Securities Lending Enters the Market Mainstream
If markets continue to be difficult next year, then more pension funds may enter the securities lending arena for the first time in a hunt for enhanced revenues.
Mark Faulkner, chief executive of Securities Finance Systems (SFS) the UK-based risk management systems provider founded by Faulkner and Charles Stopford Sackville in 1998, says: "Our experience is that pension funds, like every other asset manager, will be sharpening their pencils and looking for ways to cover costs and generate revenues.
"They will be dusting down old files on securities lending, which were not necessary during the rampant bull market."
The pension funds of Imperial Chemical Industries (ICI), the UK chemical company, and the BBA Group, the UK group serving the industrial and aviation markets, have already announced their intention to consider securities lending (see table).
Meanwhile, the [pound]3.8bn (E6.1bn) London Regional Transport pension scheme expects to make [pound]250,000 for its first full year of lending securities. Its securities lending programme, run by JP Morgan Chase, its global custodian, has so far produced returns of [pound]68,000 for the half-year ending March 31, 2001. At year-end, the LRT fund was lending [pound]128m against [pound]132m taken in collateral.
Financial News analysed the annual reports of 30 pension funds to determine the securities lending practices of UK-based schemes.
More than a quarter of the UK pension funds analysed generated additional revenues via securities lending programmes.
Only five of the 10 funds that reported securities lending as an activity, reported the revenues separately. The majority just stated the amount that was on loan and what collateral was taken.
Many pension funds that participate in securities lending, including the [pound]9.9bn British Airways Pension Investment Fund, use the revenue to cover costs such as custody, not to maximise revenues.
The British Airways pension fund, which uses Deutsche Bank as custodian and securities lender, lent [pound]797.7m as at March 31, 2001, generating an income of [pound]1.6m. In 2000, the pension fund lent [pound]404.9m, making [pound]1.2m in revenues.
In moments of market instability such as 1998, the pension fund will stop lending.
The majority of UK pension funds that lend securities do so via their custodians, often on an indemnified basis, excluding cash re-investment. But Faulkner points out that this is not the only route to market.
Pension funds can lend via their fund managers or directly, although each route carries a different risk and reward profiles.
Faulkner notes that some of the largest UK pension funds are actively looking at alternative routes, as many borrowers are keen to develop direct relationships.
The US market is more sophisticated and pension funds there are already using a combination of options. The Florida State Board of Administration is one such fund. It uses Deutsche Bank, State Street and Metropolitan West as agency lenders, and Credit Suisse First Boston, Lehman Brothers, State Street Global Advisors and Barclays Global Investors as principal lenders.
The Dutch railway pension scheme is one European fund that already lends directly.
But the Philips pension fund in Eindhoven and ABP, the E150bn Dutch public health employees pension fund, have taken the custody route and have given State Street Corporation a licence to lend.
Ralph Vitale, executive vice-president and head of the global securities lending business at State Street in Boston, says: "Securities finance is a way to offset rising costs, as well as add incremental performance returns. European funds in particular are substantial cross-border investors, an activity which increases costs."
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