Rachel Oliver examines the case for performance measurement

The lack of performance measurement tools in the securities lending market could mean institutional investors are going in blind when choosing a provider and are potentially missing out on better deals.

The business appears to have been too complex to date, for any independent body to ascertain an effective comparison between service pro-viders, to such an extent that the industry itself seems in the dark on who are the leaders in the field. The Robert Morris Association in the US is currently working on a project which will eventually create some form of benchmark to measure the best and the worst of the security lenders, based around a varying set of parameters. But in the meantime, is the industry in a classic case of the blind leading the blind?

The industry as it stands is certainly not lacking in healthy competition - the wealth of service providers reads like a banking who's who, including names such as State Street, Robeco, Citibank, UBS, and in fact most global custodians worth their salt. Whilst there are also independent securities lending agents, the only non-custodian service provider which competes with the banks on a global level is passive investor, Barclays Glo-bal Investors (BGI), with £235bn of funds under management. And BGI for one is eagerly awaiting the introduction of an effective, independent performance measurement tool as the demand for securities lending grows.

Competition is a strange thing in the business currently." says Kevin McNulty, securities and lending manager at BGI. "It's becoming more competitive because clients are beginning to get more choice. Now a pension fund can choose to use typically an investment manager who is offering the service, a custodian or potentially someone who is offering a third party lending arrangement. So we are starting to see an element of competition coming into play with clients becoming a little more mobile with how they deal with their securities lending arrangements. But with a lack of a real performance measurement benchmark, it's really quite difficult to know who's doing well and who isn't."

McNulty believes the introduction of some form of performance measurement would greatly benefit the industry, though any statistics re-leased would be anything but simple for an institutional investor to digest.

He explains: "One of the issues is that around the world there are many different types and styles of securities lending programmes that have very different risk profiles and so the im-portant thing about developing a performance measurement benchmark is that it needs to take into account the difference risk profiles of different lending programmes."

Factors he pinpoints include; "the types of counterparty you're dealing with, the types of collateral you are taking, whether or not you accept daylight exposure, all things like this will impact on your return."

One broker cited the size of the lenders "lendable pool of assets", the range of assets in the portfolios and a "good spread in many markets" as being the decisive aspects of what drives the borrowers, though he adds that size is not everything. "Who's the biggest does not necessarily mean who's the best" he says. But he nominates BGI alongside State Street as the two biggest lenders in the market "as they have the largest lendable pool of assets".

BGI's sizable pool is largely down to the fact that it is the world's largest index manager. "Our core investment management business revolves around index funds." says McNulty. "They are designed to track the indices and do nothing more and nothing less. Once we've bought the index, that position stays in place and obviously money comes in and money goes out but the relative weighting of each of the securities will stay the same".

As a result any of BGI's institutional clients who are willing to lend their securities, will probably find there is no delay in uptake, and are in fact holding some of the most popular securities around. "A borrower will know coming to us, given our large indexed core, that if they borrow a German security from us today, they will in all likelihood not be required to return the security to us until they've finished with it themselves." says McNulty, adding: "They will want to borrow more securities from this type of strategy and this will result in more revenue for the client"

So the borrower is happy, and so is the institutional client to an extent, but in light of the distinct lack of any figures with which to draw a comparison on returns, how can the pension fund decide where the portfolio will benefit most? McNulty puts it down to a key factor which he feels is not treated thoroughly enough by the custodians - credit risk. Securities lending can be a risky business and pension fund clients in particular, says McNulty, are concerned with the risks involved.

"Security lending can be regarded as a natural extension of the investment management business. We place a lot of emphasis on risk management within securities lending. We think investment management is all about risk management in many ways so we can apply the same type of risk analysis and techniques that we apply in in-vestment management."

He adds: "Investment managers more naturally have access to the ex-pertise required to understand and analyse these risks." And while the custodians will not ignore the credit risk aspect and can obviously import the necessary expertise, he thinks this element may not always be a priority. "While there are some good ones there in securities lending there are others who haven't spent a lot of time investing in programmes, so are not necessarily that good but have historically had a captive supply."

One would assume that it would be such custodians who are reluctant to see the publication of a performance measurement table. Indeed,McNulty admits that if it were left to the lenders themselves to incite a thorough analysis of their services, any progress would be understandably slow. Surprisingly though, the lack of drive seems to lie with the clients. "One of the things which perhaps has been missing is the drive from the clients, the pension funds themselves in-volved in the business, pushing to see a performance measurement style introduced." he says. Perhaps it is about time they did. IPE"