This has been driven by the general return to focusing on fund performance after several years in which the agenda has been dominated by risk management and regulatory change. The topics of Risk and Regulation are still critically important, but the headline is now the three ‘R’s – Risk, Regulation and Returns.
Superannuation funds and institutional investors have been focused on managing an unprecedented number of regulatory changes since 2009; at the same time as undertaking their own risk assessments and reviews they have had to cope with unprecedented market events, changing market requirements, and increasingly sophisticated and digitally-savvy clients and investors.
Globally, the financial crisis created a regulatory focus on risk management, capital protection and transparency of risk for investors. In Australia, the regulators added another element—choice for investors. This entailed a suite of regulatory changes that introduced flexibility for investors to switch their superannuation plans easily between providers, or to opt out of the traditional super fund model and set up their own self-managed super funds. This element of choice resulted in fees charged by superfunds becoming a major discussion topic and in some cases more of a selling point for the funds than their baseline performance – a shift to focus on net return.
Added to this has been the increasing use of collateral in the market, driven by regulatory requirements around over-the-counter (OTC) transactions and an increasing focus on mitigating and hedging open positions via collateral and margins. These factors have once again highlighted the role of securities lending to facilitate and support the different collateral needs of clients, which we can broadly classify into three groups:
- Managers who don’t have the right assets to use as collateral, therefore a securities lending programme can help them to source those assets.
- Managers who have the right assets but don’t need to use the assets themselves – thus securities lending presents them with an opportunity to lend these assets to those that need them whilst generating a fee for their investors.
- In the last category are managers who are multi-national and may have some of the right assets but hold them in the wrong places – securities lending can facilitate an overall optimisation to move assets and supplement this with externally sourced assets where needed. Having a collateral management and securities lending programme managed to enhance each other both creates optimisation opportunities but can also reduce the basic risk of co-ordination – i.e. different people trying to use the same asset at the same time.
The current environment
We are seeing growing interest for securities lending from all types of investors looking for alpha. Discussions centre on understanding what assets and collateral types can be included in a lending programme, and how best to manage borrowers, liquidity, and duration risks in reinvestment. For the first time lender the best way to start is often with Australian, US or European government fixed income assets which are most attractive from a lending perspective, but do not create the same risk profile requirements as an equity (e.g. corporate events, proxy voting etc.).
For in-house portfolio managers who are dealing with the increasing costs of trading plus the high cost/portfolio drag of using cash as collateral – we are discussing how their securities lending programmes – which were traditionally in the background – can help facilitate front office trading strategies.
Securities lending and collateral management programmes can lend either versus cash or non-cash collateral (for example, lending a bond versus an equity as collateral), which removes the client’s need to monitor cash collateral reinvestment risk should they prefer non-cash. For some of the larger funds with more experience in securities lending who have an in-house investment team, we are seeing requests for more reinvestment options as they incorporate this activity into their existing risk management protocols.
In international lending we are seeing strong returns globally for government fixed income assets that qualify as ‘high-quality liquid assets’, particularly against non-cash collateral such as major indices equities. The ability to manage non-cash collateral efficiently and effectively has become key.
In summary, securities lending is again in focus as a source of incremental returns and as a facilitator, either to improve performance or reduce operating costs and mitigate risks/help to meet regulatory obligations - an effective tool to assist in managing the three ‘R’s. However, unlike some of the programmes of the past, the new generation securities lending programmes must provide flexibility to manage more bespoke requirements as no two superannuation funds are alike.
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Securities lending: unlocking the hidden value of my portfolio
What’s in store for securities lending in 2019?