management’s loans of equities amounted to NOK313bn (€34.8bn), and loans of bonds, NOK133bn. This corresponds to about 6% of the net asset value of the fund. For the record, the report also shows that securities lending delivered incremental return of 5bps in that calendar year.
While the incremental revenues generated by securities lending might remain modest, two or three additional basis points over a five, 10 or 20-year time horizon can provide a welcome boost to a pension fund, says Matthew Chessum, an investment dealer at Aberdeen Asset Management in London. In these challenging times for investors, portfolio managers have a duty to wring every last basis point out of their securities, states another market player, and securities lending will help.
“This has never been truer than now,” says Mick Chadwick, a 20-year repo market veteran, prior to heading the securities finance business at Aviva Investors for the past decade. The extent of the incremental yield enhancement will depend upon the combination of assets and the lender’s risk appetite but it will be unlikely, at the overall portfolio level, to exceed a single-digit number of basis points per year, he adds, echoing the sentiments expressed by his peers.
For passive funds and index trackers, securities lending can enhance performance and boost the viability of offering these funds, he says. But most beneficial owners will be unwilling to take on increased risk in pursuit of an arbitrary revenue target, he states, although some funds with a liquidity profile measured in decades might be amenable to longer-term lending.
The question of whether beneficial owners are open to the idea of broadening their acceptable collateral types and/or becoming more open to term lending to increase spreads in the lower-interest-rates-for-longer environment has become particularly pertinent in recent times. Chessum says that Aberdeen has added main index equities to its collateral schedule not just to remain competitive among its peers but also because it makes sense from a correlation and risk perspective.
“Given that UCITS funds cannot lend for more than a maximum of seven days, and that we lend only overnight, changing the collateral profile in an intelligent way is one route that we can take to distinguish ourselves from the competition,” he says. But Aberdeen would never lend fixed income against equity collateral, he states firmly.
Another enduring issue centres on the quality, or perceived quality, of would-be borrowers. In brief, are lenders comfortable with their agent lending direct to hedge funds, or do they prefer to restrict lending of their assets just to the traditional broker route? Aberdeen will lend direct to brokers against collateral, but not to borrowers themselves. For Chessum, the value of lending to a highly-rated investment bank is the credit buffer that this approach provides compared with lending direct to a borrower.
“Once a CCP [central counterparty] model becomes more mainstream, then this may be possible using the CCP as the buffer but our three lines of defence are high quality brokers, good quality liquid collateral and strong indemnities offered by our agents,” he elaborates. “By removing one of these lines of defence I believe that the risk profile of the programme will be significantly weaker.”
Securities lending continues to thrive as a practice, then, at least in some quarters of the investment universe, continuously evolving to meet the new demands and challenges presenting themselves in the financial industry, exacerbated by the regulatory landscape. While the arguments for and against the use of the technique will likely never come to a conclusive end, there is little doubt that the development in relatively recent times of extensive and reliable market performance data can help by increasing transparency and efficiency, and by enabling a more reasoned assessment of pitches for new business.
Aberdeen runs quarterly performance reviews where its agents provide regional performance benchmarking. “We look at outliers and market trends and this filters into our lending strategy,” says Matthew Chessum. “We can ask optimistic wannabe providers why they think they can deliver the figures they quote, and we would advise them not to overcook their estimates to win business.” A key message is that such
providers ought not to over-promise and then under-deliver, and the proof of the pudding is surely in the eating. Aberdeen lends its securities through eSecLending, an independently owned company, and BNP Paribas Securities Services, and has never changed agents in the 15 years or so that it has been in the securities lending business.
In conclusion, there is clearly a consensus that while the market data situation has improved vastly in the past five years, at least in terms of volume, there remains much work to be done –not least in the crucial area of timeliness. Van der Struik says: “If you are using equities as collateral, you need something better than yesterday’s prices. You need greater sophistication in your monitoring because equities are inherently more volatile than bonds.”
Market participants doubt, though, that the additional work will take place in the immediate future, largely because of the cost involved in time, effort and money.
Five lessons PGGM learnt in 15 years of securities lending
• Collateral is there to mitigate risks and for no other reason.
• Securities lending is an activity that should be overseen by the front office.
• Focus on the details – make sure the scale and commitment is there to have securities lending expertise in-house.
• Do not let the tail wag the dog – in other words, remember that securities lending is an add-on rather than a core activity. Securities lending is supportive of the fund investment manager and their returns. Do not in any circumstances trade revenue for risk.
• From a risk-return perspective, securities lending would seem to be a good investment.