Securities lending is a way for institutional investors to generate incremental revenue for their portfolios by lending out their securities for collateral. George Trapp, head of Client Relations for North America at Northern Trust, Global Securities Lending, who is based in Chicago, describes it as “sort of like renting an apartment where you are an owner, but lending it out because there is demand for it.”
He says with the transaction, institutional investors should make sure they take all steps to price map correctly, do a mark to market valuation to make sure it is properly collateralized and investors are charging the right fee.
According to Trapp, there are a combination of reasons institutional investors, such as defined benefit (DB) plans, are interested in securities lending, with the primary reason being it generates incremental revenue. But, securities lending also provides liquidity in the financial market, and sometimes DB plans use other products securities lending supports—for example, a long-short strategy using hedge funds. Securities lending provides DB plans more liquidity than other securities. “And institutional investors can vet the program to meet their list of parameters,” Trapp says. “It is a low-risk investment, but investors can set parameters based on their risk tolerance, for example, using only U.S. Treasuries as collateral.”
There are a few trends Trapp and Northern Trust are seeing in the securities lending space. Higher interest rates are driving demand for clients. There are better spreads on cash collateral since service providers can charge a higher rate for borrowing securities.
“Overall as rates move up from a very low nominal rate, we’re seeing clients have the opportunity to make additional income if interest rate moves are well-predicted and transparent. If you don’t know an interest rate increase is coming or when, it dampers earnings,” he says. “The longer-term impact is positive. In a low interest rate environment, institutional investors are battling for every basis point they can. Higher interest rates are not a major issue in the securities lending market; institutional investors can charge more for loans.”NEXT: Collateral changes