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INVESTOR WWW.ISJFORUM.COM
S ERVICES
JOURNAL

SECURITIES LENDING
MARKET GUIDE

2005-2006
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Securities Lending Market Guide
Editorial
The Road to Returns
Stock market performance has delivered
mixed fortunes for institutional investors such
as pension funds, which now have drudging
deficits to take care of.
Various governments, particularly those in
Europe, are eager to increase the retirement age
of the working population and encourage
employers to include pension liabilities on the
company balance sheet. Add a set
of international accounting standards, and it is
evident that regulation has done little to calm
the nerves of pension fund trustees.
Thankfully, various services have come to the
rescue of trustees and are designed to help pen-
sions funds and other institutional investors
generate incremental revenue. Securities lend-
ing has become a foremost guarantor of such
revenue. Through skillfully applied stocklending
principles, the industry’s service providers have
ensured their clients are handsomely rewarded
through borrower fees.
Formerly perceived as a risk-tainted business,
securities lending now has the blessing of regu-
lators and institutional investors in a variety of
different markets.
Seize the Moment
Whatever the status of the industry in differ-
ent countries, pension funds are well advised to
seize the moment and realise the value of their
assets to the borrower community. In associa-
tion with esteemed industry providers, Investor
Services Journal presents a guide for institution-
al investors and pension funds, whose securi-
ties lending questions have yet to be answered.
From corporate governance to cash reinvest-
ment, industry participants provide an insight
into the world of securities lending. For an
introduction to securities lending and its link to
corporate governance, ISJ has enlisted the
expert knowledge of Mark Faulkener of
Spitalfields Advisors, a well known name in
securities lending circles. Corporate governance
has become an important priority for pension
2 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
funds who would like to become more involved
in securities lending, but who are also strongly
committed to shareholder voting. While share-
holder voting often takes precendent over secu-
rities lending, pension funds should be aware
that a happy medium between the two activities
is within reach.
Routes to Market
With the evolution of the securities lending
industry, pension funds now have a variety of
different routes to market. A particular favourite
is the auction process, whereby sophisticated
auction platforms can provide borrowers with
exclusive and multiple access to a pension
fund’s portfolio. This route to market appeals to
pension funds who want to lend their assets to
the highest bidder, who will pay a handsome
fee in return. Tri-party securities lending agents
are also given generous applause by the institu-
tional investors, who prefer to outsource their
securities lending to specialist providers who
regard lending as a core service. Institutional
investors are also reliant on their custodians to
provide securities lending programmes. Based
on the initial delivery of custody and other core
securities services, these institutional investors
have gone a step further and have instructed
custodians to lend their assets to a borrower.
Hedge funds have added significant impetus to
the securities lending industry and the increas-
ing number of pension funds who invest in
these funds are extremely attractive in the eyes
of the broker.
Technology
As the securities lending industry advances to
the next level of acceptance among pension
funds, the impact of technology on this industry
should not be underestimated. Various tools,
designed to automate the lending process, have
added an extra layer of transparency to the
securities lending industry, assuring pension
funds of a fair and clear process. In addition to
traditional securities lending, pension funds
now have the option of cash reinvestment pro-
grammes and can accept various types of collat-
eral as payment for their securities. With the
changes occurring within the lending industry,
the possibilities for institutional investors and
pension funds are endless. With this in mind,
ISJ invites you to join us on our journey down
the road to returns...
Janet Du Chenne - ISJ
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Securities Lending Market Guide
Foreword
The International Securities
Lending Association sets the
scene on one of the most
important revenue generators in
today's financial
markets.
The future success of
any industry is dependent
on its ability to provide a
competitive and cost
effective infrastructure to Richard Steele
facilitate the requirements ISLA
of its customers.
In this respect, securities lending has proven
highly adept in recent years at providing the
environment and growth opportunities for its
natural customer base to develop and prosper.
What factors explain the industry’s appeal and
its longevity?
It is well understood that securities lending
plays an important role by providing liquidity to
the equity, bond and money markets, placing it
at the heart of the financial system.
With the lending of both equity and fixed
income securities being used to cover shorts
and prevent fails as well as more complex
trading strategies such as risk and tax arbitrage,
the sector has grown and transformed rapidly
over the last decade.
According to figures compiled through the
International Securities Lending Association’s
(ISLA) quarterly market sizing survey of its
members, the total amount of securities cur-
rently available for loan exceeds EURO 6 bn,
with on loan balances in excess of EURO 1.2 bn.
To industry insiders, it is unsurprising that
many investment managers and plan sponsors
have been quietly and unobtrusively generating
useful incremental portfolio returns from securi-
ties lending over a considerable period of time.
The fact that increasing numbers of traditional
‘buy and hold’ managers have lately begun dip-
ping their toes into alternative investment
4 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
waters provides an interesting coda to this
longstanding risk/reward relationship.
With increased volumes have come
technology platforms designed to find the best
price while reducing operational costs and
mitigating risk by increasing the overall
transparency of the transactions.
As the securities lending market has grown,
so lending relationships have evolved where the
need for lenders and their agents to proactively
understand and tackle new challenges is now a
key concern.
“the industry now offers more
potential routes to market
than ever before”
Whether a client decides to participate in an
agency, directed, or exclusive programme, or
perhaps auction its portfolio to the highest bid-
der, the industry now offers more potential
routes to market than ever before.
While dealing with its growth challenges, the
industry has not lost sight of its responsibility
to promote good market practice, for example
in the corporate governance space.
In fact as featured in this Guide, ISLA recently
commissioned a well-received paper to clarify
the procedures necessary to ensure that securi-
ties lending programmes are well managed and
consistent with good corporate governance.
Looking ahead, we can expect more chal-
lenges as securities lending continues to evolve
to meet the expectations of its customers but
when I observe the level of professionalism and
client focus that exists in the industry today I
remain highly optimistic that these challenges
will be met.
Richard Steele, Chairman, International Securities
Lending Association
Richard Steele is the current Chairman of the International
Securities Lending Association. He has served on ISLA’s
Executive Committee since 2001 and was elected Deputy
Chairman of the Association in 2003.
Steele is head of international product management and devel-
opment for securities lending at JPMorgan Worldwide Securities
Services. Steele has twenty years experience in the securities
industry, eight of which have been with JPMorgan Chase.
He was previously a director at King & Shaxson Ltd, a UK
securities lending and money market intermediary and holds a
degree in Modern History from the University of St Andrews.
SLMG 2005 ML10 7/9/05 1:10 pm Page 5

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Securities Lending Market Guide

Contents
8 Introduction to Securities Lending Mark Faulkener of Spitalfields Advisors
introduces the securities lending industry
8 Part 1 What is securities lending?
11 Part 2 Lenders and intermediaries
15 Part 3 The borrowing motivation
19 Part 4 Market mechanics
23 Part 5 Risks, regulation and market oversight
26 Part 6 Securities lending & corporate governance

36 Securities lending - past, present and future

An analysis of the evolution of the securities
lending, from the origin to present day

40 The Rise of Securities Lending ISJ examines how the assets on loan in the
securities industry have increased in three years

42 Risk, Return and Performance State Street’s Peter Economou reports on the
impact of risk, return and performance
measurement on securities lending

44 Agent Lenders Paul Wilson and Gene Picone of JPMorgan

explain the principles of agency lending

47 The Auction Block Luke McCabe of eSecLending considers the

issues for lenders contemplating auctions

50 Technology Matters Technology expert Felix Oegerli of IFBS presents

the solutions for the securities lending industry

54 Panel Debate Securities Lending professionals address the

challenges and opportunities

61 Ask the Experts Securities lending experts answer a range of

questions from clients and beneficial owners
75 Company Profiles ISJ profiles esteemed names in the securities
lending industry
80 Glossary Definitions of various securities lending industry
terminology and phrases

6 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005

SLMG 2005 ML10 7/9/05 1:10 pm Page 7

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SLMG 2005 ML10 7/9/05 1:10 pm Page 8
Securities Lending Market Guide
Introducing...
Securities
Lending
The following section is an edited extract
from 'An Introduction to Securities Lending'
and 'Securities Lending & Corporate
Governance' by Mark C Faulkner, Spitalfields
Advisors. It has been prepared with Mr
Faulkner's permission. The original publication
of 'An Introduction to Securities Lending' was
commissioned by the International Securities
Lending Association, the Association of
Corporate Treasurers, the British Bankers
Association, the London Investment Banking
Association, the London Stock Exchange and
the Securities Lending and Repo Committeee.
It was welcomed by the National Association of
Pension Funds and the Association of British
Insurers. The original publication of 'Securities
Lending & Corporate Governance' was commis-
sioned by the International Securities Lending
Association and endorsed by the Association of
Corporate Treasurers, the British Bankers
Association, the London Stock Exchange, the
National Association of Pension Funds and the
Securities Lending and Repo Committeee.
Part One
What is securities lending?
Securities lending began as an informal practice
among brokers who had insufficient share cer-
tificates to settle their sold bargains, commonly
because their selling clients had mislaid their
certificates or just not provided them to the bro-
ker by the settlement date of the transaction.
Once the broker had received the certificates,
they would be passed on to the lending broker.
This business arrangement was subject to no
formal agreement and there was no exchange of
collateral.
Securities lending is now an important and
significant business that describes the market
practice whereby securities are temporarily
transferred by one party (the lender) to another
(the borrower). The borrower is obliged to
return the securities to the lender, either on
demand, or at the end of any agreed term. For
the period of the loan the lender is secured by
8 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
acceptable assets delivered by the borrower to
the lender as collateral.
Under English law, absolute title to the
securities “lent” passes to the “borrower”, who
is obliged to return “equivalent securities.”
Similarly the lender receives absolute title to the
assets received as collateral from the borrower,
and is obliged to return “equivalent collateral.”
Securities lending today plays a major part in
the efficient functioning of the securities
markets worldwide. Yet it remains poorly under-
stood by many of those outside the market.
Definitions
In some ways, the term “securities lending” is
misleading and factually incorrect. Under
English law and in many other jurisdictions, the
transaction commonly referred to as “securities
lending” is, in fact...
“a disposal (or sale) of securities linked to the
subsequent reacquisition of equivalent securi-
ties by means of an agreement.”
Such transactions are collateralised and the
“rental fee” charged, along with all other
aspects of the transaction, are dealt with under
the terms agreed between the parties. It is
entirely possible and very commonplace that
securities are borrowed and then sold or on-
lent.
There are some consequences arising from
this clarification:
- Absolute title over both the securities on loan
and the collateral received passes between the
parties.
- The economic benefits associated with
ownership – e.g. dividends, coupons etc. – are
“manufactured” back to the lender, meaning
that the borrower is entitled to these benefits as
owner of the securities but is under a
contractual obligation to make equivalent
payments to the lender.
- A lender of equities surrenders its rights of
ownership, e.g. voting. Should the lender wish
to vote on securities on loan, it has the
contractual right to recall equivalent securities
from the borrower.
- In the United Kingdom appropriately
documented securities lending transactions
avoid two taxes: Stamp Duty Reserve Tax and
Capital Gains Tax.
Different types of securities loan transaction:
Most securities loans in today’s markets are
made against collateral in order to protect the
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Securities Lending Market Guide

Transactions collateralised with other securities or assets

Lender Borrower

Reporting
Reporting Collateral

Tri Party
Loan Commences Agent

Lender Borrower

Collateral

Tri Party
Agent
Loan Terminates

lender against the possible default of the
borrower. This collateral can be cash, or other
securities or other assets.
(a) Transactions collateralised with other
securities or assets
Non-cash collateral would typically be drawn
from the following collateral types:
* Government Bonds - Issued by G7, G10 or
Non-G7 governments
* Corporate Bonds - Various credit ratings
* Convertible Bonds - Matched or unmatched to
the securities being lent
* Equities - Of specified Indices
* Letters of Credit - From banks of a specified
credit quality
* Certificates of Deposit - Drawn on institutions
of a specified credit quality
* Delivery By Value (“DBVs”)1 - Concentrated or
* Unconcentrated - Of a certain asset class
* Warrants - Matched or unmatched to the
securities being lent
*Other money market instruments
The eligible collateral will be agreed between the
parties, as will other key factors including:
* Notional Limits - The absolute value of any
asset to be accepted as collateral
* Initial margin - The margin required at the
outset of a transaction
* Maintenance margin - The minimum margin
level to be maintained throughout the
transaction
* Concentration limits - The maximum
percentage of any issue to be acceptable, e.g.
less than 5% of daily traded volume - The
maximum percentage of collateral pool that can
be taken against the same issuer, i.e. the
cumulative effect where collateral in the form of
letters of credit, CD, equity, bond and
convertible may be issued by the same firm
The example in the above diagram shows
collateral being held by a Tri Party Agent. This
specialist agent (typically a large custodian bank
or International Central Securities Depository)
will receive only eligible collateral from the
borrower and hold it in a segregated account to
the order of the lender.

SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 9

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Securities Lending Market Guide

Transactions collateralised with cash

Loan
Lender Borrower
Cash
Collateral
Cash

Money
Markets
Loan Commences

Loan
Lender Borrower
Cash
Collateral
Cash

Money
Loan Terminates Markets

The Tri Party Agent will mark this collateral to
market, with information distributed to both
lender and borrower (in the diagram, dotted
“Reporting” lines). Typically the borrower pays a
fee to the Tri Party agent.
There is debate within the industry as to
whether lenders that are flexible in the range of
non-cash collateral they are willing to receive
are rewarded with correspondingly higher fees.
Some argue that they are, others claim that the
fees remain largely static but that borrowers are
more prepared to deal with a flexible lender and
therefore balances and overall revenue rise.
much less the case outside the United States
but consolidation of the custody business and
the important role of US custodian banks in the
market means that this practice is becoming
more prevalent. The importance of this point
lies in the very different risk profiles of these
increasingly intertwined activities.
The revenue generated from cash-collater-
alised securities lending transactions is derived
in a different manner from that in a non-cash
transaction. It is made from the difference or
“spread” between interest rates that are paid
and received by the lender

(b) Transactions collateralised with cash Other transaction types

Cash collateral is, and has been for many years,
an integral part of the securities lending busi-
ness, particularly in the United States. The lines
between two distinct activities:
Securities lending and Cash reinvestment
have become blurred and to many US invest-
ment institutions securities lending is virtually
synonymous with cash reinvestment. This is
Securities lending is part of a larger set of
interlinked securities financing markets. These
transactions are often used as alternative ways
of achieving similar economic outcomes,
although the legal form and accounting and tax
treatments can differ. The other transactions
include:

