Sponsors Move to De-Risk Securities Lending Programs

July 21, 2009 (PLANSPONSOR.com) - Callan's 2009 Securities Lending Survey found that approximately 48% of respondent firms with securities lending programs are undergoing a controlled withdrawal to reduce the risk profile of the program and minimize current and future losses.

A Callan news release said the controlled unwind is the most common strategy within “work out” solutions and firms are using it for rebalancing and to raise cash for liquidity. Nearly all are utilizing their current custodian or securities lending provider for the unwind, and most believe it will take one to three years to complete, according to the news release.

Cash collateral reinvestment losses, both realized and unrealized, were common across all direct and indirect fund and plan types and sizes and was the leading concern among 76% of the organizations surveyed. Disclosure regarding risk profile and program structure — along with redemption issues and exit strategies from both direct and indirect lending — ranked highly with nearly four out of five respondents.

Securities lending income is most often utilized to offset costs — including custody and investment management fees and/or internal administration costs. One-fifth of participants use securities lending income to enhance performance.

Fund and plan sponsors said they are also reviewing their investment policies and guidelines with a resolve to manage risk, understand the attribution of earnings, tighten compliance, seek better transparency and disclosure, and strengthen accountability. The survey found less than half of respondents are concerned about litigation.

According to the survey, 44% of respondents are pondering changes to their securities lending programs. Among firms that are considering changes, fine-tuning cash collateral reinvestment guidelines ranks the highest — with mega and large funds the most interested at 67%.

A Callan news release said 27% of respondents want to participate in funds that do not lend out their assets (indirect lending) and nearly 20% indicate they may cap the program at a more manageable level.

Sixty-four percent of defined contributions plans are contemplating moving or replacing indirect lending funds with non-lending funds and nearly 25% of all participants may terminate their securities lending program altogether.

When asked about strategies for designing a securities lending program from scratch, on a scale from one to four, fund and plan sponsors gave a 3.1 to demand and general collateral lending spreads, but only if full repurchase agreements (REPO) and cash reinvestment risk indemnifications are provided. A close second at 2.9 would be to implement a pure demand lending spread using overnight REPO reinvestment guidelines.

Applying a pure demand lending spread, but using money market SEC Rule 2a-7 cash reinvestment guidelines, came in third around 2.8.

Callan surveyed 72 fund and plan sponsor organizations, with public and corporate funds, at 42% and 38%, respectively, comprising the majority of survey participants. More than half (54%) are mid-sized funds that hold from $1 billion to $9 billion in fund assets; 19% are small funds that have less than $1 billion; and the remaining assets are split between mega funds (13%) and large funds (14%) which hold more than $25 billion and $10 billion to $24 billion, respectively.