Securities Lending & Commission Management Update

Transcription

1 N O R T H E R N T R U S T Securities Lending & Commission Management Update Prepared for Retirement Boards of the City of Fresno Fire & Police and Employees Retirement Systems Don Anderson Antwon McGruder Securities Lending Relationship Manager Northern Trust Securities Vice President Vice President (312) (312) DSA3@ntrs.com AM240@ntrs.com 2012 Northern Trust Corporation

2 Commission Management Review Rolling 12 Months July 1, 2011 through June 30, 2012 Program Commission $ 756, Rebate basis $ 59, Rebate $ 46, Rebate % 80 Domestic 70 International % CM trades of total % Effective commission rate Before rebate After rebate 1.49 cps (cents per share) 1.40 cps 2

3 3 Effective Commission Rates Rolling 12 Months

4 Commission Management Summary Current Environment Commissions have been falling for the last few years Providers excluding trades having commissions under a specified level, usually 3cps Many CM providers and participating brokers left the space Program economics tough in the lower commission environment Northern s Commission Management, a smarter approach Northern Trust Securities restructured its Commission Management program Economics work for all parties All trades are eligible Rebate basis is 80% commission in excess of the executing brokers cost of trade processing Economics work for City of Fresno Retirement Systems Recaptured amount lowers effective commission Benefit to plan until there is no rebate available No rebate available means plan is trading at broker s cost. 4

5 Northern Trust Global Securities Lending 2012 Northern Trust Corporation northerntrust.com

6 Background of the Lending Process It promotes market efficiency and liquidity Integral component of developed securities market for both domestic and international investors Allows price discovery and the arbitrage of pricing inefficiencies Supports the development of the capital markets by facilitating various investment strategies Important part of risk management Used for fail coverage to ensure smooth settlement cycles Why do borrowers borrow and lenders lend? Who lends securities and why? Long-Term, Institutional Investors An investment tool to enhance portfolio returns To offset or eliminate costs of custody and administration Does not interfere with portfolio strategy investment manager should continue regardless of securities lending Who borrows securities and why? Investment banks (Prime Brokers), investment funds, prop traders, market makers and other intermediaries Hedging Short sell Arbitrage strategies Settlement obligations 6

7 The Life Cycle of a Loan Securities Lending Authorization Agreement Master Borrowing Agreement 1. Initiate Loan Client Northern Trust has 358 participants in our program Security Availability Loan Allocations Collateral (Cash & Non Cash) Northern Trust Collateral Pool 2. Negotiate Terms 3. Receive Collateral 4. Move Security 5. Daily Mark to Market Borrower Northern Trust currently has 42 approved Counterparties 6. Return Security 7. Return Collateral As March 31, 2012 (updated quarterly) Source: Northern Trust 7

8 Understanding the Components of Securities Lending Income Yield on Cash Collateral Investment Reinvestment Spread: Basis points earned from reinvestment of cash collateral Federal Funds (or benchmark) Rate (Yield on Cash Collateral Investment Fed Funds Rate) Intrinsic Value Spread: Basis points earned from lending security to borrower, based on intensity of borrower demand (Fed Funds Rate Rebate Rate) Total Securities Lending Spread Rebate Rate (paid to Borrower) Reinvestment Spread + Intrinsic Value Spread = Total Securities Lending Spread Total Securities Lending Spread x Loan Volume = Total Gross Securities Lending Income 8

9 How Revenue is Generated: Cash Collateral Loan Example: Northern Trust lends $25 million of US Treasuries at par The $25 million market value loan is for 30 days collateralized with cash (fed funds at 0.15%) 1 Receive cash collateral valued at $25,500,000 (102%) 2 Cash collateral invested in a collateral pool at yield of 0.20% $ 4, Rebate paid to borrower at rate of 0.05% $ (1,062.50) 4 Gross Revenue (gross spread 15 bps) $ 3, Monthly lender s fee (@ 40%) $ 1, Net client earnings $ 1, Gross Spread = Lending Spread + Investment Spread Lending Spread = Fed Funds Rebate Rate Investment Spread = Reinvestment Yield Fed Funds 9

10 Program Overview June 30, 2012 Lendable Base Distribution Network Collateral Structure 358 participating clients 50 worldwide markets $93.8 billion cash and non-cash collateral $645 billion lendable securities 24-hour trading via Chicago, Toronto, London and Hong Kong $91 billion loans outstanding 42 approved counterparties with state of the art electronic links Cash managed jointly with $215 billion in NT s Short Duration Fixed Income Division Array of pooled Collateral Sections and custom fund collateral options 42 approved counterparties Approved Counterparties 21% AA- long-term S&P rating or better 76% A long-term S&P rating or better 2% BBB+ long-term S&P rating Top 10 all have A- or better long-term S&P rating Top Ten Borrowers Customization Goldman Sachs, JP Morgan Chase,Morgan Stanley,Citigroup, Royal Bank of Scotland, Credit Suisse Group, Bank of America, UBS AG, Deutsche Bank, Royal Bank Of Canada Ability to place restrictions or caps on borrowers 10