10 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005

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(a) Sale and repurchase agreements
Sale and repurchase agreements or repos
involve one party agreeing to sell securities to
another against a transfer of cash, with a
simultaneous agreement to repurchase the
same securities (or equivalent securities) at a
specific price on an agreed date in the future. It
is common for the terms ”seller” and “buyer” to
replace the securities lending terms “lender”
and ”borrower”. Most repos are governed by a
master agreement called the TBMA/ISMA
Global Master Repurchase Agreement
(GMRA)2.
Sale and repurchase agreements
or repos involve one party
agreeing to sell securities to
another against a transfer of cash
Repos occur for two principal reasons – either
to transfer ownership of a particular security
between the parties or to facilitate collateralised
cash loans or funding transactions.
The bulk of bond lending and bond financing
is conducted by repo and there is a growing
equity repo market. An annex can be added to
the GMRA to facilitate the conduct of equity
repo transactions.
Repos are much like securities loans collater-
alised against cash, in that income is factored
into an interest rate that is implicit in the pric-
ing of the two legs of the transaction.
At the beginning of a transaction, securities
are valued and sold at the prevailing “dirty”
market price (i.e. including any coupon that has
accrued). At termination, the securities are
resold at a predetermined price equal to the
original sale price together with interest at a
previously agreed rate known as the repo rate.
In securities-driven transactions (i.e. where the
motivation is not simply financing) the repo
rate is typically set at a lower rate than
prevailing money market rates to reward the
“lender” who will invest the funds in the money
markets and thereby seek a return. The “lender”
often receives a margin by pricing the securities
above their market level.
In cash-driven transactions, the repurchase
price will typically be agreed at a level close to
current money market yields, as this is a financ-
ing rather than a security-specific transaction.
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 11
Securities Lending Market Guide
The right to substitute repoed securities as
collateral is agreed by the parties at the outset.
A margin is often provided to the cash “lender”
by reducing the value of the transferred
securities by an agreed “haircut” or discount.
(b) Buy/sell backs
Buy/sell backs are similar in economic terms
to repos but are structured as a sale and
simultaneous purchase of securities, with the
purchase agreed for a future settlement date.
The price of the forward purchase is typically
calculated and agreed by reference to market
repo rates.
The purchaser of the securities receives
absolute title to them and retains any accrued
interest and coupon payments during the life of
the transaction. However, the price of the
forward contract takes account of any coupons
received by the purchaser.
Buy/sell back transactions are normally con-
ducted for financing purposes and involve fixed
income securities. In general a cash borrower
does not have the right to substitute collateral.
Until 1996, the bulk of buy/sell back transac-
tions took place outside of a formal legal
framework with contract notes being the only
form of record. In 1995, the GMRA was
amended to incorporate an annex that dealt
explicitly with buy/sell backs. Most buy/sell
backs are now governed by this agreement.
Part Two
Lenders and intermediaries
The securities lending market involves various
types of specialist intermediary which take prin-
cipal and/or agency roles. These intermediaries
separate the underlying owners of securities –
typically large pension or other funds, and
insurance companies – from the eventual bor-
rowers of securities
A Intermediaries
1. Agent intermediaries
Securities lending is increasingly becoming a
volume business and the economies of scale
offered by agents that pool together the
securities of different clients enable smaller
owners of assets to participate in the market.
The costs associated with running an efficient
securities lending operation are beyond many
smaller funds for which this is a peripheral
SLMG 2005 ML10 7/9/05 1:10 pm Page 12
Securities Lending Market Guide
activity. Asset managers and custodian banks
have added securities lending to the other
services they offer to owners of securities port-
folios, while third party lenders specialise in
providing securities lending services.
Owners and agents “split” revenues from
securities lending at commercial rates. The split
What was once a back office low
profile activity is now a front
office growth area for many asset
managers
will be determined by many factors including
the service level and provision by the agent of
any risk mitigation, such as an indemnity.
Securities lending is often part of a much bigger
relationship and therefore the split negotiation
can become part of a bundled approach to the
pricing of a wide range of services.
(a) Asset managers
It can be argued that securities lending is an
asset management activity – a point that is
easily understood in considering the
reinvestment of cash collateral. Particularly in
Europe, where custodian banks were perhaps
slower to take up the opportunity to lend than
in the United States, many asset managers run
significant securities lending operations.
What was once a back office low profile
activity is now a front office growth area for
many asset managers. The relationship that the
asset managers have with their underlying
clients puts them in a strong position to
participate.
(b) Custodian banks
The history of securities lending is inextricably
linked with the custodian banks. Once they
recognised the potential to act as agent
intermediaries and began marketing the service
to their customers, they were able to mobilise
large pools of securities that were available for
lending. This in turn spurred the growth of the
market.
Most large custodians have added securities
lending to their core custody businesses. Their
advantages include: the existing banking
relationship with their customers; their
investment in technology and global coverage
of markets, arising from their custody business-
es; the ability to pool assets from many smaller
12 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
underlying funds, insulating borrowers from the
administrative inconvenience of dealing with
many small funds and providing borrowers with
protection from recalls; and experience in
developing as well as developed markets.
Being banks, they also have the capability to
provide indemnities and manage cash collateral
efficiently – two critical factors for many
underlying clients.
Custody is so competitive a business that for
many providers it is a loss making activity.
However, it enables the custodians to provide a
range of additional services to their client base.
These may include:
Foreign exchange, trade execution, securities
lending and fund accounting.
(c) Third-party agents
Advances in technology and operational
efficiency have made it possible to separate the
administration of securities lending from the
provision of basic custody services, and a
number of specialist third-party agency lenders
have established themselves as an alternative to
the custodian banks.
Their market share is currently growing from
a relatively small base. Their focus on securities
lending and their ability to deploy new
technology without reference to legacy systems
can give them flexibility.
2. Principal intermediaries
There are three broad categories of principal
intermediary:
Broker dealers
Specialist intermediaries
Prime brokers
In contrast to the agent intermediaries, they
can assume principal risk, offer credit
intermediation and take positions in the
securities that they borrow. Distinctions
between the three categories are blurred. Many
firms would be in all three.
In recent years securities lending markets
have been liberalised to a significant extent so
that there is little general restriction on who can
borrow and who can lend securities.
Lending can, in principle, take place directly
between beneficial owners and the eventual
borrowers. But typically a number of layers of
intermediary are involved. What value do the
intermediaries add?
SLMG 2005 ML10 7/9/05 1:10 pm Page 13
A beneficial owner may well be an insurance
company or a pension scheme while the
ultimate borrower could be a hedge fund.
Institutions will often be reluctant to take on
credit exposures to borrowers that are not well
In many cases, principal
intermediaries provide a service
to the market in matching the
supply of beneficial owners that
have large stable portfolios with
those that have a high borrowing
requirement
recognised, regulated, or who do not have a
good credit rating, which would exclude most
hedge funds.
In these circumstances, the principal interme-
diary (often acting as prime broker) performs a
credit intermediation service in taking a princi-
pal position between the lending institution and
the hedge fund.
A further role of the intermediaries is to take
on liquidity risk. Typically they will borrow from
institutions on an open basis – giving them the
option to recall the underlying securities if they
want to sell them or for other reasons – whilst
lending to clients on a term basis, giving them
certainty that they will be able to cover their
short positions.
In many cases, as well as serving the needs of
their own propriety traders, principal intermedi-
aries provide a service to the market in match-
ing the supply of beneficial owners that have
large stable portfolios with those that have a
high borrowing requirement. They also distrib-
ute securities to a wider range of borrowers
than underlying lenders, which may not have
the resources to deal with a large number of
counterparts.
These activities leave principal intermediaries
exposed to liquidity risk if lenders recall securi-
ties that have been on lent to borrowers on a
term basis. One way to mitigate this risk is to
use in-house inventory where available. For
example, proprietary trading positions can be a
stable source of lending supply if the long posi-
tion is associated with a long-term derivatives
transaction.
Efficient inventory management is seen as criti-
cal and many securities lending desks act as
central clearers of inventory within their organi-
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 13
Securities Lending Market Guide
sations, only borrowing externally when netting
of in-house positions is complete.
This can require a significant technological
investment. Other ways of mitigating ‘recall
risk’ include arrangements to borrow securities
from affiliated investment management firms,
where regulations permit, and bidding for exclu-
sive (and certain) access to securities from
other lenders.
On the demand side, intermediaries have his-
torically been dependent upon hedge funds or
proprietary traders that make trading decisions.
But a growing number of securities lending
businesses within investment banks have either
developed “trading” capabilities within their
lending or financing departments, or entered
into joint ventures with other departments or
even in some cases their hedge fund cus-
tomers. The rationale behind this trend is that
the financing component of certain trading
strategies is so significant that without the loan
there is no trade.
(a) Broker dealers
Broker dealers borrow securities for a wide
range of reasons:
- Market making
- To support proprietary trading on behalf of
clients
Many broker dealers combine their securities
lending activities with their prime brokerage
operation (the business of servicing the broad
requirements of hedge funds and other alterna-
tive investment managers). This can bring sig-
nificant efficiency and cost benefits. Typically
within broker dealers the fixed income and equi-
ty divisions duplicate their lending and financ-
ing activities.
(b) Specialist intermediaries
Historically, regulatory controls on participa-
tion in stock lending markets meant that global-
ly there were many intermediaries. Some spe-
cialised in intermediating between stock lenders
and market makers in particular, e.g. UK Stock
Exchange Money Brokers (“SEMB”). With the
deregulation of stock lending markets, these
niches have almost all disappeared.
Some of the specialists are now part of larger
financial organisations. Others have moved to
parent companies that have allowed them to
expand the range of their activities into propri-
etary trading.
SLMG 2005 ML10 7/9/05 1:10 pm Page 14
Securities Lending Market Guide
(c) Prime brokers
Prime brokers serve the needs of hedge funds
and other ‘alternative’ investment managers.
The business was once viewed, simply, as the
provision of six distinct services, although many
others such as capital introduction, risk man-
agement, fund accounting and start up assis-
tance have now been added:
Two strategies that are heavily
reliant on securities borrowing
are long/short equity and con-
vertible bond arbitrage
Services provided by prime brokers
Securities lending is one of the central
components of a successful prime brokerage
operation, with its scale depending on the
strategies of the hedge funds for which the
prime broker acts. Two strategies that are heavily
reliant on securities borrowing are long/short
equity and convertible bond arbitrage.
The cost associated with the establishment of
a full service prime broker is steep, and recog-
nised providers have a significant advantage.
Some of the newer entrants have been using
total return swaps, contracts for difference and
other derivative transaction types to offer what
has become known as “synthetic prime broker-
age”.
Again securities lending remains a key com-
ponent of the service as the prime broker will
still need to borrow securities in order to hedge
the derivatives positions it has entered into with
the hedge funds, for example, to cover short
positions. But it is internalised within the prime
broker and less obvious to the client.
Beneficial owners
Those beneficial owners with securities portfo-
lios of sufficient size to make securities lending
worthwhile include:
Pension funds
Insurance and assurance companies
Mutual funds/unit trusts
Endowments
When considering whether and how to lend
14 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
securities, beneficial owners need first to con-
sider the characteristics of their organisations
and portfolio.
1. Organisation characteristics
(a) Management motivation
Some owners lend securities solely to offset
custody and administrative costs. Others are
seeking more significant revenue.
(b) Technology investment
Lenders vary in their willingness to invest in
technological infrastructure to support securi-
ties lending.
(c) Credit risk appetite
The securities lending market consists of organ-
isations with a wide range of credit quality and
collateral capabilities.
A cautious approach to counterpart selection
(AAA only) and restrictive collateral guidelines
(G7 Bonds) will limit lending volumes.
2. Portfolio characteristics
(a) Size
Other things being equal, borrowers prefer large
portfolios.
(b) Holdings size
Loan transactions generally exceed $250,000.
Lesser holdings are of limited appeal to direct
borrowers. Holdings of under $250,000 are
probably best deployed through an agency pro-
gramme, where they can be pooled with other
inventories.
(c) Investment strategy
Active investment strategies increase the likeli-
hood of recalls, making them less attractive
than passive portfolios.
(d) Diversification
Borrowers want portfolios where they need liq-
uidity. A global portfolio offers the greatest
chance of generating a fit. That said, there are
markets that are particularly in demand from
time to time and there are certain borrowers
that have a geographic or asset class focus.
SLMG 2005 ML10 7/9/05 1:10 pm Page 15
(e) Tax jurisdiction and position
Borrowers are responsible for "making good"
any benefits of share ownership (excluding vot-
If the cost of manufacturing divi-
dends or coupons to a lender is
low then its assets will be in
greater demand
ing rights) as if the securities had not been lent.
They must "manufacture" (i.e. pay) the econom-
ic value of dividends to the lender. An institu-
tion's tax position compared to that of other
possible lenders is therefore an important con-
sideration. If the cost of manufacturing divi-
dends or coupons to a lender is low then its
assets will be in greater demand.
(f) Inventory attractiveness
"Hot" securities are those in high demand
whilst general collateral or general collateral
securities are those that are commonly avail-
able. Needless to say, the "hotter" the portfolio,
the higher the returns to lending.
Having examined the organisation and portfolio
characteristics of the beneficial owner, we must
now consider the various possible routes to
market.
The possible routes to the securities lending
market
(a) Using an asset manager as agent
A beneficial owner may find that the asset man-
ager they have chosen, already operates a secu-
rities lending programme. This route poses few
barriers to getting started quickly.
(b) Using a custodian as agent
This is the least demanding option for a benefi-
cial owner, especially a new one. They will
already have made a major decision in selecting
an appropriate custodian. This route also poses
few barriers to getting started quickly.
(c) Appointing a third-party specialist as agent
A beneficial owner who has decided to out-
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 15
Securities Lending Market Guide
source may decide it does not want to use the
supplier’s asset manager(s) or custodian(s),
and instead appoint a third-party specialist. This
route may mean getting to know and under-
stand a new provider prior to getting started.
The opportunity cost of any delay needs to be
factored into the decision.
(d) Auctioning a portfolio to borrowers
Borrowers demand portfolios for which they bid
guaranteed returns in exchange for gaining
exclusive access to them. There are several dif-
ferent permutations of this auctioning route:
Do-it-yourself auctions
Assisted auctions
Agent assistance
Consultancy assistance
Specialist “auctioneer” assistance
This is not a new phenomenon but one that has
gained a higher profile in recent years. A key
issue for the beneficial owner considering this
option is the level of operational support that
the auctioned portfolio will require and who will
provide it.
e) Selecting one principal borrower
Many borrowers effectively act as wholesale
intermediaries and have developed global fran-
chises using their expertise and capital to gener-
ate spreads between two principals that remain
unknown to one another. These principal inter-
mediaries are sometimes separately incorporat-
ed organisations, but more frequently, parts of
larger banks, broker-dealers or investment bank-
ing groups. Acting as principal allows these
intermediaries to deal with organisations that
the typical beneficial owner may choose to
avoid for credit reasons e.g. hedge funds.
(f) Lending directly to proprietary principals
Normally after a period of activity in the lending
market using one of the above options, a bene-
ficial owner that is large enough in its own
right, may wish to explore the possibility of
establishing a business “in house”, lending
directly to a selection of principal borrowers
that are the end-users of their securities. The
proprietary borrowers include broker-dealers,
market makers and hedge funds. Some have
global borrowing needs while others are more
regionally focused.
SLMG 2005 ML10 7/9/05 1:10 pm Page 16
Securities Lending Market Guide
(g) Choosing some combination of the above
Just as there is no single or correct lending
method, so the options outlined above are not
mutually exclusive. Deciding not to lend one
portfolio does not preclude lending to another;
similarly, lending in one country does not neces-
sitate lending in all. Choosing a wholesale inter-
mediary that happens to be a custodian in the
United States and Canada does not mean that a
lender cannot lend Asian assets through a third-
party specialist, and European assets directly to
a panel of proprietary borrowers.
Part Three
The borrowing motivation
One of the central questions commonly asked
by issuers and investors alike is “Why does the
borrower borrow my securities?” Before consid-
ering this point let us examine why issuers
might care.
When Initial Public Offerings
are frequent and corporate
merger and acquisition activity is
high, the securities lending
business benefits
Issuers
If securities were not issued, they could not
be lent. Behind this simple tautology lies an
important point. When Initial Public Offerings
are frequent and corporate merger and acquisi-
tion activity is high, the securities lending busi-
ness benefits. In the early 2000s, the fall in the
level of such activity depressed the demand to
borrow securities leading to:
A depressed equity securities lending market
meaning:
Fewer trading opportunities
Less demand
Fewer ”specials”
Issuer concern about the role of securities lend-
ing, such as
Whether it is linked in any way to the decline in
the value of a company’s shares?
Whether securities lending should be discour-
aged?
How many times does an issuer discussing a
specific corporate event stop to consider the
impact that the issuance of a convertible bond,
16 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
or the adoption of a dividend reinvestment plan
might have upon lending of their shares.
There is a significant amount of information
available on the ”long” side of the market and
correspondingly little on the short side.
Securities lending activity is not synonymous
with short selling. But it is often, although not
always, used to finance short sales (see below)
and might be a reasonable and practical proxy
for the scale of short selling activity in the
absence of full short sale disclosure. It is there-
fore natural that issuers would want to under-
stand how and why their securities are traded.
Reasons to borrow
Borrowers, when acting as principals, have no
obligation to tell lenders or their agents why
they are borrowing securities. In fact they may
well not know themselves as they may be on-
lending the securities to proprietary traders or
hedge funds that do not share their trading
strategies openly. Some prime brokers are delib-
erately vague when borrowing securities as they
wish to protect their underlying hedge fund cus-
tomer’s trading strategy and motivation.
This chapter explains some of the more com-
mon reasons behind the borrowing of securi-
ties. In general, these can be grouped into: (1)
borrowing to cover a short position (settlement
coverage, naked shorting, market making, arbi-
trage trading); (2) borrowing as part of a financ-
ing transaction motivated by the desire to lend
cash; and (3) borrowing to transfer ownership
temporarily to the advantage of both lender and
borrower (tax arbitrage, dividend reinvestment
plan arbitrage).
Borrowing to cover short positions
(a) Settlement coverage
Historically, settlement coverage has played a
significant part in the development of the secu-
rities lending market. Going back a decade or
so, most securities lending businesses were
located in the back offices of their organisations
and were not properly recognised as businesses
in their own right. Particularly for less liquid
securities – such as corporate bonds and equi-
ties with a limit free float – settlement coverage
remains a large part of the demand to borrow.
The ability to borrow to avoid settlement fail-
ure is vital to ensure efficient settlement and
SLMG 2005 ML10 7/9/05 1:10 pm Page 17
has encouraged many securities depositories
into the automated lending business. This
