Are Beneficial Owners Lending?
Consensus Is Yes, but Cautiously

Beneficial owners want to lend their securities, but they are only cautiously optimistic.

At least that was the consensus of the speakers at the conference panel “Beneficial Owners: Are They Lending Securities Now?” Panelists were Moderator John Piccitto, John Piccitto Consulting Ltd.; Julie-Anne Atkins, Executive Director, Collateral Management Sales, JPMorgan London; Robert D.M. Coxon, Senior Vice President and Head of International Securities Lending, Bank of New York Mellon, London; Ian Hovey, Managing Director, State Street, London; Stefan Kaiser, Business Strategies, Equity & Capital Markets Group, Barclays Global Investors, London; and Timothy J. Smith, Senior Vice President, Sales, SunGard Securities Finance, New York.

Panelists said most beneficial owners have the same concern at the top of their agenda: what to do with their securities lending programs. Most of them seem to be taking one of two approaches. As Piccitto explains, “One group is reviewing their total positions of what they can lend out, and some are saying, well, we were lending out 70% of our portfolios, we’re going to reduce that to 40–50%. Some of these have even reduced that amount to 25–30% because they don’t want to have that much outstanding. The second group has revised and made serious changes to their collateral reinvestments as well as to their parameters for accepting and investing collateral.”

Piccitto added that, for European beneficial owners, the main concern was whether or not to take more noncash collateral because they were concerned about what cash collateral would be invested in, he said, “for example, government securities or equities they know are liquid.”

Panelists added that their beneficial owners are staying away from certain markets. Piccitto said some institutions were not looking at markets in South America and Eastern Europe, as they believed there was not much liquidity in those markets currently. Others, however, instructed their lenders that if “someone calls looking for a stock in that market, we’ll lend it, but we’ll have to make sure; we’re changing our collateral parameters and instead of taking 102% or 105%, depending on what we’re lending out, we’re asking for 110%. And it’s got to be noncash, perhaps U.S. Treasuries. But there are certain governments no one will take because the domestic government securities market itself is not liquid enough.”

“They’re not saying no,” Piccitto continued, “they’re just increasing their parameters. They are being more diligent and lending on a more cautious note.”

The agent lenders on the panel said some of their beneficial owners did not want to lend anymore but left their securities with their lenders, so that if they found a special in the portfolios they would make calls to these beneficial owners. “We know you’re not lending anymore, but you have a stock we can probably get 5–6% for if we lend it out. That’s how it works. This is what our beneficial owners are telling us,” said one agent lender. Beneficial owners want their lenders to be careful about what collateral they are taking; they do not want cash invested in anything esoteric. In fact, most beneficial owners do not want cash at all.

This chart shows the changes in securities lending global equity volume over time. By showing volume, this takes out the market price movements. As can be seen, from the nadir of the turn of the year, securities lending volumes have started to pick up as the markets have moved upwards as well. The main thrust is that there has been a movement towards special only lending and not the general collateral as everyone is becoming more circumspect as in their cash collateral reinvestment. The latter is more of a U.S. phenomenon but has spilled over into other markets.
(chart provided by SunGard ASTEC Analytics)

“Volumes have started to move higher, but there is an underlying caution. Lenders are now paying special attention to the traditional aspects of good risk management and therefore volumes are increasing in 2009, but not as fast as they did in early 2007,” Piccitto said. “Furthermore, when compared with the trading patterns prior to the events of autumn 2008, lenders are less willing to show their entire portfolio holdings to the market for fear of not being able to get the shares back when they need them owing to remaining uncertainty about counterparties down the line.”

All of the panel members agreed that the business can be done safely if controls are in place and monitored regularly. After 2008, securities lending is no longer a “risk free” business. However, appropriate risk management provisions will support the potential to put liquidity back into the worldwide markets and meet developing regulatory frameworks.