Asian institutional asset owners’ re-definition of risk over the last two years has altered the way sovereign funds, central banks and large pension funds lend securities and select their custodians.
Institutions used to regard asset lending as additional revenue streams, but that has changed since the financial crisis, says Chong Jin Leow, head of BNY Mellon Asset Servicing, based in Singapore. “Now, institutions better appreciate that reinvesting revenues from securities lending is not a risk-free exercise,” he says.
Non-cash collateral is also not risk-free because there are counterparty and other risks. “So, institutions want a greater understanding of securities lending and consider training as pre-requisite. The credit crunch has caused clients to further assess the risk-reward profile of their lending programme, which reflects the shift of securities lending decision making into the front office, away from investment administration.
“In part, this demonstrates a desire for a more complete on-boarding process that prioritises thorough due diligence across all aspects of programme management, from trading through to collateral management and operational efficiency.”
When an institution accepts cash as collateral and invests that cash, for example, there is the risk of loss. Previously, the risk wasn’t significant, as much of the income from securities lending was re-invested in fixed income, US Treasuries and other relatively safe assets. In fact, Leow says he has only witnessed loss-incurring events twice in his almost 30-year career: in 2007 and 2008, and in the 1980s.
AIG’s example in 2008 petrified the securities lending markets. AIG had lent high-grade fixed income assets and accepted cash as collateral. The cash was re-invested into mortgage-related assets, including US subprime mortgages whose value was decimated during the crisis. By mid-2008, AIG had written down US$13 billion on cash collaterals from securities lending. Nonetheless, Leow estimates that investment outside the traditional asset classes of fixed income, Treasuries and other “safe” assets is likely to continue.
Recently, Asian institutions have begun to cut their re-investment risk management more finely. For example, instead of taking cash as collateral, an institution might lend US Treasuries and take EU bonds as collateral as a sort of risk arbitrage during certain market swings.
The global custody survey indicates that the major global custodians loaned US$1.13 trillion worth of assets as of second quarter 2009. The enhanced sensitivity to counter-party and other risks is also changing the way Asia’s institutions select their custodians.
In fact, Asia Pacific institutions’ return to prudence raised the assets under custody (AUC)at the world’s largest custodians such as BNY Mellon, JP Morgan, State Street, Citigroup, BNP Paribas and HSBC.
From 2008 to 2009, BNY Mellon’s AUC in Asia expanded by 60% to 70%, says Leow. At some asset servicing firms in Australia and New Zealand, AUC growth was reported to be as much as 100% during the financial crisis.
In Asia, the asset services generally sought by institutional investors are basic and tend toward performance and risk reporting, Leow says.
The need for more accurate, timely and consolidated data, especially when an investor has multiple fund managers, may lead Asian institutions down the path already taken by US and European institutions, Leow predicts.
“To focus on their core activity of managing assets, Asian institutions will want to outsource data-centric functions, financial reporting and other mid- and back-office functions as the data load and reporting requirements become more demanding,” he says.
In more developed markets, investors use specialised administration services for alternative asset classes such as hedge funds, private equity and real estate. But among Asian institutions, Leow says the demand for such services will take time to develop.
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