means that they remunerate customers for mak-
ing their securities available to be lent by the
depository automatically in order to avert any
settlement failures.
(b) Naked shorting
Naked shorting can be defined as borrowing
securities in order to sell them in the expecta-
tion that they can be bought back at a lower
Components of Return
Short
Interest
Rate Leverage
Current Related
+ Returns
+ Yield
0
- Dividend Interest
Exposure Exposure
price in order to return them to the lender.
Naked shorting is a directional strategy, specu-
lating that prices will fall, rather than a part of a
wider trading strategy, usually involving a corre-
sponding long position in a related security.
Naked shorting is a high-risk strategy.
Although some funds specialise in taking short
positions in the shares of companies they judge
to be overvalued, the number of funds relying
on naked shorting is relatively small and proba-
bly declining.
(c) Market making
Market makers play a central role in the provi-
sion of two-way price liquidity in many securi-
ties markets around the world.
They need to be able to borrow securities in
order to settle ”buy orders” from customers and
to make tight, two-way prices.
The ability to make markets in illiquid small
capitalisation securities is sometimes hampered
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 17
Securities Lending Market Guide
by a lack of access to borrowing, and some of
the specialists in these less liquid securities
have put in place special arrangements to
enable them to gain access to securities. These
include guaranteed exclusive bids with securi-
ties lenders.
The character of borrowing is typically short
term for an unknown period of time. The need
to know that a loan is available tends to mean
that the level of communication between
market makers and the securities lending
business has to be highly automated.
Total
Return
=
A market maker that goes short and then finds
that there is no loan available would have to buy
that security back to flatten its book.
(d) Arbitrage trading
Securities are often borrowed to cover a short
position in one security that has been taken to
hedge a long position in another as part of an
“arbitrage” strategy. Some of the more common
arbitrage transactions that involve securities
lending are described below.
(i) Convertible bond arbitrage
Convertible bond arbitrage involves buying a
convertible bond and simultaneously selling the
underlying equity short and borrowing the
shares to cover the short position (see Box 3).
Leverage can be deployed to increase the return
in this type of transaction. Prime brokers are
particularly keen on hedge funds that engage in
convertible bond arbitrage as they offer scope
SLMG 2005 ML10 7/9/05 1:10 pm Page 18
Securities Lending Market Guide
for several revenue sources:
Securities lending revenues
Provision of leverage
Execution of the convertible bond
Execution of the equity
(ii) Pairs trading or relative value “arbitrage”
This in an investment strategy that seeks to
identify two companies with similar characteris-
tics whose equity securities are currently trading
at a price relationship that is out of line with
an arbitrage opportunity arises
when the same security trades
at different prices in
different markets
their historical trading range.
The strategy entails buying the apparently
undervalued security while selling the apparent-
ly overvalued security short, borrowing the latter
security to cover the short position.
Focusing on securities in the same sector or
industry should normally reduce the risks in this
strategy.
(iii) Index arbitrage
In this context, arbitrage refers to the simulta-
neous purchase and sale of the same commodi-
ty or stock in two different markets in order to
profit from price discrepancies between the
markets.
In the stock market, an arbitrage opportunity
arises when the same security trades at different
prices in different markets. In such a situation,
investors buy the security in one market at a
lower price and sell it in another for more, capi-
talising on the difference. However, such an
opportunity vanishes quickly as investors rush
in to take advantage of the price difference.
The same principle can be applied to index
futures. Being a derivative product, index
futures derive their value from the securities
that constitute the index. At the same time, the
value of index futures is linked to the stock
index value through the opportunity cost of
funds (borrowing/lending cost) required to play
the market.
Stock index arbitrage involves buying or sell-
ing a basket of stocks and, conversely, selling or
buying futures when mispricing appears to be
18 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
taking place.
(2) Financing
As broker dealers build derivative prime bro-
kerage and customer margin business, they
hold an increasing inventory of securities that
requires financing.
This type of activity is high volume and takes
place between two counterparts that have the
following coincidence of wants:
One has cash that they would like to invest on
a secured basis and pick up yield
The other has inventory that needs to be
financed
In the case of bonds, the typical financing
transaction is a repo or buy/sell back. But for
equities, securities lending and equity, repo
transactions are used.
Tri Party agents are often involved in this type
of financing transaction as they can reduce
operational costs for the cash lender and they
have the settlement capabilities the cash bor-
rower needs to substitute securities collateral as
their inventory changes.
(3) Temporary transfers of ownership
(a) Tax arbitrage
Tax driven trading is an example of securities
lending as a means of exchange.
Markets that have historically provided the
largest opportunities for tax arbitrage include
those with significant tax credits that are not
available to all investors – examples include
Italy, Germany and France.
The different tax positions of investors around
the world have opened up opportunities for bor-
rowers to use securities lending transactions, in
effect, to exchange assets temporarily for the
mutual benefit of purchaser, borrower and
lender. The lender’s reward comes in one of
two ways: either a higher fee for lending if they
require a lower manufactured dividend, or a
higher manufactured dividend than the post-tax
dividend they would normally receive (quoted as
an “all-in rate”).
For example, an offshore lender that would
normally receive 75% of a German dividend and
incur 25% withholding tax (with no possibility to
reclaim) could lend the security to a borrower
that, in turn, could sell it to a German investor
who was able to obtain a tax credit rather than
SLMG 2005 ML10 7/9/05 1:10 pm Page 19
incur withholding tax. If the offshore lender
claimed the 95% of the dividend that it would
otherwise have received, it would be making a
significant pick-up (20% of the dividend yield),
whilst the borrower might make a spread of
between 95% and whatever the German
investor was bidding. The terms of these trades
vary widely and rates are calculated accordingly.
(b) Dividend reinvestment plan arbitrage
Many issuers of securities create an arbitrage
opportunity when they offer shareholders the
choice of taking a dividend or reinvesting in
additional securities at a discounted level.
Income or index tracking funds that cannot
deviate from recognised securities weightings
may have to choose to take the cash option and
forgo the opportunity to take the discounted
reinvestment opportunity.
One way that they can share in the potential
profitability of this opportunity is to lend securi-
ties to borrowers that then take the following
action:
Borrow as many guaranteed cash shares as
possible, as cheaply as possible
Tender the borrowed securities to receive the
new discounted shares
Sell the new shares to realise the “profit”
between the discounted share price and the
market price
Return the shares and manufacture the cash
dividend to the lender
Part Four
Market mechanics
This section outlines the detailed processes in
the life of a securities loan including:
Loan negotiation
Traditionally securities loans have been negoti-
ated between counterparts (whose credit
departments have approved one another) on
the phone, and followed up with written or elec-
Today, there is an increasing
amount of bilateral and
multilateral automated lending
tronic confirmations. Normally the borrower ini-
tiates the call to the lender with a borrowing
requirement. However, pro-active lenders may
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 19
Securities Lending Market Guide
also offer out in-demand securities to their
approved counterparts. This would happen par-
ticularly where one borrower returns a security
and the lender is still lending it to others in the
market, they will contact them to see if they
wish to borrow additional securities.
Today, there is an increasing amount of bilat-
eral and multilateral automated lending where-
by securities are broadcast as available at partic-
ular rates by email or other electronic means.
Where lending terms are agreeable, automatic
matching can take place.
An example of an electronic platform for
negotiating equity securities loan transactions is
EquiLend, which began operations in 2002 and
is backed by a consortium of financial institu-
tions. EquiLend’s stated objective is to: “Provide
the securities lending industry with the technol-
ogy to streamline and automate transactions
between borrowing and lending institutions and
… introduce a set of common protocols.
EquiLend will connect borrowers and lenders
through a common, standards-based global
equity lending platform enabling them to trans-
act with increased efficiency and speed, and
reduced cost and risk.” EquiLend is not alone in
this market; for example, SecFinex offers similar
services in Europe.
Confirmations
Written or electronic confirmations are
issued, whenever possible, on the day of the
trade so that any queries by the other party can
be raised as quickly as possible. Material
changes during the life of the transaction are
agreed between the parties as they occur and
may also be confirmed if either party wishes it.
Examples of material changes are collateral
adjustments or collateral substitutions. The par-
ties agree who will take responsibility for issuing
loan confirmations.
Confirmations would normally include the fol-
lowing information:
Contract and settlement dates
- Details of loaned securities
- Identities of lender and borrower (and any
underlying principal)
- Acceptable collateral and margin percentages
- Term and rates
- Bank and settlement account details of the
lender and borrower
SLMG 2005 ML10 7/9/05 1:10 pm Page 20
Securities Lending Market Guide
Term of loan, and selling securities while on
loan
Loans may either be for a specified term or
open. Open loans are trades with no fixed
maturity date. It is more usual for securities
loans to be open or “at call”, especially for equi-
If fixed, the lender is not obliged
to accept the earlier return of
securities
ties, because lenders typically wish to preserve
the flexibility for fund managers to be able to
sell at any time. Lenders are able to sell securi-
ties despite their being on open loan because
they can usually be recalled from the borrower
within the settlement period of the market con-
cerned. Nevertheless open loans can remain on
loan for a long period.
Term trades – fixed or indicative?
The general description “term trade” is used
to describe differing arrangements in the securi-
ties lending market. The parties have to agree
whether the term of a loan is “fixed” for a defi-
nite period or whether the duration is merely
“indicative” and therefore the securities are
callable. If fixed, the lender is not obliged to
accept the earlier return of the securities; nor
does the borrower need to return the securities
early if the lender requests it. Accordingly, secu-
rities subject to a fixed loan should not be sold
while on loan.
Where the term discussed is intended to be
“indicative”, it usually means that the borrower
has a long-term need for the securities but the
lender is unable to fix for term and retains the
right to recall the securities if necessary.
Putting securities “on hold” (also known as
“icing”)
Putting securities “on hold” (referred to in the
market as “icing” securities) is the practice
whereby the lender will reserve securities at the
request of a borrower on the borrower’s expect-
ed need to borrow those securities at a future
date. This occurs where the borrower must be
sure that the securities will be available before
committing to a trade that will require them.
20 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
While some details can be agreed between the
parties, it is normal for any price quoted to be
purely indicative, and for securities to be held to
the following business day. The borrower can
“roll over” the arrangement (i.e. continue to ice
the securities) by contacting the holder before
9am, otherwise it terminates.
Key aspects of icing are that the lender does
not receive a fee for reserving the securities and
they are generally open to challenge by another
borrower making a firm bid. In this case the
first borrower would have 30 minutes to decide
whether to take the securities at that time or to
release them.
“Pay-to-hold” arrangements
A variation of icing is “pay-to-hold” where the
lender does receive a fee for putting the securi-
ties on hold. As such, they constitute a contrac-
tual agreement and are not open to challenge
by other borrowers.
How are loans settled?
Securities lenders need to settle transactions
on a shorter timeframe than the customary set-
tlement period for that market. Settlement will
normally be through the lender’s custodian
bank and this is likely to apply irrespective of
whether the lender is conducting the operation
or delegating to an agent. The lender will usual-
ly have agreed a schedule of guaranteed settle-
ment times for its securities lending activity
with its custodians. Prompt settlement informa-
tion is crucial to the efficient monitoring and
control of a lending programme, with reports
needed for both loans and collateral.
In most settlement systems securities loans
are settled as “free-of-payment” deliveries and
the collateral is taken quite separately, possibly
in a different payment or settlement system and
maybe a different country and time zone. For
example, UK equities might be lent against col-
lateral provided in a European International
Central Securities Depository or US dollar cash
collateral paid in New York. This can give rise to
what is known in the market as “daylight expo-
sure”, a period during which the loan is not cov-
ered as the lent securities have been delivered
but the collateral securities have not yet been
received. To avoid this exposure some lenders
insist on pre-collateralisation, so transferring
the exposure to the borrower.
The CREST system for settling UK and Irish
SLMG 2005 ML10 7/9/05 1:10 pm Page 21
securities is an exception to the normal practice
as collateral is available within the system. This
enables loans to be settled against cash intra-
day and for the cash to be exchanged, if desired,
at the end of the settlement day for a package
of DBV securities overnight. The process can be
reversed and repeated the next day.
CREST settlement facility for stock lending
CREST also has specific settlement arrange-
ments for stock loans, requiring the independ-
ent input of instructions by both parties, who
must complete a number of matching fields,
including the amount and currency of any cash
collateral, together with the percentage value of
applicable loan margin. Loans may be effected
against sterling, euro or dollar consideration or
made free-of-payment.
Immediately after the settlement of the loan,
Open loans may be terminated
by the borrower returning
securities or by the lender
recalling them
CREST automatically creates a pre-matched
stock loan return transaction with an intended
settlement date of the next business day. The
return is prevented from settling until the bor-
rower intervenes to raise the settlement priority
of the transaction. The stock lender may freeze
the transaction in order to prevent the stock
from returning.
Termination of the loan
Open loans may be terminated by the borrow-
er returning securities or by the lender recalling
them. The borrower will normally return bor-
rowed securities when it has filled its short posi-
tion. A borrower will sometimes refinance its
loan positions by borrowing more cheaply else-
where and returning securities to the original
lender. The borrower may, however, give the
original lender the opportunity to reduce the
rate being charged on the loan before borrowing
elsewhere.
Redelivery, failed trades and legal remedies
When deciding which markets and what size
to lend in, securities lenders will consider how
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 21
Securities Lending Market Guide
certain they can be of having their securities
returned in a timely manner when called, and
what remedies are available under the legal
agreement (see below) in the event of a failed
return.
Procedures to be followed in the event of a
failed redelivery are usually covered in legal
agreements or otherwise agreed between the
parties at the outset of the relationship.
Financial redress may be available to the lender
if the borrower fails to redeliver loaned securi-
ties or collateral on the intended settlement
date. Costs that would typically be covered
include:
Direct interest and/or overdraft incurred
Costs reasonably and properly incurred as a
result of the borrower’s failure to meet its sale
or delivery obligations
Total costs and expenses reasonably incurred by
the lender as a result of a “buy-in” (i.e. where
the lender is forced to? purchase securities in
the open market following the borrower’s failure
to return them)
Costs that would usually be excluded are
those arising from the transferee’s negligence
or wilful default and any indirect or consequen-
tial losses. An example of that would be when
the non-return of loaned securities causes an
onward trade for a larger amount to fail. The
norm is for only that proportion of the total
costs which relates to the unreturned securities
or collateral to be claimed. It is good practice,
where possible, to consider “shaping” or “par-
tialling” larger transactions (i.e. breaking them
down into a number of smaller amounts for set-
tlement purposes) so as to avoid the possibility
of the whole transaction failing if the transferor
cannot redeliver the loaned securities or collat-
eral on the intended settlement date.
Corporate actions and votes
The basic premise underlying securities lend-
ing is to make the lender “whole” for any corpo-
rate action event – such as a dividend, rights or
bonus issue – by putting the borrower under a
contractual obligation to make equivalent pay-
ments to the lender, for instance by “manufac-
turing” dividends. However a shareholder’s
right to vote as part owner of a company cannot
be manufactured. When securities are lent, legal
ownership and the right to vote in shareholder
SLMG 2005 ML10 7/9/05 1:10 pm Page 22
Securities Lending Market Guide
meetings passes to the borrower, who will often
sell the securities on. Where lenders have the
right to recall securities, they can use this
option to restore their holdings and voting
rights. The onus is on the borrower to find the
securities, by borrowing or purchasing them in
the market if necessary. This can damage mar-
ket liquidity, which is a risk that intermediaries
manage.
It is important that beneficial owners are
aware that when shares are lent the right to vote
is also transferred. The SLRC’s code of guid-
ance (see Chapter 5) states in section 2.5.4 that
lenders should make it clear to clients that vot-
ing rights are transferred. A balance needs to
be struck between the importance of voting and
the benefits derived from lending the securities.
Beneficial owners need to ensure that any
agents they have made responsible for their vot-
ing and stock lending act in a co-ordinated way.
Borrowing securities in order to build up a
holding in a company with the deliberate pur-
pose of influencing a shareholder vote is not
necessarily illegal in the United Kingdom.
However, institutional lenders have recently
become more aware of the possibility, and tend
Stocklending is important
in maintaining market
liquidity but borrowing of
shares for the purpose of
voting is not appropriate
not to see it as a legitimate use of securities
borrowing.
A number of market bodies, in the United
Kingdom and internationally, have been
addressing the relationship between securities
lending and voting. For example, a recent
report by Paul Myners to the UK Shareholder
Voting Working Group3 made the following rec-
ommendation:
Stocklending is important in maintaining mar-
ket liquidity but borrowing of shares for the pur-
pose of voting is not appropriate… it is impor-
tant that beneficial owners are fully aware of the
implications for voting if they agree to their
shares being lent. In particular, when a resolu-
tion is contentious I start from the position that
the lender should automatically recall the relat-
ed stock, unless there are good economic rea-
sons for not doing so.’
Internationally, a working group of the
22 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
International Corporate Governance Network is
currently examining best practices for long-term
investors in relation to securities lending and
voting. The SLRC is also considering additions
to its code in this area.
UK tax arrangements and London Stock
Exchange reporting by member firms
London Stock Exchange rules require lending
arrangements in securities on which UK Stamp
Duty/Stamp Duty Reserve Tax (SDRT)4 is
chargeable to be reported to the Exchange.
This enables firms to bring their borrowing
and lending activity ‘on Exchange’ and to allow
them to be exempt from Stamp Duty/SDRT.
Firms which are not members of the
Exchange but which conduct borrowing and
lending through a member firm are also eligible
for relief from stock lending Stamp Duty/SDRT.
On Exchange lending arrangements are evi-
denced by regulatory reports that are transmit-
ted to the Exchange by close of business on the
day the lending arrangement is agreed.
Prior to entering into a lending arrangement,
member firms are required to sign a written
agreement with the other party.
The Exchange has authorised the following
agreements:
- Global Master Securities Lending Agreement
- Master Equity & Fixed Interest Stock Lending
Agreement (1996)
- PSA/ISMA Global Master Repurchase
Agreement as extended by supplemental terms
and conditions for equity repo forming Part 2 of
Annex 1 of the agreement
Where an authorised agreement does not cover
the circumstances in which a member firm
wishes to enter into a lending arrangement, the
firm must ensure that the agreement includes
provisions equivalent to those contained within
the Exchange’s rules on lending arrangements
in relation to member firm default.
Transparency in the UK market
CREST provides time-delayed information on
the value of securities financing transactions in
the top 350 UK equities.
This is a subscription service begun in
September 2003 following extensive discussion
with market participants and the Financial
Services Authority.
The information it provides pertains to total
SLMG 2005 ML10 7/9/05 1:10 pm Page 23
Stamp Duty Reserve Tax-exempt transactions
taking place in each security on a given day and
excludes intermediary activity where possible.
CREST has provided answers to many frequent-
ly asked questions on its website,
www.crest.co.uk.
The launch of its securities financing data
service coincided with its publication of settle-
ment failure statistics The London Stock
Exchange monitors both and makes public