11 Philosophy and Overview Philosophy: Investment activity designed to enhance the return of an overall investment program We customize collateral selection and participation to match individual risk tolerance Does not interfere with investment strategy Viewed as an asset management business Strive to extract the highest amount of intrinsic value from each loan Core Business for Northern Trust: Among first US master custodians to lend securities in 1981 and US banks to lend globally in 1988 Core business for Northern Trust in terms of revenue and trust fees 199 employees worldwide dedicated to lending Securities Lending Team: Relationship Manager coordinates all components of securities lending to ensure superior service and performance. Account Manager supports relationship managers by handling daily servicing and reporting needs for clients Experts: Trading Collateral Investment Borrower Credit Analysis Risk Analysis Operations & Control Technology Product Development Legal 11

12 Managing Risk Risk Definition Mitigating Factors Borrower Risk Trade Settlement Risk Borrower default combined with insufficient collateral to buy-in replacement securities & compensate for accrued entitlements Investment manager sells loaned security and borrower fails to return in time to settle the trade Rigorous credit committee review of borrowers and exposure limits Daily marking of loans/collateral Borrower default indemnification Risk analysis tools (MSCI Barra) to measure and calibrate exposure Robust automated reallocations Trade settlement protection Additional Risks with Taking Cash as Collateral Cash Collateral Reinvestment Risk Interest Rate Risk Cash collateral investment becomes impaired or decreases in value Loan rebate rate exceeds earnings on cash collateral investments Multiple risk committee reviews and robust oversight of cash pools and investments Dedicated team of Fixed Income Research analysts Daily automated monitoring of portfolio guidelines and compliance Close daily communication between lending and cash management teams Shared risk between Northern Trust and client Weekly gap analysis and periodic stress testing of portfolio 12

13 Borrower Risk Management Ongoing Monitoring We employ a dynamic, ongoing risk and exposure management process for our borrowers Credit analysts review market commentary and data to analyse financial stability Provides oversight while maintaining a responsive capability to take actions as needed Daily review Quarterly review Summary information on each borrower is presented to Senior Credit Committee Reviews financial performance of our borrowers based on their latest quarterly results, capital, public rating of the parent and compliance with our three concentration tests Monitors borrower exposures derived from a Value at Risk approach using each borrower's loan and collateral positions Supplements traditional credit analysis by providing insight into risk from borrowers' securities lending activity Counterparty and Collateral Risk Committee Annual review We present a comprehensive analysis on borrowers and credit limits to the Senior Credit Committee Wide-scale analysis includes review of financial statements, VaR, capital calculations, market share, and regulatory compliance 13

14 General Recent Observations and Trends Demand from the Borrower Community Global loan balances remain modest as the escalating European fiscal crisis and renewed fears of a possible EuroZone breakup contribute to overall higher levels of market volatility, pushing many investors to the sidelines. Hedge funds remain overall cautious in this uncertain market environment, contributing to lower levels of borrowing demand. Equity Markets Overall levels of trading activity remain subdued as uncertainty and a lack of conviction among market participants persists. Hard to borrow securities continue to see strong borrower demand and wide intrinsic spreads. Demand for core European and emerging markets equities, with a particular focus in Asia, remains strong. Fixed Income Markets Strong demand continues for both core and peripheral European sovereign debt due to ongoing volatility in parts of that region. Additionally, demand for distressed assets and emerging market debt remains robust. Market Drivers Global equity markets have given back much of the gains from earlier in the year, the result of a significant sell-off in Q2, as investors took risk off the table. Market volatility, as measured by the VIX (CBOE Volatility Index), has eased after having risen as much as 87% in Q2. 14

