$8bn extra revenue: a compelling reason to consider securities lending
October 6, 2017

The generation of US$8 billion in additional revenue through securities lending in 2016 is a compelling reason to consider what is often a misunderstood and underappreciated practice in the international financial markets.

This simple statement comes from John Wallis, London-based Global Head of Business Development and Co-Head of European Securities Lending at Brown Brothers Harriman (BBH), referring to the figure cited as revenues generated from the $15 trillion plus of assets in lending programmes tracked by the Markit Securities Finance Database. The message, it would appear, if his own experience is replicated elsewhere, is beginning to be heard, and acted upon, by asset managers and others.

"We are undergoing a renaissance in our particular niche, which is meeting the particular needs of asset managers running registered funds such as UCITS and mutual funds," he says. "People who declined invitations to discuss the issue in the past are now happily lending securities from their portfolios and the additional revenue is going straight into the pockets of end investors."

Wallis says this turnaround demonstrates that securities lending, which has been the brunt of much unfavourable publicity down the decades, most recently in the wake of the collapse of Lehman Brothers in September 2008, does in fact have a social purpose.

"Securities lending has probably never been the subject of as much interest since the Lehman crisis," he continues. "It is a valuable part of the industry that has too often been overlooked. It seldom receives the positive coverage that it deserves and many leading asset managers do not realize just how prevalent it actually is."

Wallis stresses that it was not the lending of stock that caused the problems at the time the financial crisis began to wreak havoc. It was the unwise reinvestment of cash collateral that caused great difficulty to some market participants who had ventured too far along the credit and duration curve. Firms who reinvested the cash conservatively might have endured a stressful few days as their lending agents liquidated collateral and replaced their stock but none lost money, he notes.

The reasons behind the resurgence sound familiar to anyone who follows global finance closely on a day-to-day basis. But they bear repeating nevertheless. One key factor is the ultra-low interest rates that have been the norm for such an extended period of time. Another is the profound change that has taken place in the asset management industry itself with the shift from active investment to passive investment. Any extra income is to be warmly welcomed and securities lending creates that opportunity.

The type of securities lending preferred by the more traditional asset managers can generate additional revenue for minimal risk, says Wallis. He identifies two main approaches to securities lending. One focused on volume, maximizing revenue by lending as much as possible of a portfolio on a general collateral basis, earning a few basis points.

The other is focused on value, charging what can be very significant fees for stocks that are in high demand (specials, as they are known). It is the latter approach that traditional asset managers in BBH's niche market tend to prefer. "You can lend a stock and take in a top-rated government bond as collateral," he observes. "This gives you a huge upgrade in the quality of what you have in your portfolio, and the government bond will rise in value in the case of panic."

He describes this as 'right-way risk'. What an investor lends and what an investor takes as collateral are negatively correlated. If share prices fall, they are fine and thanks to the arithmetic of collateral margining and marking to market will have more than enough cash available to buy back stock in the event it is not returned as contracted. In short, the quality of the portfolio is enhanced and the lender earns additional revenue.

The narrative transforms from a good story into a compelling one that is at the very least clearly worth listening to.





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The generation of US$8 billion in additional revenue through securities lending in 2016 is a compelling reason to consider what is often a misunderstood and underappreciated practice in the international financial markets.

This simple statement comes from John Wallis, London-based Global Head of Business Development and Co-Head of European Securities Lending at Brown Brothers Harriman (BBH), referring to the figure cited as revenues generated from the $15 trillion plus of assets in lending programmes tracked by the Markit Securities Finance Database. The message, it would appear, if his own experience is replicated elsewhere, is beginning to be heard, and acted upon, by asset managers and others.

"We are undergoing a renaissance in our particular niche, which is meeting the particular needs of asset managers running registered funds such as UCITS and mutual funds," he says. "People who declined invitations to discuss the issue in the past are now happily lending securities from their portfolios and the additional revenue is going straight into the pockets of end investors."

Wallis says this turnaround demonstrates that securities lending, which has been the brunt of much unfavourable publicity down the decades, most recently in the wake of the collapse of Lehman Brothers in September 2008, does in fact have a social purpose.

"Securities lending has probably never been the subject of as much interest since the Lehman crisis," he continues. "It is a valuable part of the industry that has too often been overlooked. It seldom receives the positive coverage that it deserves and many leading asset managers do not realize just how prevalent it actually is."

Wallis stresses that it was not the lending of stock that caused the problems at the time the financial crisis began to wreak havoc. It was the unwise reinvestment of cash collateral that caused great difficulty to some market participants who had ventured too far along the credit and duration curve. Firms who reinvested the cash conservatively might have endured a stressful few days as their lending agents liquidated collateral and replaced their stock but none lost money, he notes.

The reasons behind the resurgence sound familiar to anyone who follows global finance closely on a day-to-day basis. But they bear repeating nevertheless. One key factor is the ultra-low interest rates that have been the norm for such an extended period of time. Another is the profound change that has taken place in the asset management industry itself with the shift from active investment to passive investment. Any extra income is to be warmly welcomed and securities lending creates that opportunity.

The type of securities lending preferred by the more traditional asset managers can generate additional revenue for minimal risk, says Wallis. He identifies two main approaches to securities lending. One focused on volume, maximizing revenue by lending as much as possible of a portfolio on a general collateral basis, earning a few basis points.

The other is focused on value, charging what can be very significant fees for stocks that are in high demand (specials, as they are known). It is the latter approach that traditional asset managers in BBH's niche market tend to prefer. "You can lend a stock and take in a top-rated government bond as collateral," he observes. "This gives you a huge upgrade in the quality of what you have in your portfolio, and the government bond will rise in value in the case of panic."

He describes this as 'right-way risk'. What an investor lends and what an investor takes as collateral are negatively correlated. If share prices fall, they are fine and thanks to the arithmetic of collateral margining and marking to market will have more than enough cash available to buy back stock in the event it is not returned as contracted. In short, the quality of the portfolio is enhanced and the lender earns additional revenue.

The narrative transforms from a good story into a compelling one that is at the very least clearly worth listening to.




More on:  Securities lending