Why most Institutional Investors still don’t Lend
Why most Institutional Investors still don’t Lend
By Roy Zimmerhansl
Why most Institutional Investors don’t lend! At first glance, the €21 trillion of securities available for loan at the end of 2019 seems a large figure and indeed it is. However, by various estimates, the total amount of institutionally managed assets was above €60 trillion at the same time. In other words, approximately 2/3 of institutional money is outside of lending programmes. I explore the four primary reasons why I believe this is the case.
Suitability
Securities lending isn’t for every investor and here are five examples where lending is not an obvious choice.
1. There is a minimum size threshold below which the effort to obtain the requisite approvals and establishing the oversight infrastructure may not be worthwhile.
2. Some assets are already available in abundance – think of the S&P 500 passive funds that are already available for loan – additional new lenders need not apply.
3. Some regulators continue to ban domestic investors’ participation. For example, Spanish institutions are not permitted to lend domestic securities, so lending revenues for Spanish equities leave the country.
4. Small-cap managers may decide not to lend due to concerns over short selling or loss of control tightly held companies.
5. Some products are required to abstain from engaging in lending or repo.
ESG
There are several considerations for ESG – but two primary concerns are typically cited – the impact of short selling and the ability for investors to exercise their ownership entitlements. Short selling will be the subject of a future article, but let me leave you with two thoughts – dedicated short selling funds represent less than 1% of hedge fund assets under management, and not all short selling is reliant on price falls for trading-strategy profitability. Of concern to many is the impact of lending on ownership entitlements, particularly voting. Securities lending and active shareholder engagement can and do co-exist with many well-known institutional investors generating meaningful revenues without sacrificing voting or direct meetings with the companies they invest in. However, I do sense an undertone which could lead to some investors to systematically recalling shares in the run-up to AGMs and EGMs as is common practice in several Asian markets.
Risk
As with all investment activity, securities lending carries risk. The two primary risks are counterparty default and cash collateral reinvestment losses. I’m not convinced this stands up to scrutiny. Daily settled mark-to-market collateral movements limit exposure to potential losses from the infrequent bank and broker-dealer insolvencies. Additionally, agent lender indemnifications protect investors even further. Cash collateral investments seem to generate losses every 10-15 years. However, the most conservative cash investors seldom suffer losses with those more ‘adventurous’ potentially victims. They need to consider the cumulative returns from riskier investments prior to losses to assess the risk-reward appropriately. Ultimately, securities lending is a positive contributor to investor returns in rising or falling markets. History has demonstrated that it is a low-risk business that adds cumulative annual performance which stands up well under scrutiny.
Knowledge
This is where I see the gap. While communication and understanding have improved dramatically over the years, academic and regulatory support for securities lending has often come only in postcrisis analyses. The continuing lack of transactional transparency undermines non-practitioners’ confidence in securities lending’s legitimacy. The EU’s Securities Finance Transactions Reporting regulation that will have a phased rollout starting early in the second half of 2020 may not be public but hopefully go some way to assuage lingering concerns held by both lenders and non-lenders.
About the Author: Roy is an expert on all aspects of Securities Finance. He was vice-chair of ISLA and taught ‘An Introduction to Securities
Lending’ and has recently launched an online version of the course with CISI CPD Accreditation. He was also a board member of PASLA
(the Asian securities lending trade association) and a member of the Bank of England Securities Lending and Repo committee.
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