Our firm retained some researchers to look into how the largest 50 UK pension funds view securities lending and more specifically risk management related issues. Our research was conducted purely in the UK, as the feeling was that there would be little difference across Europe. All the funds had over £2bn (E3.2bn) under management.
Securities lending is an enormous and profitable business. At any one time, a trillion dollars of assets might be on loan and every year the beneficial owners earn about $5bn in fees for what is hopefully configured as a relatively low risk activity.
What one has to ask is whether trustees should completely over look such a profitable business with a fiduciary responsibility to do the best for their underlying beneficiaries – particularly in light of the potentially high risk-adjusted returns.
So what did we expect to find out and how did the results surprise us? Given the peripheral nature of this activity, we did not expect universal participation.
We also expected the universe to be on top of the risks associated with lending securities and to be comfortable with the information that they were receiving.
Our first surprise was a pleasant one – how open minded our respondents were – 38 of our 50 targets were happy to reply in detail. Then we had a big surprise. Less than 50% of the largest UK pension funds actually lend securities – only 18 of our 38 respondents.
There were more surprises to come. When asked why they did not lend, the non-participants gave some rather interesting responses. Of the 20, seven cited their belief that securities lending was ‘too risky’ or ‘not worth it’. When asked to quantify how much was too risky, or to define ‘it’, we were greeted with silence.
From our perspective, this was fascinating. The good news was that risk was a serious issue and concern for the respondents. The bad news was that they had drawn subjective non-quantifiable conclusions. However, our overwhelming feeling was that they were wrong to cite risk as a catchall excuse for not lending.
Securities lending programmes come in all shapes and sizes – one can accept cash collateral or not, daylight exposure or not, be indemnified or not - all, of these decisions alongside many others impact the risk of lending. Financial risks can be quantified and you can therefore implement a programme that suits your risk profile rather than choose to not participate on risk grounds without tackling the issue.
It should be remembered at this point that securities lending is, as one astute agent puts it ‘an over-collateralised business’, done with a limited number of counterparts under the terms of industry-standard documentation. It is by no means risk free, but the risks can be quantified, managed and mitigated. The other non-participants were ‘unsure’ as to their rationale, cited a lack of interest and had no feel for how much money was being generated. However, as they sought to explain, one phrase kept coming up. Securities lending was ‘too much hassle’.
This was a surprise as outsourcing securities lending to custodians, as most of the active lenders had done so, or using specialist agents or principals is a pretty straightforward way of getting involved and outsourcing to experts.
Given the borrowers’ hunger for assets and the attraction of large pools of inventory it is shocking that the asset managers, custodians or brokers have not made their argument stick. It may be that there are ‘lower hanging fruit’ elsewhere and that the UK pension funds fiscal position, historic lack of interest in cash re-investment and asset mix are reasons behind this lack of penetration. It may also be that the perception that lending is ‘too much hassle’ is one the marketing and sales staffs need to address head-on. We believe lending can be conducted safely and easily without creating too much work for the beneficial owners and their trustees but our research shows that this message is not getting through.
The response to another of our questions may reveal why this is the case. We asked the active lenders how frequently they reviewed their lending programmes. Fifty percent of them reviewed their lending on a monthly basis and the others did so annually. Few were fully happy with their risk management information and several got ‘none’.
With those that are engaged giving the activity such little attention, imagine how short that of the non-lenders must be. Given the above, the sales and marketing people need to get their stories straight, address the prospects’ fundamental concerns and deliver a clear, concise and compelling message.
Firstly, for the sales people, don’t sell securities lending as risk free. Everyone knows that there is no such thing as a free lunch. Lunch costs far less than $5bn a year and how much less can be calculated. You all know this and your target market does too. But do not get carried away with the risks – they are quantifiable. So quantify them and communicate them. On a risk adjusted-basis this can be a very attractive business, so tell that story and back it up with some facts and figures. Given the widely held misconception (that’s our view and we are sticking with it) about the hassles associated with lending, you need to prove how easily this business can be conducted. Lose this argument and you will lose your audience.
Secondly, for the pension funds, give securities lending a little more attention.Here is a rich vein to be mined. The good news is that this can be done safely and the really hard work can be outsourced. The bad news is that you’ll have to be prepared for a few more sales calls!
Mark Faulkner is CEO of Securities Finance Systems in London