Exclusive Online Only ContentSecurities Lenders Seek to Unwind Positions, Reduce Risks
July 22, 2009
Firms participating in securities lending programs are trying to reduce their risks and push for greater disclosure of what happens to cash given as collateral, according to a survey released this week by Callan Associates, a San Francisco-based investment consulting firm.
About half of the respondents to the Callan survey said they are undergoing a process called “controlled unwind” to reduce the risks in their existing securities lending programs and minimize current and future losses. Properly executed, an unwind involves recalling securities out on loan without incurring any financial loss or restricting either the number of transactions or the types of securities lent.
Almost all the respondents are using their current custodian or securities lending provider for the unwind and most believe it will take one to three years to complete, said Callan.
Fees from securities lending are often used to offset custody and investment management charges and other administration fees. Some fund managers use securities lending as a way to enhance the performance of their funds.
More than half of the 44 respondents who said they wanted to make changes to their securities lending programs rank fine-tuning their cash collateral reinvestment guidelines as their top priority. This reflects a common concern among respondents about losses coming from the reinvesting of cash used as collateral against the securities that are lent out.
Unlike their European counterparts, U.S stock lenders have traditionally preferred cash collateral valued at about 102 percent of the lent securities. This is designed to reduce risk and provide an opportunity to reinvest the monies and increase the yield. However, some assets held in such pools such as mortgage-backed or asset-backed securities may become illiquid and hard to value or convert when cash is needed back.
Northern Trust and JP Morgan Chase are the targets of lawsuits from pension fund trustees for alleged wrongdoing resulting in large losses in from the cash collateral they reinvested for pension fund clients. As a result, many plans are also finding that it behooves them to ask more questions and pay closer attention to the fine print of their securities lending programs.
“Fund and plan sponsors said they are reviewing their investment policies and guidelines with a resolve to manage risk, understand the attribution of earnings, tighten compliance, seek better transparency and disclosure and strengthen accountability,” said Callan. “Disclosure regarding risk profile and program structure – along with redemption issues and exit strategies ranked highly with nearly four out of five respondents.”
The firm surveyed 72 fund and plan sponsor organizations of which public and corporate funds comprised the majority of survey respondents. About 54 percent of the respondents were mid-sized funds that hold from $1 billion to $9 billion in fund assets. Nineteen percent of the respondents were small funds with less than $1 billion. The remaining respondents were split between “mega” funds with more than $25 billion in assets and large funds with between $10 billion and $24 billion in assets.