announcements on stock lending activity when
it feels it is appropriate.
UK Takeover Panel
If it is proposed that any securities lending
should take place during an offer period for a
UK company, the Takeover Panel should be con-
sulted to establish whether any disclosure is
required and whether there are any other conse-
quences.
Part Five
Risks, regulation and market oversight
This chapter describes the main financial risks
in securities lending, and how lenders usually
manage them. It is not a comprehensive
description of the various operational, legal,
market and credit risks to which market partici-
pants can be exposed. The chapter then briefly
summarises the UK regulatory framework for
securities lending market participants and the
role of the UK Stock Lending and Repo
Committee. Financial risks in securities lending
are primarily managed through the use of collat-
eral and netting. As described in Chapter 1, col-
lateral can be in the form of securities or cash.
The market value of the collateral is typically
greater than that of the lent portfolio. This mar-
gin is intended to protect the lender from loss
and reflect the practical costs of collateral liqui-
dation and repurchase of the lent portfolio in
the event of default. Any profits made in the
repurchase of the lent portfolio are normally
returned to the borrower’s liquidator. Losses
incurred are borne by the lender with recourse
to the borrower’s liquidator along with other
creditors.
Risks and risk management
When taking cash as collateral
Because of its wide acceptability and ease of
management, cash can be highly appropriate
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 23
Securities Lending Market Guide
collateral. However, the lender needs to decide
how best to utilise this form of collateral. As
described in Chapter 1, a lender taking cash as
collateral pays rebate interest to the securities
borrower, so the cash must be reinvested at a
higher rate to make any net return on the collat-
eral. This means the lender needs to decide on
an appropriate risk-return trade-off. In simple
terms, reinvesting in assets that carry one of the
following risks can increase expected returns:
a higher credit risk: a risk of loss in the event of
defaults or a longer maturity in relation to the
likely term of the loan
Many of the large securities lending losses
over the years have been associated with rein-
vestment of cash collateral.
Typically, lenders delegate reinvestment to
their agents, (e.g. custodian banks). They spec-
ify reinvestment guidelines, such as those set
out in Chapter 1. There is a move towards more
quantitative, risk-based approaches; often speci-
fying the ”value-at-risk” in relation to the differ-
ent expected returns earned from alternative
reinvestment profiles. Agents do not usually
offer an indemnity against losses on reinvest-
ment activity so that the lender retains all of the
risk while their agent is paid part of the return.
Compared with cash collateral,
taking other securities as
collateral is a way of avoiding
reinvestment risk
When taking other securities as collateral
Compared with cash collateral, taking other
securities as collateral is a way of avoiding rein-
vestment risk. In addition to the risks of error,
systems failure and fraud always present in any
market, problems then arise on the default of a
borrower. In such cases the lender will seek to
sell the collateral securities in order to raise the
funds to replace the lent securities. Transactions
collateralised with securities are exposed to a
number of different risks:
Reaction and legal risk. If a lender experi-
ences delays in either selling the collateral secu-
rities or repurchasing the lent securities, it runs
a greater risk that the value of the collateral will
fall below that of the loan in the interim.
Typically, the longer the delay, the larger the risk.
Mispricing risk. The lender will be exposed if
SLMG 2005 ML10 7/9/05 1:10 pm Page 24
Securities Lending Market Guide
either collateral securities have been over-valued
or lent securities under-valued because the
prices used to mark-to-market differ from prices
that can actually be traded in the secondary
market. One example of mispricing is using
mid rather than bid prices for collateral. For
illiquid securities, obtaining a reliable price
source is particularly difficult because of the
lack of trading activity.
Liquidity risk. Illiquid securities are more like-
ly to be realised at a lower price than the valua-
tion used. Valuation “haircuts” are used to mit-
igate this risk (i.e. collateral is valued at, for
example, 98% or 95% of the current market
value). The haircuts might depend upon:
The proportion of the total security issue held in
the portfolio – the larger the position, the
greater the haircut
The average daily traded volume of the securi-
ty: the lower the volume, the greater the haircut
The volatility of the security; the higher the
volatility, the greater the haircut
Congruency of collateral and lent portfolios
(mismatch risk). If the lent and collateral port-
folios were identical then there would be no
market risk. In practice, of course, the lent and
collateral portfolios are often very different.
The lender’s risk is that the market value of the
lent securities increases but that of the collater-
al securities falls before rebalancing can be
effected. Provided the counterpart has not
defaulted, the lender will be able to call for addi-
tional collateral on any adverse collateral/loan
price movements. However, following default, it
will be exposed until it has been able sell the
collateral and replace the lent securities.
The size of mismatch risk depends on the
expected co-variance of the value of the collater-
al and lent securities. The risk will be greater if
the value of the collateral is more volatile, the
value of the lent securities is more volatile, or if
their values do not tend to move together, so
that the expected correlation between changes
in their value is low. For example, in deciding
whether to hold UK government securities or
UK equities to collateralise a loan of BP shares,
a lender would have to judge whether the
greater expected correlation between the value
of the UK equities and the BP shares reduced
mismatch risk by more than the lower expected
volatility in the value of the government securi-
ties.
Many agent intermediaries will offer beneficial
owners protection against these risks by agree-
24 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
ing to return (buy-in) lent securities immediate-
ly for their clients following a fail, taking on the
risk that the value of the collateral on liquida-
tion is lower.
Realistic valuations
The first consideration is whether the valua-
tion prices are fair. Assuming the portfolios
have been conservatively valued at bid and offer
(not mid) prices, then the lender might require
some adjustment (haircut) to reflect concentra-
tion and price volatility of the different assets.
For example, in the case of the sterling cash col-
lateral, the haircut might be negligible. But for
Many agent intermediaries
will offer beneficial owners
protection against these risks by
agreeing to return lent securities
immediately for their clients
following a fail
the Malaysian equity portfolio, a high adjust-
ment might be sought on the assumption that
it would probably cost more than £100m to buy
back this part of the lent portfolio. Required
haircuts might be based on the average daily
liquidity for the asset class, the price volatility of
the asset class and the residual risk on individ-
ual securities, taken from Table 2.
Risk Analysis for Borrower 1 under different assumptions
Probability of Loss Expected Loss on
Scenario
on Default Default (£m)
Base Case 26% 4.00
Asset Risk Increased
33% 8.00
by 50%
Reduce Liquidity by
31% 5.10
50%
Source: Barrie & Hibbert
Risk calculation (post-default) one diagram
Using the adjusted portfolios, the lender can
then calculate the risk of a collateral shortfall in
the event of the borrower defaulting. Broadly,
this will need to assess the volatility of each
asset class, the correlation between them and
the residual risk of securities within them to
derive a range of possible scenarios from which
probabilities of loss and the most likely size of
SLMG 2005 ML10 7/9/05 1:10 pm Page 25
losses on default can be estimated. Working
on the assumption that the lender can realise
its collateral and replace its lent securities in a
reaction time of twenty days, Table 4 shows the
results for the portfolio, together with some
sensitivity analysis in case market volatility and
liquidity that has been significantly changed. By
Netting is an important element
of risk management given that
market participants will often
have many outstanding trades
with a counterpart
increasing the volatility assumption or reducing
the liquidity assumption, the probability and
scale of expected losses increase.
Netting
Netting is an important element of risk man-
agement given that market participants will
often have many outstanding trades with a
counterpart. If there is a default the various
standard industry master agreements for securi-
ties lending should provide for the parties’ vari-
ous obligations under different securities lend-
ing transactions governed by a master agree-
ment to be accelerated, i.e. payments become
due at current market values. So instead of
requiring the parties to deliver securities or col-
lateral on each of their outstanding transactions
gross, their respective obligations are valued
(i.e. given a cash value) and the value of the
obligations owed by one party are set off
against the value of the obligations owed by the
other, and it is the net balance that is then due
in cash.
This netting mechanism is a crucial part of
the agreement. That is why there is so much
legal focus on it: for example, participants need
to obtain legal opinions about the effectiveness
of netting provisions in jurisdictions of overseas
counterparts, particularly in the event of a coun-
terpart’s insolvency.
That is also why regulators of financial firms
typically expect legal opinions on the robustness
of netting arrangements before they will recog-
nise the value of collateral in reducing counter-
part credit exposures for capital adequacy pur-
poses. In the United Kingdom, SLRC has a net-
ting sub-group, which, on behalf of subscribing
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 25
Securities Lending Market Guide
banks, is monitoring an exercise to gather opin-
ions on the legal bases for netting in different
jurisdictions.
UK regulation
Any person who conducts stock borrowing or
lending business in the United Kingdom would
generally be carrying on a regulated activity
under the terms of the Financial Services and
Markets Act 2000 (Regulated Activities) Order
2001, and would therefore have to be autho-
rised and supervised under that Act. The stock
borrower or lender would, as an authorised per-
son, be subject to the provisions of the FSA
Handbook, including the Inter-Professional
chapter of the Market Conduct Sourcebook.
They would also need to have regard to the
market abuse provisions of the Financial
Services and Markets Act 2000, and the related
Code of Market Conduct issued by the Financial
Services Authority (FSA). The Conduct of
Business Sourcebook requires a beneficial
owner’s consent to carry on stock lending on its
account. The FSA Handbook contains rules,
guidance, and evidential provisions relevant to
the conduct of the firm in relation to the FSA’s
High Level Standards.
Stock Borrowing and Lending Code
In addition to the essentially prudential stan-
dards set by the FSA, market participants have
drawn up a code, the Stock Borrowing and
Lending Code. This is a code that UK-based
participants in the stock borrowing and lending
markets of both UK domestic and overseas
securities observe as a matter of good practice.
The Code covers matters such as agents, bro-
kers, legal agreements, custody, margins,
defaults and close-outs, and confirmations. It
is based on the current working practices of
leading market practitioners and is kept under
regular review. The Code does not in any way
replace the FSA’s or other authorities’ regulatory
requirements; nor is it intended to override the
internal rules of settlement systems on borrow-
ing or lending transactions. Work is currently in
progress to produce a UK Annex to the Code
that will consider specific aspects of UK law and
practices in the equity stock lending market.
The Code is available on the Bank of England’s
website at www.bankofengland.co.uk/
markets/stockborrowing.pdf.
SLMG 2005 ML10 7/9/05 1:10 pm Page 26
Securities Lending Market Guide
Securities Lending and Repo Committee
The Stock Borrowing and Lending Code was
produced by the Securities Lending and Repo
Committee (SLRC), that is a UK-based commit-
tee consisting of market practitioners, members
of bodies such as CREST, the United Kingdom
Debt Management Office, the Inland Revenue,
the London Clearing House, the London Stock
Exchange and the FSA. It provides a forum in
which structural (including legal, regulatory,
trading, clearing and settlement infrastructure,
tax, market practice and disclosure) develop-
ments in the stock lending and repo markets
can be discussed, and recommendations made.
It also co-ordinates the development of gilt repo
and equity repo codes; produces and updates
the Gilts Annex to the ISMA/TBMA Global
Master Repurchase Agreement (GMRA); keeps
under review the other legal agreements used in
the stock lending and repo markets; and main-
tains a sub-group on legal netting. It liaises with
similar market bodies and trade organisations
covering the repo, securities and other financial
markets, both in London and internationally.
Minutes of SLRC meetings are available on the
Bank of England’s website, at www.bankofeng-
land.co.uk/markets/slrc/htm. The SLRC’s
terms of reference are shown in Appendix 2.
The work of the SLRC complements the work
of the various market associations, including, in
the securities lending field, the International
Securities Lending Association (ISLA). The
objectives of ISLA include representing the
common interests of securities lenders and
assisting in the orderly, efficient and competi-
tive development of the securities lending mar-
ket. ISLA has helped to produce standard mar-
ket agreements, including the Overseas
Securities Lending Agreement (OSLA 1995 ver-
sion), the Master Equity and Fixed Interest
Securities Lending Agreement (MEFISLA 1999
version) and the Global Master Securities
Lending Agreement (GMSLA May 2000).
Part 6
Securities Lending and Corporate gover-
nance
What is Corporate Governance?
Corporate Governance has increased in
importance over recent years. This high profile
has been supported by investors, their associa-
26 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
tions and increasingly by regulators. As the
Organisation for Economic Co-operation and
Development writes in response to the follow-
ing frequently asked question “What is corpo-
rate governance and why is it important?”
Corporate governance deals with the rights
and responsibilities of a company’s manage-
ment, its board, shareholders and various stake-
holders. How well companies are run affects
market confidence as well as company perform-
ance. Good corporate governance is therefore
essential for companies that want access to
Exercising the right to vote is an
integral and important aspect of
good corporate governance
capital and for countries that want to stimulate
private sector investment. If companies are well
run, they will prosper. This, in turn, will enable
them to attract investors whose support can
help to finance faster growth. Poor corporate
governance, on the other hand, weakens a com-
pany’s potential and, at worst, can pave the way
for financial difficulties and even fraud.
Exercising the right to vote is therefore an
integral and important aspect of good corporate
governance for institutional investors. To be
more precise the exercising of a right to vote
against management is the ultimate sanction
that a shareholder has and can be seen as a
major step in meaningful engagement with the
company.
Avoiding Conflict
There has been widespread discussion regard-
ing the possible conflict between the exercising
of good corporate governance on behalf of
investors and the lending of securities. This dis-
cussion focuses upon the ability of investors,
either directly or by instructing their agents, to
vote when they have securities on loan.
We will draw upon specific examples, where
appropriate, and highlight best practice.
The Legal Position
There are differing views in the market place
as to the exact meaning of the term Securities
Lending. “The word ‘lending’ is in some ways
misleading. In law the transaction is, in fact, an
absolute transfer of title against an undertaking
SLMG 2005 ML10 7/9/05 1:10 pm Page 27
to return equivalent securities.”
This results in some important consequences
arising from the nature of securities lending
transactions:
Absolute title over both lent and collateral
securities passes between parties, meaning that
There has been widespread
discussion regarding the
possible conflict between
the exercising of good
corporate governance on behalf
of investors and the lending
of securities
these securities can be sold outright or “on
lent”
Once securities have been passed, the new
owner of them has certain rights. For example
they have the right to sell or lend them to
another buyer and vote in the AGMs/EGMs if
they are the holder at the record date
The lender of equities no longer owns them
and has no entitlement to vote. But they are still
exposed to price movements on them since the
economic exposure to owning those securities
is not passed. Typically lenders reserve the right
to recall equivalent securities from the borrower
and must exercise this option if they wish to
vote
Shares should not be borrowed for the purpose
of voting
As Paul Myners writes in the March 2005
Report to the Shareholder Voting Working
Group, ‘Review of the Impediments to voting
UK shares’:
“Borrowing shares for the purpose of acquiring
the vote is inappropriate, as it gives a propor-
tion of the vote to the borrower which has no
relation to their economic stake in the company.
This is particularly the case in takeover situa-
tions or where there are shareholder resolutions
involving acquisitions or disposals. The poten-
tial to vote borrowed shares means that there is
a risk that decisions could be influenced by
those that do not have an economic interest in
the business. I believe that this merits the atten-
tion of lenders, fund managers and the ultimate
beneficial owners, and their respective trade
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 27
Securities Lending Market Guide
associations. They should visit existing practices
to see whether practical procedures could be
put in place to prohibiting the borrowing of
stock for the purposes of voting. In this respect,
the Securities Borrowing and Lending Code of
Guidance states: “there is consensus in the
market that securities should not be borrowed
solely for the purposes of exercising the voting
rights at, for example, an AGM or EGM.
Lenders should also consider their corporate
governance responsibilities before lending stock
over a period in which an AGM or EGM is
expected to be held” .
Similarly collateral held, which can be of equal
or greater value than the shares lent, should not
be voted.
This is a clear position and one of which practi-
tioners actively engaged in the business of secu-
rities lending are acutely aware.
The Right to Recall
It is the case that securities on loan cannot be
voted by the lender. Should they wish to exer-
cise their right to vote, they need to recall these
securities by the pre-determined time i.e. record
date.
Notwithstanding the above, it is not the case
that, in aggregate, all votes on lent shares are
lost.
Some shares that have been borrowed will be
delivered into the market to settle sales and end
up with buyers. These buyers will be oblivious
to the fact that these shares have been bor-
rowed and will view them as their property and
choose to vote as they see fit.
It is the case that there may be some loss of
votes associated with collateral positions or
positions sitting long in trading books because
shares held as collateral or in trading books are
not normally voted.
The right to recall any security on loan is
enshrined in the legal agreement underpinning
this activity and typically the lender recalling
securities must provide their agent or borrower
with “standard settlement period notice.”
Recalls are part and parcel of the securities
lending business.
However, borrowers seek to avoid recalls wher-
ever possible and frequent recalls may discour-
age borrowers from accessing portfolios.
In practice the lenders, or their agent, commu-
SLMG 2005 ML10 7/9/05 1:10 pm Page 28
Securities Lending Market Guide
nicate the lender’s position with regards to vot-
ing to the borrowers so as to avoid any surpris-
es.
It is important for all parties that they under-
stand the importance of this communication
and the rights of the underlying client to recall
their securities to vote.
There are several positions that can be taken
and these are driven by the owners of the assets
made available for loan.
At all times it is the owner who determines
what can and cannot be done with their securi-
ties.
The beneficial owners of these assets include
the following types of organisations:
- Pension Funds
- Mutual Funds
- Insurance Companies
- Unit Trusts
- Charities and Religious Institutions
The Lenders’ Choices
The following positions are possible and there
are securities lending programmes constructed
to cater for each of them:
Voting (and therefore recalling) securities at
every opportunity e.g. when the owner has a
strong culture of voting and does not wish to
miss an opportunity to demonstrate its position
to the company
This is quite a rare position to take and is
often only made in a subset of markets that are
very important to the owner e.g. A UK pension
fund might wish to recall all UK securities to
vote. In his report, Paul Myners accepted that
investors might have legitimate economic rea-
sons for not recalling all securities to vote. 10
Voting (and therefore recalling) securities only
when the vote is deemed important enough e.g.
when a takeover is being considered
This is a more commonplace position and
enables the owners to enjoy higher securities
lending revenues whilst voting when they feel it
is warranted. It is important to note that the
beneficial owner determines when it is impor-
tant to vote, not their agents or borrowers. Here
again the owners might focus upon their local
market where their corporate governance aspi-
rations are understandably higher than they
might be overseas.
Not voting securities at all
There are still organisations that choose, for
28 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
their own reasons, not to vote. This is their
decision although increasing pressure in the UK
from the government and others with regulatory
responsibility may well encourage greater voting
over time. However, should they change their
mind and make an exception, they would have
the capability to notify their agent or borrower
and recall the securities in the normal way.
To ensure that the beneficial
owner receives direct advice
regarding voting the retention of
at least one share in their
account is advisable
Maintaining a buffer of at least one share in all
holdings
To ensure that the beneficial owner or asset
manager receives direct advice regarding voting
(and all other corporate actions) the retention
of at least one share in their account is advis-
able. This has the advantage of ensuring the
efficient and direct flow of information whilst
retaining optimal lending returns. It is typical