15 Collateral Reinvestment: Current Observations & Trends Recent Market Developments Elevated levels of systemic risk and market uncertainty pervade the fixed income markets: Eurozone sovereign and financial institution debt Significant bifurcation of the debt markets showing a sharp contrast and spread widening between the debt costs of those credits considered strong versus weak Uncertain future of Euro currency Scope of challenges in periphery Eurozone countries such as Greece and Spain sparking doubts the Euro will continue to be a viable long term currency union as it s currently structured US fiscal decision points loom with potential negative economic impact Pending expiration of tax cuts and automatic spending cuts Rating agency downgrades Large number of downgrades in financial and sovereign debt narrowing the supply of highly rated issuers US Federal Reserve actions / statements Extension of Operation Twist (maturity extension program) and the reiteration of the commitment to keep rates low until late Result: Increased uncertainty keeping investors risk tolerance low, with a significant amount of short term funds in the market: Investment yields in perceived safe-haven sovereign debt or corporate issuers are at or near historic lows and actually trading negative in some examples Flat yield curve in the short-end requiring investors to go out the curve to get yield Current Portfolio Positioning Principal Preservation Maintain overweight exposure in government guaranteed securities with maturities out the curve; while selectively gaining credit exposures in strong issuers, with maturities maintained on the shorter end of the curve. Maintaining Short-Term Liquidity Maintaining ample liquidity by holding higher levels of overnight exposures, focused primarily on repurchase agreements and time deposits of well-capitalized financial institutions. 15

16 Investment Profile: Core USA Cash Collateral Fund June 30, 2012 * Based upon traded basis from holdings reports Core USA 6/30/12 Fresno Average Yield Market to Book Avg Loan Duration 0.33% Days 16 NOTE: This information was created using the best unaudited data available to us and may not be completely reliable, accurate, or timely. Data is prepared on a settled basis, which may differ from traded basis data on the Cash Collateral Holdings report. Traded Basis reflects pending trades.

17 Core USA Supplemental Characteristics Report June 30, 2012 Note: This report has been created using the best available data and may contain information provided by third parties, derived by third parties or derived from third party data and/ or data that may have been categorized or otherwise reported based upon client direction. This report is for the exclusive use of clients and is not intended to be used for any other purpose. The information contained in the report is unaudited (and therefore may not be completely reliable). Portfolio holdings are subject to change at any time without notice. The report is provided for informational purposes only. Northern Trust assumes no responsibility for the accuracy, timeliness or completeness of any such information. This is not intended as a recommendation, offer or solicitation to buy, hold or sell any of the listed securities. 17

18 Core USA Supplemental Characteristics Report June 30, 2012 Note: This report has been created using the best available data and may contain information provided by third parties, derived by third parties or derived from third party data and/ or data that may have been categorized or otherwise reported based upon client direction. This report is for the exclusive use of clients and is not intended to be used for any other purpose. The information contained in the report is unaudited (and therefore may not be completely reliable). Portfolio holdings are subject to change at any time without notice. The report is provided for informational purposes only. Northern Trust assumes no responsibility for the accuracy, timeliness or completeness of any such information. This is not intended as a recommendation, offer or solicitation to buy, hold or sell any of the listed securities. Exposure is calculated based on cash collateral holdings. 18

19 Core USA Market to Book History June 30, 2012 CORE USA FUND Date Market to Book Ratio 9/18/ /30/ /31/ /28/ /31/ /30/ /27/ /31/ /30/ /29/ /30/ /31/ /31/ /30/ /30/ /30/ /31/ /31/ /28/ /31/2010* /30/ /28/ /30/ /31/ /31/ /30/ /31/ /30/ /31/ /31/ /28/ /31/ /30/ /31/ /30/ /31/ /31/ /30/ /31/ /30/ /31/ /31/ /29/ /31/ /30/ /31/ /30/ Market to Book *As of March 2010, receivable is included in MTB ratio. 19

20 20 Core USA: Spread Versus Federal Funds

21 Securities Lending Update Investment Guideline Updates Updated Investment Guidelines Issued for Several Commingled Collateral Sections: Applicable Collateral Sections include: Core, Core Select, Core USA and Global Core All new investments purchased in these Collateral Sections after the effective date of December 16, 2011 will be subject to the updated guidelines. Clients are not required to execute any updated documentation; no action is needed. Highlights of the Updated Guidelines: 21 These are the first updates to the investment guidelines since In general, the updated guidelines are designed to provide the flexibility to achieve suitable diversification given prevailing market conditions. These changes continue to reflect the conservative investment strategy we have in place today and expect to maintain. The changes remain generally aligned with the principles governing registered money market funds that are subject to SEC Rule 2a-7. Highlights of guideline changes are outlined below: Credit Quality Section - Clarifies the definition of Tier One Securities - Updates the requirements for applying ratings issued by Nationally Recognized Statistical Ratings Organizations (NRSROs) - Requires that creditworthiness of repurchase agreement counterparties will be monitored by Agent s internal risk committee. Diversification - Clarifies that residual cash balances that cannot be invested in the marketplace are not subject to diversification limits. Such residual cash balances currently sweep to an overnight deposit with The Northern Trust Company, Cayman Islands Branch.

