More global custodians and UK fund managers are considering a move into securities lending following a sharp rise in popularity among pension schemes.
Historically, securities lending – which is the process of earning “rental” income from gilts and bonds – has been regarded with suspicion as the end value of the loaned securities can fall.
But Morley Fund Management - one of the biggest UK securities lenders - said the risks for pension schemes are negligible.
Currently, Morley is solely lending securities held by its parent, insurance giant CGNU, but it is now looking to expand into third party business.
Head of securities lending Sarah Nicholson said: “There is a trend of more willingness to look at the concept, historically we have had bad press, pension funds are naturally conservative and rightfully so and its an area they have naturally avoided.
“I think there is a sign of a trend that more pension funds will look at it. I think a lot of the problems are is that there understanding is based on misconceptions.”
State Street Bank Europe is set to offer securities lending for the first time as a service separate to its global custody service.
State Street – which is already a market leader in securities lending in the US – currently has 20 UK pension schemes with assets over £500m using its service.
State Street senior vice-president Robert Ash said: “During the last few years State Street has increasingly been requested by clients to provide securities lending by clients, who do not use State Street as their custodian.”
However, consulting actuary Lane Clark & Peacock warned that pension schemes should not overlook the dangers of securities lending.
LC&P investment partner Paul Gibney said schemes would need “to have a very rigorous vetting procedure over whom they deal with and that they should seek added safeguards such as getting greater than 100% collateral. Gibney pointed out that some collateral could lose its value over the term of a deal but this could be counteracted by asking for 110% collateral.
How Securities Lending WorksStep 1: A pension scheme signs a deal with a securities lender.Step 2: The lender then tells investment banks and brokers of the access it has to that scheme's securities. Step 3: When these dealers spot a market weakness for one of the securities - typically this might be an imbalance in prices between separate exchange markets - they then borrow the securities and trade them, in theory selling them high and then buying back at a low price.Step 4: The dealers meanwhile provide collateral for the securities, which the lender holds to protect the pension scheme's interest.Step 5: Once this process - which can take between several weeks to several months - is over, the securities are returned to the pension scheme, earning it a portion of the profits on the deal.
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