for there to be some retention or “buffer” of
securities to be made in a lending programme
and this level could be as low as one share or
could be expressed as a percentage of the value
of the holding.
Market Practice
Currently the majority of lenders of securities
do not recall securities for voting except for the
more contentious votes. This choice is theirs to
make and should they wish to alter this position
they are free to do so.
Typically a lender of securities would let their
counterparts know their position regarding cor-
porate governance and propensity to vote
before joining a lending programme.
Lending agents have strong operational pro-
cedures in place to ensure recalls are made
where appropriate.
Putting Disenfranchisement in Context
So there is a material amount of borrowing in
this blue chip index that peaks over dividend
dates. What impact does this pattern have upon
voting turnout and thereby upon corporate gov-
SLMG 2005 ML10 7/9/05 1:10 pm Page 29
ernance?
It is difficult to say in specific terms without
going into detailed examples and space pro-
hibits us from doing so here.
However, the following conclusions easily
emerge from the research.
The scale of securities lending does not typically
Currently the majority of lenders
of securities do not recall
securities for voting except for
the more contentious votes
exceed the voluntary disenfranchisement one
sees at typical AGMs.
In other words more investors choose not to
vote (for whatever reason) than choose to lend
(and not recall).
Suggestions
So what should be done to alleviate the per-
ceived problem? Here are some suggestions
that are currently being considered and that will
make a difference if implemented:
- Transparency
All stakeholders, not just securities lending
professionals, e.g. fund managers and corpo-
rate governance professionals, should under-
stand the following:
- The established legal framework underpinning
the lending arrangement
- Securities must be recalled to vote
- The exact notice required to recall the shares
to vote - this may be different to normal market
settlement periods depending on the lending
agent being used
- Which securities are on loan
- How to access loan and/or governance infor-
mation
- The potential effect of dividend record dates
Some beneficial owners are already in receipt
of detailed reporting from their lending agents,
although it is fair to say that the frequency and
distribution of this information varies. Best
practice is to provide daily reports securely on
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 29
Securities Lending Market Guide
the internet. This enables permissioned users
throughout the beneficial owners organisation
to understand which securities are on loan.
- Consistency
A clear policy is required so that the inherent
conflict between the securities lending income
forgone and the “value” of recalling to vote is
addressed explicitly. This policy should be care-
fully drafted and agreed by stakeholders. In
practice, accurately assessing the economic
trade off is challenging – the opportunity cost of
making a recall may be known and is easier to
assess than the benefit of making a vote. Any
policy should be flexible enough to take into
account a wide variety of security specific situa-
tions.
- Communication
It is imperative that all stakeholders have
access to all necessary information in time to
make informed decisions. This requires accu-
rate communication of data throughout the
chain of organisations that are involved in lend-
ing, including the stakeholders at the beneficial
owners, all teams at their providers and also the
issuer. The efficient communication of any
recalls is a vital part of the process that is nor-
mally well documented in the securities lending
agreement. Beneficial Owners should typically
expect that securities on loan will be returned
upon the provision of standard settlement peri-
od notice.
- Timing
Given the scale of lending activity around the
dividend record date it is constructive to main-
tain the separation of the record date from the
AGM.
However, the issuers should ensure that the
necessary documentation regarding the share-
holders meeting are distributed prior to the
record date so that the owners can decide
whether they would prefer to vote or make the
securities available for loan.
Furthermore, bringing the payment date
closer to the AGM would ensure that the
dividend timetable is not unduly lengthened.
This would enable lenders that wish to
participate in profitable dividend related lending
activity to do so with less voting conflict.
It will also ensure that lenders are fully
informed and can vote when it matters to them.
This change does not require changes in
SLMG 2005 ML10 7/9/05 1:10 pm Page 30
Securities Lending Market Guide
company law and could be affected by the issu-
ing companies.
- Guidance
It is clear from the SLRC Code of Guidance
and the Myners reports on the subject of securi-
ties lending and voting that the practice of bor-
rowing shares specifically to vote is unaccept-
able.
Many active participants in the securities
lending business already have the suggested
measures outlined above in place. That should
be a source of comfort to those concerned
about the activity.
Lending is only part of the picture
The evidence suggests that lending is not one
of the primary reasons why voting turnout is
low.
The value of a vote is determined by the
owner of that vote – if they do not value it they
may choose not to exercise their right, irrespec-
tive of their willingness to lend.
As the law currently stands in the UK, borrow-
ing securities in order to build up a holding in a
company with the deliberate purpose of influ-
encing a shareholder vote is not illegal.
However, based on recent headlines and the
work done by the International Corporate
Governance Network, institutional lenders have
recently become more aware of this possibility,
and tend not to see it as a legitimate use of
securities borrowing.
Since the demise of the borrowing purpose
test, it is technically possible for someone to
borrow securities to vote.
However, it has been made very clear that this
is not acceptable practice as the UK Annex to
the Stock Borrowing and Lending Code, SLRC,
11 May 2004 makes clear.
Should this activity become an issue of con-
cern in the future, it would draw regulatory
attention very quickly, with the widespread sup-
port of the securities lending industry.
It is vital that beneficial owners are aware that
when shares are lent the right to vote is also
transferred. The SLRC Code of Guidance states
that “agents should make it clear to clients that
voting rights are transferred.”
Going forward, a balance needs to be struck
between voting securities and the benefits
derived from lending securities. Quantifying
these competing benefits is challenging.
30 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
The income derived from securities lending
can be explicitly measured but the value of a
vote is perhaps less tangible - particularly now
that most securities carry a vote and the majori-
ty of equity securities in publicly quoted compa-
nies rank pari passu (i.e. there are fewer compa-
nies that issue both voting and non voting
shares that can be compared with one another).
Beneficial owners need to ensure that any
agents they have made responsible for their vot-
ing and stock lending act in a co-ordinated way.
This may mean that portfolio managers need to
receive reports regarding securities on loan so
as to avoid any situation whereby votes that
they intend to make are not possible.
This should be straightforward as notification
of a vote taking place is given well in advance
and securities can easily be recalled if necessary.
Securities lending and the pursuit
of good corporate governance are
not necessarily in conflict
Conclusion
Securities lending and the pursuit of good
corporate governance are not necessarily in
conflict. Both activities can and do co-exist hap-
pily within the investment management main-
stream.
Today, many of the foremost proponents of
good corporate governance successfully com-
bine an active voting role with a successful
securities lending role.
The information flow and communication
necessary to ensure that conflict is avoided is
already in place but could be developed further.
Those that are concerned about possible con-
flict need to openly discuss the issue with their
securities lending counterparts and corporate
governance colleagues.
There is no need for anyone to feel that secu-
rities lending will disenfranchise them. At all
times it should be remembered that the owner
of the securities determines whether securities
are either lent or voted.
Mark Faulkener, Spitalfields Advisors
SLMG 2005 ML10 7/9/05 1:10 pm Page 31
Frequently Asked
Questions
The securities lending business is seen by many
non-practitioners as difficult to understand and there
are many questions asked. Here, we provide answers to
some of them.
Legal
What do people mean when they talk about transfer of
title?
Contracts provide for ownership of lent securities to pass
from the lender to the borrower.
A moment's thought about one of the principal motiva-
tions for borrowing and lending securities will make the
necessity for this clear.
Say the borrower needs to borrow securities to cover a
short position, i.e. to fulfil a contract it has entered into to
sell on the securities.
The buyer is expecting the borrower to pass it ownership
on settlement of that sale, as is normal in a sale.
If the borrower cannot do that, the borrower will not be
able to fulfil its contract with that purchaser. In order to
enable it to fulfil its contract, the borrower obtains title
from the lender and then passes it on to the purchaser,
hence “transfer of title”.
What does this mean for the lender?
The lender needs to be aware that it will be transferring
ownership of the securities and of the various conse-
quences that flow from this.
First, any transfer taxes applicable to a purchase of
securities will be due unless an exemption applies.
This will typically be an issue for the borrower on the
initial leg of the transaction. But the lender should
recognise that the return leg of the transaction (i.e. when
the borrower transfers securities back to the lender) may
also attract transfer taxes where they are applicable.
Second, the transfer of the lent securities is in legal terms
a disposal of them, and the lender needs to establish
whether such a disposal will have any consequences.
Again this is usually a tax question e.g. are there tax con-
sequences for the lender in disposing of the lent securities?
Third, and very importantly, the obligation of the borrower
on the return leg of the transaction is to transfer
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 31
Securities Lending Market Guide
equivalent securities back to the lender, not the original
securities.
In a securities lending transaction, the borrower is not
“holding” the securities in trust or in custody on behalf of
the lender. The borrower actually owns them, which is to
say that the lender has no right to securities that are in
the hands of the borrower.
Given that the borrower will often have sold on the
securities, it is unlikely that the securities would be in the
borrower's hands).
Fourth, as the lender will cease to be the owner, it will
no longer be entitled to income from the securities, will
not receive notice or proceeds of corporate actions, and
will lose all voting rights in respect of the securities.
The standard documentation sets out contractual
mechanisms for putting the owner in a comparable
economic position in respect of income and corporate
actions.
Voting rights are transferred and the lender must recall
equivalent securities from the borrower in order to vote.
Why is it called securities “lending” when there is
transfer of title?
Because commercially and economically people think of it
as lending. Reflecting this, for accounting and capital
requirements it is usually treated as a loan.
Does it mean that the lender gets exactly the same
securities back?
No. The borrower’s obligation is to return “equivalent
securities” i.e. from the same securities issue with the
same International Securities Identification Number (ISIN).
Often it will have sold the original lent securities and has
to borrow or purchase securities in the market to fulfil its
obligation to the lender.
Does the lender have a pledge over the collateral?
No. Under standard market agreements and English law,
there is usually a transfer of title to the collateral. If the
collateral is cash, all that means is that there is a cash
payment by the borrower into the lender’s bank account. If
the collateral is securities, there is a transfer of title of
those securities to the lender.
Many of questions that arise for borrowers in relation to
collateral securities also arise for lenders in relation to
lent securities.
Why are there so many different agreements?
Historically the different tax treatment of securities
SLMG 2005 ML10 7/9/05 1:10 pm Page 32
Securities Lending Market Guide
lending in different jurisdictions has driven the need for
different agreements (such as OSLA – the Overseas
Securities Lenders' Agreement, MEFISLA – the Master
Equity and Fixed Income Stock Lending Agreement, and so
on). Following tax changes it has generally become possi-
ble to use a single document and the GMSLA – the Global
Master Securities Lending Agreement, consolidates the
various historical documents.
Why is it called securities lending
when there is a transfer of title?
If the securities lending is carried out under English
Law, but a custodian appoints a sub-custodian in anoth-
er country, or lends to an entity in another country
which does not recognise English Law, what happens
when something goes wrong?
Simplifying a bit, there are three elements in the appli-
cation of law to a securities lending transaction. The first
is the contractual law, the second are the home country
laws applying to each party, and the third is the law
applying to the place where the securities are held.
The contractual law is that which applies to the legal
agreement between the parties, which sets out the con-
tractual terms relating to the lending transaction.
Most lending agreements are in practice subject to
English law, so that any disputes can be settled in the
courts of England.
Where a party incorporated in England proposes to conduct
a securities lending transaction with a party incorporated in
another country, the UK-incorporated party will need to
check, normally by obtaining a legal opinion, that the home
country law of the other party will allow the contract to be
given effect in accordance with its terms.
This opinion will normally focus in particular on the close
out and netting (set-off) provisions of the legal agreement
that apply in the insolvency of either party (see section on
netting in Chapter 5). This together with the collateralisation
and margin arrangements should keep the risks in conduct-
ing such business to acceptable levels.
As regards the law relating to where the securities are
held, securities borrowers need to be certain that they
have good title to the securities since there is a potential
for conflicts of laws or legal uncertainty in this respect.
The traditional rule for determining the validity of a dis-
position of securities is to look to the law of the place
where the securities are located [the “lex sitae” or “lex
situs” principle].
This is, however, difficult to apply if securities are held
32 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
through a number of intermediaries. The generally pre-
ferred approach now is to look to the location of the inter-
mediary maintaining the account into which the securities
are credited (the “PRIMA” principle).
The EU Collateral Directive as implemented in EU mem-
ber states applies the PRIMA principle, and there are
plans to extend it further through the so-called Hague
Convention.
Dividends and coupons
What happens if the lender has lent a stock over the
dividend period?
The “borrower” of stock makes good to the lender the divi-
dend amount that the lender would have received had it
not lent the stock in the first place. This amount is the
gross dividend less any withholding tax that the lender
would usually incur.
Does the lender still receive the dividend or coupon
payment?
No, the lender receives from the borrower a “manufac-
tured” dividend or coupon rather than the dividend or
coupon itself.
Does the lender still receive the (manufactured) divi-
dend or coupon payment on the due date?
Yes, the lender’s account should be credited on the due
date by the borrower, even if the borrower has not actually
received it.
What happens if the lender has loaned a stock over a
scrip dividend record date – does it get the relevant cash
or stock on the pay date?
The lender should tell the borrower in advance which it
would like to receive. Again the borrower must manufac-
ture the cash or stock for the lender even if it is receiving
the other.
Who organises that?
It is between the borrower and the lender (or its designat-
ed agent or custodian).
Why do lenders get higher loan rates if they take cash
for a scrip dividend?
Usually there is a financial incentive offered by a company
to shareholders that take scrip rather than cash. Therefore
the borrower can take scrip, sell it to give additional
income over the cash amount of the dividend, and may
SLMG 2005 ML10 7/9/05 1:10 pm Page 33
share this with the lender.
What happens if the lender
has lent a stock over the
dividend period?
Collateral and risk management
What is collateral?
Financial instruments given by borrowers to lenders to
protect them against default over the term of the loan.
Collateral securities are usually marked to market every
day.
Borrowers are required to maintain collateral with a
market value at least equal to the market value of the
loaned securities plus some agreed margin “haircut”.
What is a haircut?
“Haircut” or margin is the extra collateral that a borrower
provides in order to mitigate any adverse movements in
the value of the loan and value of collateral between the
mark-to-market date, and the value of liquidated collater-
al and repurchased loan securities on the default date.
How often is the collateral valued?
Usually every day, as with the loaned securities, but it can
be more frequent in exceptional circumstances.
Is the collateral held in the lender’s name or its agent’s
name?
It should be held in the lender’s name, but can be held by
an agent to the lender’s order if so desired.
Is collateral valued at the individual client level or does
the custodian value it at a summed level and then allo-
cate the collateral amongst its clients?
Again this can be done either way as desired by lenders
and agents.
What happens if the borrower defaults?
The lender liquidates the collateral and repurchases the
loaned (lost) securities. Any excess should be returned to
the borrower or liquidator. Any shortfall should be claimed
from the borrower or liquidator.
How do lenders get their securities back? How long
does it take?
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 33
Securities Lending Market Guide
Within the usual settlement cycle for the securities in
question (see Chapter 4), after they have been repur-
chased.
Who liquidates the collateral?
Lenders or their agents (if they use them).
How do lenders ensure that the liquidation of the collat-
eral is done at market rates?
In a similar manner as they might check on any sales
made in the usual course of business. Some agents will
indemnify lenders against borrower default, in which case
they will return the loaned assets and deal with liquidat-
ing the collateral themselves.
What happens if market prices rise between the bor-
rower defaulting and cash being made available follow-
ing the liquidation of the collateral?
Any shortfall should be claimed from the borrower or its
liquidator in insolvency. N.B. Up to a 48-hour window is
available under the OSLA, MEFISLA and GESLA (see the
glossary for definitions) depending on whether default
takes place within or outside normal business hours. This
is extended to 5 days in the new GMSLA.
What happens if the markets move such that the
collateral held is less than the required collateral
amount?
Any shortfall should be claimed from the borrower or its
liquidator in insolvency, otherwise more collateral should
be sought. If markets are particularly volatile then intra-
day marking–to- market may be appropriate.
How often is the collateral topped up (i.e. marked to
market and margin called)?
Usually every day or as required.
Are the collateral securities and the securities on loan
valued at the same time/prices/frequency?
Not always. The collateral and loan securities might be
located in different markets and time-zones. Otherwise
both valuations should be made at least daily.
Is accrued interest included in the calculations of mar-
ket value for collateral, loans and fees?
The GMSLA provides for the valuation of both securities
and collateral to include accrued income dividend or inter-
est payments declared but not yet due by the issuer divi-
SLMG 2005 ML10 7/9/05 1:10 pm Page 34
Securities Lending Market Guide
dends paid in the form of securities but not other rights or
assets deriving from ownership of the securities or collat-
eral.
What happens if a borrower doesn’t return a stock when
called or at maturity?
The lender may decide to expedite a “buy-in”, whereby it
purchases the unreturned stock in the market and invoic-
es the borrower for any costs.
Who would pay the overdraft fees if a lender’s fund
manager had sold stock and the lender had failed to
settle the trade because the borrower hadn’t returned
the stock?
The lender may claim against the borrower for any direct
costs incurred. However it should be noted that conse-
quential loss might not be covered.
Where the borrower’s failure to redeliver securities to the
lender causes a larger onward transaction to fail, the
norm is for the lender to claim only that proportion of the
costs that relate directly to the loaned securities.
What is cash reinvestment?
In many cases, particularly in the United States, stock is
loaned against cash collateral. Rather than the borrower
paying a fee, it receives a rebate (e.g. 0.4%) being the
interest rate payable on the cash (e.g. 1%) less the fee
(e.g. 0.6%).
In such situations the lender, or their agent, has cash
and an obligation to pay this rebate to the borrower.
The lender therefore reinvests the cash to receive an
interest rate (e.g. 1.1%) so that the lender receives the
fee plus any reinvestment pick-up (e.g. 0.1%) or less any
reinvestment shortfall.
The reinvestment market in the US is aptly described as
‘the tail that wags the dog’.
The pursuit of income in a fairly mature lending market
for US securities means that reinvestment opportunities
frequently drive loan transactions that are little more than
a method of raising cash.
What are the risks attached to cash reinvestment?
There is the chance that the reinvestment rate achieved is
less than the rebate rate. This usually happens in rising
interest rate environments if the interest rate paid to the
borrower is the overnight rate fixed daily and reinvest-
ments are for a fixed period (e.g. one month).
So, if short-term rates rise during the time that the rein-
vestment is fixed, the lender can lose.
34 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
Also, reinvestments are sometimes made into invest-
ments of lower credit quality to achieve returns.
If this instrument defaults on interest payments or is
downgraded by rating agencies, it is likely to fall in value.
Most reinvestment is made into US Treasury or US
Agency mortgage-backed securities, in which cases custo-
dian/banks will usually indemnify lenders in the case of
default.
What is a haircut?