22 Historical Net Earnings Fiscal Years Ended June 30 CITY OF FRESNO $2,500,000 $2,000,000 $1,500,000 $1,000,000 $871,934 $1,153,376 $2,154,273 $1,723,512 $823,419 $1,105,631 $1,025,408 Int'l Equity Int'l Fixed US Equities US Corp Bds US Agencies US Treasuries $500,000 $

23 23 Earnings Scorecard Year Ended 06/30/12

24 24 Earnings Performance Comparison Year Ended 06/30/12 versus Year Ended 06/30/11

25 US Regulatory Developments Northern Trust s Global Securities Lending team is tracking US regulatory developments that may impact the securities lending industry and is actively engaged with various federal agencies (Agencies) on these regulations (either directly or through industry groups such as the Risk Management Association s Committee on Securities Lending (RMA)). Below is a brief overview of some of the key US regulatory developments. Regulatory Development Important Dates Summary of Regulation Dodd-Frank Wall Street Reform and Consumer Protection Act Law enacted July 21, 2010 Securities Lending Transparency (Section 984) Proposed Rules expected mid to late 2012 Requires Securities & Exchange Commission (SEC ) to increase transparency in securities lending. SEC is engaging with RMA, among others, to identify ways to address this transparency mandate. Volcker Rule (Section 619) Proposed Rule issued October 11, 2011 Comments due February 13, 2012 Effective date July 21, 2012 Compliance date July 21, 2014 Restricts a bank s participation in proprietary trading and investing in or sponsoring private equity funds and hedge funds. The Volcker Rule s broad definitions of hedge fund and private equity fund may encompass certain unregistered cash collateral reinvestment pools sponsored by agent lenders. As a result, lending agents may consider alternative investment strategies or structures for cash collateral reinvestment. Northern Trust (directly and through RMA) commented on the impacts to securities lending. Orderly Liquidation Authority (OLA) (Title II, Section 210(c)) Final Rule effective August 15, 2011 Establishes OLA as an alternative to traditional bankruptcy proceedings for systemically significant financial institutions. RMA is engaging with governing bodies to mitigate impacts to securities lending transactions during OLA proceedings. Counterparty Concentration Limits (Section 165(e)) Proposed Rule issued December 20, 2011 Comments due April 30, 2012 Effective date October 1, 2013 Limits a bank s combined credit exposure to a single counterparty to no more than 25% of the bank s capital. Under the proposed rules, credit exposure calculations include indemnified securities lending transactions. RMA commented on the impacts to the securities lending industry. Leverage and Capital Rules (Section 171) Effective date July 21, 2010 Requires a bank to calculate its capital requirements under both Basel I and Basel III and to comply with the standard that requires more capital. Short Selling Disclosure and Reform (Sections 417 and 929X) No mandatory date for rules New short sale disclosures for hedge funds and broker-dealers, including monthly reporting of short sale volumes and other details. US Money Market Fund Reforms Proposals expected mid to late 2012 Introduces new reforms for money market funds and SEC Rule 2a-7, which may include requiring variable NAVs and/or capital buffers. 25

26 Securities Lending Data Block on Passport Helping to keep you informed about your securities lending performance. Facilitates the online distribution of vital, tailored information on each client s portfolio holdings, characteristics, investment performance and commentary Enables clients to access dynamic reporting output 26

27 Why Northern Trust Northern Trust provides managed risk and proven performance supported by committed professionals. 1 5 Fully committed to Securities Lending Capitalize on Northern Trust s Asset Servicing and Asset Management strengths Stable and experienced team dedicated to securities lending Dedicated relationship staff demonstrating corporate culture of exceptional client service Anticipate client needs and proactively customize solutions Unrivaled Client Focus A Core Business Northern Trust Global Securities Lending Proven Performance Results 4 Exceptional Capital Strength Unique Global Integration Sustained financial strength and stability Important for clients to work with a stable and disciplined agent Indemnification only as strong as provider Market expertise provided by a single global team of professionals Technology efficiency achieved through a single, global proprietary trading platform 2 3 Relationship focused, not transaction oriented 30-year track record of innovative solutions supported by robust risk management Focused on optimizing the intrinsic value of client assets Competitive advantage gained via distinctive global infrastructure Consistently exceeds industry composite benchmarks 27

28 Disclosures CONFIDENTIALITY N OTI CE: This communication is confidential, may be privileged and is meant only for the intended recipient. If you are not the intended recipient, please notify the sender ASAP and delete this message from your system. IRS CIR CUL AR 230 N OTI CE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see Evaluations are based on the asset allocation, actual historical spread and on-loan figures provided to Northern Trust. Consequently, as changes in these factors occur and as trading patterns of the portfolio managers shift, actual earnings generated in securities lending may be impacted. Even with these limitations, this evaluation is a useful indicator of the earnings potential of your portfolio. 28