In collaboration with Global Pensions, Data Explorers Consulting brings you the latest global trends and analysis on securities lending
Last year was a year to forget for many pension funds – a tough comment to make perhaps, in the broader context where rising equity markets might have lifted some of the under funding gloom, but it certainly applied to those pension funds in securities lending programs.
Pension funds started the year facing some unusual issues: securities lending being projected into the limelight as a result of the Lehman default; money market fund issues surrounding cash reinvestment; and its packaging with short selling as a business no self-respecting pension fund trustee should be involved with, to name but three.
Global Pensions has already covered the issues associated with pension funds taking cash collateral – much of the problem centred upon either issuer default or liquidity. There were unfortunately even some pension funds with Lehman Brothers paper in their re-investment portfolios. Others owned substantial portfolios of asset backed paper that fell below par on a mark to market basis and were problematic to liquidate. A quick glance at the table below emphasises why the cash issues were strongest in the US – 95% of collateral taken by US pension funds was cash.
[asset_library_tag 744,Click here to see chart 1.]
Re-investment challenges were much less marked for Canadian and UK pension funds where the historical approach that initially only allowed acceptance of non-cash collateral proved to be a substantial protective cloak. Interestingly, Australian super funds which also had a broad exposure to cash collateral were relatively unscathed by some of the issues that seemed to prevail in the US, perhaps due to a more conservative, shorter maturity, reinvestment profile. There were definitely issues for some of the pension funds based in mainland Europe – the Netherlands and Swedish pension fund communities in particular saw some issues result from their relatively sizable cash exposure.
Finally the funds faced the reputational questions raised as a result of securities lending being inextricably linked to “evil short sellers”. In Australia, the local press was particularly vitriolic and this was not helped by domestic issues concerning collapsed stockbroker Opes Prime and margin lending that mistakenly implicated securities lending. This led super funds to step up their educational processes for trustees – a process repeated in board rooms across the globe. In general, the consistent reiteration by regulators that securities lending remains a legitimate and important liquidity tool assisting market efficiency has put some of these concerns to bed but there remains a lot of work to be done in continuing the education process.
Some of the US pension fund community has sought legal recourse and there are a number of outstanding individual and class actions. Some pension funds have withdrawn from lending but many have already returned and most did not even stop in the first place. The legal cases will be followed closely over the next few months and maybe even years – but life, and securities lending goes on.
What can we expect to see in 2010? Firstly, we expect to see clarity on short selling disclosure – regulators have been consistent in seeking more information about short selling activities. This may not fall to securities lending practitioners per se as a loan does not equal a short sale in the vast majority of cases, but because of the links, this needs to be monitored closely. In all likelihood the pension fund will not be affected by this regulation other than possibly using the increased transparency of their short positions. The Australian regulators have already enacted quite comprehensive securities lending and short selling disclosure processes although there are questions about its effectiveness in recording activity by offshore practitioners.
Probably more important for the global pension fund community is the likely reaction of regulators to the cash reinvestment issues. The US SEC is already looking closely at adjusting regulation around collateral – we would not be surprised to see other regulators take similar steps, particularly in other markets that experienced issues.
The bottom line is that issues have been global. Individual markets have suffered more than others but the response needs to be globally coordinated to provide more consistency to global pension regulation. As one UK pension fund considering entering securities lending for the first time said to me last month – “securities lending is an investment we have to look at – it is unique in being a revenue earner and not costing anything – there are only positives”. Managed correctly, that is spot on.
Ed Oliver is a director at Data Explorers Consulting; www.dataexplorers.com
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