Securities Lending Overview. January 25, 2007

Transcription

1 January 25,

2 Securities lending is an investment strategy in which institutional investors can generate incremental revenue from their investment portfolios by making short-term collateralized loans. In exchange for the security, the Borrower provides the Lender with collateral in the form of cash or other securities. Industry Statistics and Drivers Currently in the securities lending industry Securities lending is a global business with lendable assets of nearly $12.4 trillion and $2.6 trillion of securities on loan.* Over the past two decades, the industry has grown to trade securities from more than 27 countries markets. Why are the lending markets growing? Global expansion of capital markets Increase in hedge funds Increase in market participants Express support from central banks Deregulation of international markets Increase in short selling activity * Performance Explorer data as of 1/9/

3 Traditional Program Structures Traditional Custodial: Custodian also acts as lending agent; assets of all clients are pooled and custodian negotiates loans with borrowers on a best-efforts basis; with lending opportunities allocated according to queuing algorithm. Traditional 3 rd Party Agency: Similar to traditional custodial lending programs utilizing pooled, best-efforts approach and queue; lending services unbundled from custody services through the use of 3 rd party, non-custodian specialist lending agent. Exclusive / Principal: Broker-dealer negotiates directly with lender for a guaranteed revenue amount in exchange for exclusive borrowing rights. Securities Lending Manager/Auction Specialist: Separate programs established for each client, utilizing multiple exclusive borrowers; direct, non-pooled nature of programs eliminates the need for a queue; auction process utilized to optimize program returns. The Incentives Why Lend? Increase returns: Improve portfolio yield Reduce portfolio expenses Why Borrow? Facilitate market transactions: Support hedge fund and prime brokerage activities Developing markets Arbitrage activity Short selling M & A activity Convertible bond trades Prevent sell-fails Participate in market neutral and other program trades Market Participants Lenders Investment funds Corporate and public pension funds Endowments and foundations Insurance companies Borrowers Broker-dealers Prime brokerage units / proprietary trading desks Hedge funds 3

4 Primary Trading Strategies Yield Enhancement Risk Arbitrage Convertible Bond Arbitrage Index Arbitrage SCRIP Trades Arbitrage - the practice of taking advantage of a state of imbalance between two (or possibly more) markets: a combination of matching deals are struck that exploit the imbalance, the profit being the difference between the market prices. 4

5 Lendable Securities US securities Equities Treasuries and Agencies Corporate bonds MBS and ABS securities ADRs International securities Equities Non-US sovereign debt Non-US corporate bonds Emerging market securities High Demand Portfolios Micro, small and mid-cap portfolios International equities Portfolios that continually purchase new issues High-yield bonds Emerging markets equity and debt Newly issued US Treasury Notes and Bonds 5

6 Recent Industry Trends Globalization Leading firms active in as many as 27 markets globally Liberalization of markets allowing the entrance of new participants, increasing competition Consolidation of financial intermediaries Mergers between global custodians and investment firms have reduced the number of players Increase of prime brokerage arrangements Increase in hedge fund activity via prime brokerages has increased the loan activity in securities lending Unbundling of securities lending Third party agent lenders continue to increase market share Beneficial owners increasingly utilizing best of class selection process for securities lending agents. Improved risk management techniques Application of investment industry disciplines Leveraging technology to reduce operational and legal risks Increasing utilization of securities lending by mutual funds US mutual funds own over 30% of lendable assets Continuing trend toward multiple providers of lending services 6

7 Transaction Basics In a typical securities lending transaction, the beneficial owner of the assets will lend securities to a borrower. The borrower must provide collateral in an amount equal to the market value of the security plus margin (2% or 5%). The borrower must return a like quantity of the same security. The diagram below describes a a basic securities lending transaction where cash is accepted as collateral and the collateral is re-invested into a short-term money market investment vehicle. *The above model is based upon a cash collateral securities lending transaction with a margin of 105%. 7

8 When properly planned and executed, securities lending is a low-risk investment strategy. Risk Counterparty Risk: Failure to redeliver securities due to borrower default Controls Focus on well capitalized, high quality borrowers Extensive ongoing credit reviews Borrower exposure limits Daily collateral mark-to-market Indemnification insurance provided in the event of borrower default Reinvestment Risk: Losses or underperformance of cash collateral Establish conservative reinvestment guidelines Monitor weighted average maturity, credit quality, sector allocation and issuer diversification Maintain adequate ongoing liquidity Operational Risk: Processing mistakes and errors Daily reconciliation between program participants Control and confirmation procedures Effective use of technology and reporting Legal/Contractual Risk: Compliance with program guidelines Standardized documentation Audit and compliance reporting External legal counsel with expertise in securities lending 8