What happens if the assets being held as collateral
become worthless?
So long as the borrower has not defaulted too, they will
substitute, or top-up collateral to the agreed level in the
course of the mark-to-market process.
What happens if the assets on loan become worthless?
The borrower will ask for collateral back to the agreed
level in the course of the mark-to-market process.
What is an indemnity?
It is a kind of insurance policy offered to lenders to miti-
gate risks associated with lending. One of the most com-
monly offered indemnities is against borrower default.
Usually, like insurance policies, they cover specific
events and are not a catchall so, as with insurance poli-
cies, read the small print!
Who offers them?
Usually custodian banks offer indemnities to their lending
customers. Third Party Agents obtain them from insurance
companies on behalf of lender clients.
What strings are attached?
Lenders may be asked to split revenue to give the custodi-
an a larger share, reflecting the value of the indemnity.
How important is it to create a set of lending/collateral
guidelines before starting to lend rather that accepting
the standard terms/guidelines?
For a new lender, an agent’s standard terms/guidelines
are probably a good place to start. The next step is to con-
sider what is and is not appropriate to accept from the
standard terms/guidelines in terms of a risk.
It is the client’s prerogative to alter these guidelines as
they see fit.
SLMG 2005 ML10 7/9/05 1:10 pm Page 35
Operational and logistical
What is the difference between overnight and term
loans?
Most loans are transacted on an “open” or overnight
basis. Sometimes lenders are prepared to guarantee that
they will maintain the loan over a longer period, but this is
fairly rare. In such cases the borrower has certainty that
lent securities will not get recalled inside the term of the
loan. It is more usual that a hedge fund borrower will
obtain term loans from an investment bank, which will
have multiple lenders so that if one should recall they can
borrow from another.
How long are term loans usually on loan for?
A month would be a typical period, but it depends on the
nature of the trade underlying the need to borrow.
How long does it take to recall a stock?
Recalling should be exactly like buying. If a lender gives
an instruction by a specific deadline, then it should
receive the stock back within the usual settlement cycle of
the market in question.
Corporate Governance
Can lenders vote in an AGM/EGM whilst stock is on loan?
No. Stock lending is in one sense a misnomer: it involves
the transfer of title, and with that, all voting rights associ-
ated with the securities; indeed securities are often bor-
rowed in order to settle an outright sale, so that the securi-
ties pass onto another outright owner
But borrowers have a contractual obligation to return
equivalent securities to lenders on demand. Lenders there-
fore treat securities loans as temporary transactions that
do not affect their desired holding in a stock.
In the case of votes, lenders have the choice whether to
recall equivalent securities in order to vote their entire
“desired holding” or to leave stock on loan, forgoing the
right to vote. (Although, this does not mean that votes are
necessarily 'lost' in aggregate, as the new owner may
choose to vote.)
If they opt to leave the stock on loan they have no means
of controlling or knowing how the current owner might vote.
Their decision on recalling the stock boils down to
whether the benefits of voting are greater than those of
lending. Investors make their own choices.
It is worth noting that returns to lenders often increase
around key corporate actions.
Can lenders recall stock to vote, and does this affect
their reputation as lenders?
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 35
Securities Lending Market Guide
It is quite common for lenders to retain a buffer when
lending stock so they can always go to or vote in an
AGM/EGM whilst stock is on loan. However if they wish to
vote all their holding, they must recall the lent securities.
If a borrower is still holding the stock (i.e. it has not yet
been used to fulfil short-sale obligations) lenders may ask
them to vote the stock on their behalf.
Is it acceptable to borrow stock in order to accumulate
a large temporary holding and influence a vote?
Borrowing stock for the purpose of accumulating a tempo-
rary holding to influence a vote is not a practice that most
market participants regard as acceptable.
Can lenders loan more stocks from a portfolio that has
very little trading/turnover rather than a very actively
traded portfolio?
Yes, as greater certainty about the stability of the loan is
a critical factor for all borrowers.
How do custodians decide whose stock they lend if they
have many clients that hold a particular stock?
They have allocation algorithms, but no two seem to be
the same.
What is an exclusive lending relationship?
Where a lender makes available all, or segments of, its
assets to a particular borrower or borrowers exclusively.
How is this different to going via a custodian?
It can indeed be done via a custodian, which will do all
the necessary administration, etc. Unlike in an exclusive
relationship custodian will usually parcel out loans to bor-
rowers on a stock-by-stock basis, with the “algorithm”
making the allocations between lenders.
How long do exclusive arrangements normally last?
There is no standard timeframe but many last one year.
How does the custodian make money from securities
lending?
Mostly they split the income between lenders and
themselves.
What fees do they normally charge?
Usually the lender gets between 60% and 90%, but
percentages vary. ISJ
SLMG 2005 ML10 7/9/05 1:10 pm Page 36
Securities Lending Market Guide
Securities Lending -
Past, Present and
Future...
The evolution of the securities lending indus-
try is a remarkable development to behold.
Despite the notable take up of securities lend-
ing in recent years, the practice is deeply rooted
in the financial markets of the 19th century. In
the UK, for example, specialist intermediaries
sourced gilts for market makers. Collateral, typi-
cally non-cash, was passed between the parties
at the end of the trading day and offered protec-
tion for the lenders. Much of the borrowing led
to “bond washing,” a practice whereby tax
advantages were exchanged between parties
around record and ex-dividend dates. This was
the stage before tax arbitrage. The market
became two-tier, comprising a security-specific
or “special” market, and a more generic financ-
ing or “general” market.
The securities lending market developed in
conjunction with the UK and US securities trad-
ing markets in the 1960s. During this time, the
first formal equity lending transactions took
place in London. This complemented the devel-
opment of an active interdealer market in the
US. Block trading volume in the US markets
also increased considerably. The settlement sys-
tem for this practice continued to be paper-
based, resulting in large backlogs of settlement
fails and back offices borrowing securities for
settlement cover.
In the 1970s the US market developed and
assumed much of the shape that would be
recognised today. The UK market would not
develop to its present form until deregulation
took hold in the 1980s. According to Mark
Faulkener of Spitalfields Advisors, some of the
key developments that took place during this
time are listed in the adjacent box:
Cross border securities lending grew rapidly
during the 1980s, driven partly by the interna-
tional expansion of the US broker dealers and
custodian banks. Institutional lending of over-
seas securities increased because US and UK
lenders were willing to expand their pro-
grammes from being domestic only. Increases
36 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
in the debt of most G10 governments encour-
aged the growth of government bond lending
and repo markets.
Trading demand continued to grow, driven by
a variety of strategies:
- The international derivatives markets expand-
ed, with many derivatives hedging strategies
requiring short coverage e.g. index arbitrage
- Tax arbitrage – the tax anomalies available to
exploit internationally were numerous
- Hedge funds were established in significant
numbers
- Some institutional lenders began to enter into
KEY DEVELOPMENTS
- The establishment of the US Depository Trust Company (DTC)
reduced settlement related demand but facilitated an increase in
trading activity
- Trading demand from arbitrageurs increased. Strategies
included:
i. Convertible bond arbitrage
ii. Tax Arbitrage
iii. Initial Public Offering (IPO)-related trading
- The US custodian banks began to lend securities on behalf of
their clients:
* Endowments
* Insurance Companies
* Pension Funds (amendments to ERISA legislation in 1981 per-
mitted lending in accordance with guidelines)
- Treasury dealers began “matched book” repo trading – thereby
generating borrowing demand
- The US Treasury bond repo market became a key part of the
money markets
- The US non-cash “bonds borrow” market promoted broker-to-
bank business:
- Cash collateral was a problem for banks wishing to avoid capital
charges
- Using long inventory saved the borrowers money
- Using non-cash collateral reduced their balance sheet when
compared to cash
- The use of derivatives and leverage in transactions expanded
because returns could be increased and banks were willing to
extend the necessary finance
- The creation of “finders” – specialists that lacked capital but
had significant relationships and could find the securities that
borrowers needed – emerged
- The first cross border or international securities lending transac-
tions took place
- Typically offshore from the US or the UK
- Initially involving experienced traders using trading techniques
that had been proven over time in their local markets
- Several key advantages such as time zone, and a high concen-
tration of international fund management expertise, put the United
Kingdom at the centre of international securities lending
SLMG 2005 ML10 7/9/05 1:10 pm Page 37
exclusive lending relationships with borrowers
The securities lending industry suffered a
temporary setback on May 17th 1982, when
Drysdale Securities, a minor bond dealer, col-
lapsed. Drysdale had over $2 billion in US
Treasury loans outstanding when it defaulted.
Institutional supply temporarily dried up follow-
ing the Drysdale affair, particularly via the custo-
dians, due to legal uncertainties, the US
Government Securities Act of 1986 followed.
The Bond Market Association also developed a
standardised securities lending legal agreement,
a specification of collateral margins, collaterali-
sation of accrued interest and disclosure of bor-
rowers and lenders by custodian banks.
In the autumn of 1988 Robert Maxwell autho-
rised securities lending transactions from the
Mirror Group Newspaper pension fund. It was
not until after his death on 5 November 1991
that the consequences of these and subsequent
transactions became apparent to the authori-
ties, the market and the pensioners. As the
Department of Trade and Industry (DTI) puts it
in a chronology of events on www.dti.gov.uk:
“From November 1988, Mr Robert Maxwell
therefore began to make use of the more mar-
ketable blue chip shares held by the pension
funds and First Tokyo Index Trust as collateral
for bank borrowings to the private side; this was
described as 'stock lending' to make it appear
to be the legitimate practice of lending securi-
ties to market makers as part of ordinary share
dealing activities. Cash continued to be bor-
rowed from the pension funds by the private
side without providing any collateral to the pen-
sion funds for these loans.”
Despite the Maxwell incident, securities lending
volumes rose sharply in most markets through-
out the 1990s. The decade ushered in a grow-
ing demand to borrow securities to support
hedging and trading strategies. Technological
advances, including computer processing
power, access to real time price information and
automated trade execution made possible new
trading strategies, such as statistical arbitrage.
The 1990s saw further rapid growth in hedge
fund assets under management, despite a
pause following the collapse of Long Term
Capital Management in 1999.
Investment banks developed global prime bro-
kerage operations to support the activities of
hedge fund clients, including securities lending
and financing.
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 37
Securities Lending Market Guide
During the decade, regulators began to remove
many regulatory, tax and structural barriers to
securities lending throughout the world. Some
of the major changes and developments in the
repo market were driven by the removal of spe-
cific legal or regulatory barriers, including:
1993 French repo
1996 Japanese repo
1996 UK repo
1997 Italian buy-sell back
1998 Swiss repo
From 2000 onwards, the securities
lending market became more
segmented and specialist players
began to develop.
The sharp increase in US short-term interest
rates in the early 1990s led to losses for many
securities lenders that had taken US dollar cash
as collateral and were reinvesting it in a variety
of money market instruments. In many cases
their agents, typically custodian banks, compen-
sated their underlying clients for these losses
even though they were not legally obliged to do
so. Lessons included improved risk manage-
ment procedures, better documentation and
clear reinvestment guidelines.
During the Asian crisis in 1997-98, the author-
ities in a number of countries imposed restric-
tions on short selling, drawing a link with cur-
rency speculation, e.g. Malaysia and Thailand
both in August 1997.
From 2000 onwards, the securities lending
market became more segmented and specialist
players began to develop. In addition to this
segmentation, the market for outsourcing
began to develop and the market for third party
securities lending agents was born. Tax arbi-
trage opportunities began to disappear as tax
harmonisation occurred. Continuing deregula-
tion and tax changes made possible the estab-
lishment of new securities lending markets, e.g.
in Brazil, India, Korea, Taiwan.
New transaction types included:
- Equity repo – much more accepted and wide-
spread than in 1990s
- Contracts for Differences (CFDs)
-Total return swaps
-Prime brokers using CFDs and total return
swaps to allow clients to take positions in equity
and bond derivatives rather than the underlying
securities (synthetic prime brokerage)
SLMG 2005 ML10 7/9/05 1:10 pm Page 38
Securities Lending Market Guide
-Fewer Initial Public Offering (IPO) and Mergers
and Acquisition (M&A) opportunities in 2002
and 2003 with fewer “hot” stocks. The rate of
growth of equity stock lending slowed but the
development of traded credit and corporate
bond markets encouraged growth in the fixed
income part of the business.
Acceptance
Securities lending has been accepted by asset
managers and plan sponsors looking to gener-
ate additional portfolio returns and reduce
administration costs. “Some of the new found
interest has undoubtedly been driven by the
reduced market performance of recent years
which has led managers to explore alternative
avenues of return,” says Richard Steele, chair-
man of the International Securities Lending
Association. “Annualised securities lending
returns of three basis points on a portfolio will
look more attractive in an environment where
double digit investment returns are no longer
the norm. Securities lending has also proved
very adaptive to changing market conditions
and has generated growth opportunities by
moving into attractive new markets such as
South Korea and Taiwan which have helped off-
set the reduction of tax arbitrage opportunities
due to changes in the tax credit regime in some
European countries.”
The link between securities lending and hedge
funds is frequently observed and there is no
doubt that the growth in alternative investment
strategies has generated sustained demand
over the last decade. “The hedge fund market is
increasingly being seen as a maturing market as
traditional asset gatherers and banks become
more involved, but clearly this sector will con-
tinue to play an important role for years to
come,” says Steele.
The use of technology has also played its part.
“By automating transactions and activities such
as dividend and contract compare, the technol-
ogy platforms introduced into the industry dur-
ing the last five years are helping to drive down
costs, leading to risk reduction and increased
efficiency which can in turn create more
demand,” says Steele.
Routes to market
Compared to when securities lending first
began, pension funds and institutional investors
now have a variety of routes to market.
“Arguably, there has never been a better time for
38 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
customers to shop around for the best options
to meet their specific requirements to maximise
portfolio returns,” says Steele. “Given that the
range of lending options available now includes
agency, directed, third party, exclusive, synthetic,
and portfolio auction, it’s difficult to predict any
completely novel routes coming through, but
we can expect to see each of these models
undergoing further refinement as the market
matures and providers consolidate their service
offerings.”
John Arnesen, managing director at the Bank
“Some of the new found interest
has undoubtedly been driven
by the reduced market
performance of recent years”
of New York testifies to an increased interest in
the industry. "In the early 1990s we saw a boom
in securities lending. This was driven largely by
the investment banks and the rise of hedge
funds exploring new markets and ways of gener-
ating revenue on the back of securities.
However, the supply at that point was fairly lim-
ited and was held mainly by the large custodi-
ans."
The increasing demand and limited supply
meant that spreads during the 1990s were
superb. "General collateral in most of the equity
markets was easily 300 to 400 basis points for
something that wasn't particularly special at the
time," says Arnesen. "Most fixed income lend-
ing then was done against US dollars. This may
seem odd now, but it began with a dollar-based
transaction. Again, spreads were reasonably
wide."
The 1990's were characterised by the rise of
hedge funds and technology. "Systems that
allowed you to transact easily were certainly a
key theme," says Arnesen.
As securities lending became more attractive,
supply and demand met, leading to spread
compression. The focus nowadays is one of
absolute cost, forcing providers to have high
degrees of automation and to broadcasting
portfolios to borrowers. "In the US, auto-alloca-
tion of US equity lending is important. Nothing
is touched, the borrower sees availability and
takes it down. Systems like these are a key
theme. The rise of tri-party repo and collateral
management are key to lenders and borrowers
because theyt are a way of outsourcing costs.
Obviously there is a price involved, but it just
SLMG 2005 ML10 7/9/05 1:10 pm Page 39
makes the practice more efficient.
I would say there has never been a better time
for a beneficial owner to enter the market
because increased competition has led to some
very competitive arrangements."
In spite of the range of routes to market, a
significant percentage of beneficial owners still
use their custodians for securities lending.
"Custodians provide a host of benefits, includ-
ing the absorption of transaction costs, indem-
nification against borrower insolvency and cus-
tomised or tailor made reinvestment strategies.
These services are really important to clients
however tird parties do exist. For example , The
Bank of New York has been appointed on a
number of occasions as the agent lender with-
out custody but it is important to be absolutely
clear about the service level agreement between
the agent lender,custodian and beneficial owner.
This should be established at the outset."
Auctions
Since their launch, the purpose of an auction
is to extract maximum value from the lending
process. Clients must be aware if they are sur-
rendering anything in terms of value or risk mit-
igation, says Arnesen. "The questions beneficial
owners should ask include: whether it is
appropriate to tie up their securities in an auc-
tion Lending is clearly not done on an open
basis and. auctions usually last for a fixed peri-
od of time. Is the bidder paying a price reflec-
tive of where the market might be in a month or
six months from now? Beneficial owners should
ask themselves if they achieved their goals by
auctioning their securities or could they make
more money by not entering that process? The
charge for using an auction platform is another
consideration. If the drive behind an auction is
to guarantee a revenue stream, would the client
be better off approaching an agent lender to
negotiate such an arrangement which carries
with it all of the benefits of an agency pro-
gramme.
According to Arnesen and other securities
lending service providers, the future of the secu-
rities lending market will be determined largely
by hedge funds. "Hedge funds are the driver of
the business, the true engine behind it," says
Arnesen. "Hedge funds will begin to move into
multi-asset class offerings. In so doing, demand
is absolutely bound to grow. These funds will
expand into emerging markets, which will open
up and produce demand we have not seen
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 39
Securities Lending Market Guide
before. Investors are entering emerging mar-
kets, which should create a healthy outlook for
securities lending." Regulation governing secu-
rities lending is increasing and will continue to
increase. "Further beneficial owners are going
to start seeking a lot more reporting," says
Arnesen. "They want transparent risk manage-
ment tools. We will attempt as an industry, to
automate almost every conceivable working part
of a transaction, because we have to get costs
down. Getting costs down allows us to do more
volume. In some ways I almost feel we are
entering an IT approach to the securities lend-
ing industry. I suspect there will be less
providers in the future with consolidation of
investor services providers in general. Some
institutions will revert back to their core busi-
ness andt there is bound to be consolidation
and we, The Bank of New York will always be
here, hopefully to take advantage of that."
Arnesen agrees there are a number of routes
to market that have been explored. "There are
certain ways for a beneficial owner to enter the
market, with the custodian as agent, directly
approaching a borrower, through auctions or by
“Hedge funds will begin to move
into multi-asset class offerings”
entering a principal programme," explains
Arnesen. "A favoured method could emerge but
the key is not to forget the primary aim of secu-
rities lending, which is to provide incremental
revenue in a disciplined risk managed environ-
ment . If institutional investors choose a differ-
ent route to market, they should ask whether
those risks are still being mitigated.In our expe-
rience, beneficial owners have largely stuck with
and lent securities through their custodians. I In
the last five years, I have certainly seen
increased interest from the pension fund sec-
torsin securities lending. Trustees are far more
comfortable with the concept and they under-
stand the benefits in terms of revenue. They
have their own challenges and pressures to con-
sider because of the shift from final salary to
defined contribution plans. Legacy final salary
elements have to be a tremendous drain on
some funds. They, like all of us have to get their
costs down and their revenue up. Lending is
certainly one of the areas where they can
achieve that."
Source: Mark C Faulkner, Spitalfields Advisors
SLMG 2005 ML10 7/9/05 1:10 pm Page 40

