Securities Lending: New Look, but Increased Importance for Asset Managers

Despite lower revenues in the post-Lehman era, securities lending continues to be an important activity for asset managers, according to Finadium’s 2013 survey of asset managers.

This sixth annual survey by Finadium, a securities finance consultant, includes responses from 39 asset management professionals, covering $18.9 trillion in assets or 30% of the P&I/Towers Watson list of top 500 asset managers by AUM.

“Even though the executives we spoke with expect their securities lending revenues to be down, there appears to be increased comfort with these programs, as well as increases in the sense of how important securities lending revenues are,” said Josh Galper, managing director at Finadium and author of the survey.

Firms are placing an increased importance on these revenues because revenues as a whole have been harder to come by recently. But besides serving as a source of revenue, securities lending can also be used as a source of liquidity and to generate collateral for other purposes such as OTC derivatives. This trend has grown as a result of new regulations that have emerged from the financial crisis.

“Securities lending is no longer a silo unto itself,” said Galper.

Due to the current zero interest rate environment and tightening of the overnight repo marked backed by government bonds, managers interested in broadening their securities lending programs have had to look at other investment options for cash collateral pools. Specifically, the survey found that managers are starting to look at term repo and alternative repo backed by corporate bonds and equities, both of which provide greater yields than overnight, government bond repo.

Of those surveyed by Finadium, 68% of asset managers are theoretically comfortable with alternative repo, and 47% feel the same about term loans extending past 30 days. Only a few firms are actually putting these investment strategies into practice today, but new regulations could cause more of a shift in collateral placement.

“With 2a-7 money market reform, there is a very strong argument to be made that 2a-7 funds will no longer be appropriate for securities lending cash collateral pools,” said Galper. “So those assets will go into separately managed accounts that have a 2a-7 like kind of structure.”

Plus, shifting away from overnight repo to term repo over 30 days will improve the Liquidity Coverage Ratios of repo dealers, which will be necessary once Basel III is implemented.

While these alternatives to government bond repo do offer higher revenues, participants in the survey said they were not solely reaching for greater returns. Instead, managers want to remain flexible with how they use their cash collateral pools.