Securities Lending Market Guide

Total on Loan in USD million

No. 1

The Rise of Q1 2005

Securities Q1 2004

Lending Q1 2003

700,000
100,000

400,000
300,000

1,000,000
800,000
200,000

500,000

600,000

900,000
The securities lending industry
has recorded consistent perform- Source: RMA

ance over the last three years. No. 2 350,000

North American Treasuries on Loan in USD Million

Here we present the increase in 300,000

U.S. Treasuries
U.S. Agencies

the total number of securities on U.S. Corporate Bonds

Canadian Bonds

loan and the fees earned. 250,000

200,000

From the first diagram it can be noted that the 150,000

total amount of assets on loan have increased sub-
stantially of the last three years, from $456,79 bn in 100,000

the first quarter of 2003, to $633,65 bn in the first

quarter of 2004 to $914,91 bn in the first quarter of 50,000

2005. 0
The second diagram indicates a remarkable Q1 2003 Q1 2004 Source: RMA Q1 2005

increase in the amount of US treasuries on loan,

from $218,43 bn in the first quarter of 2004 to No. 3 250,000
US Equities on Loan in USD million

$330,590 bn in the first quarter of 2005.

US agencies and US corporate bonds showed a 200,000
similar pattern of activity for the three years com-
mencing at the first quarter of 2003. US agencies
150,000
increased their involvement from $50,3 bn in the
first quarter of 2004 to $62,39 bn in the first quar-
ter of 2005. 100,000

US corporate bonds increased their participation

from $56,48 bn in the first quarter of 2004 to 50,000

$69,92 bn in the first quarter of 2005.

Despite being the least involved in securities 0
Q1 2003 Q1 2004 Q1 2005
lending programmes, Canadian bonds increased Source: RMA

their involvement in lending from $2,4 bn in 2004

to $4,8 bn in the first quarter of 2005. No. 4 30,000
European Equities on Loan in USD million
French Equities
US equity involvement in securities lending German Equities

increased rapidly over the last three years (as can 25,000 Italian Equities
UK Equities
be seen from diagram 3), from $102,58 bn in the Scandinavian Equities
first quarter of 2003 to $215,41 in the first quarter 20,000

of 2004.
15,000
European equity involvment in securities lending
has climbed steadily for the last three years (please 10,000
refer to diagram 4).
French equities increased their involvement sig- 5,000
nificantly, from $12,01 bn in the first quarter of
2003 to $27,4 bn in the first quarter of 2005. 0
Q1 2003 Q1 2004 Q1 2005
German equities also increase their involvement in Source: RMA

40 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005

SLMG 2005 ML10 7/9/05 1:10 pm Page 41

Securities Lending Market Guide

Pac-Rim Equities on Loan in USD Million

30,000
Japanese Equities
securities lending, from $8,03 bn in the first quar-
Hong Kong Equities ter of 2003 to $12 bn in the first quarter of 2005.
25,000 Australia
Italian equities were the least involved, but did
increase their involvement from $4,93 bn in the
20,000
first quarter of 2003 to $7,16 bn in the first quarter
15,000
of 2005.
Pacific-Rim equities have become more involved
10,000 in securities lending over the last three years
(please refer to diagram 5).
5,000 The total of Japanese equities on loan, in particu-
lar has increased from $15,19 bn in the first quarter
0
Q1 2003 Q1 2004 Source: RMA Q1 2005 of 2003 to $25,56 bn in the first quarter of 2005.
The value of Australian equities on loan also
Euro Denominated Sovereign Bonds on Loan in
increased from $2,4 bn in the first quarter of 2003
4,000 USD million
French Sovereign Bonds
to $3,49 bn in the first quarter of 2005. The value
3,500
German Sovereign Bonds of Hong Kong equities increased more gradually,
Italian Sovereign Bonds
Spanish Sovereign Bonds
from $1,56 bn in the first quarter of 2003 to $2,59
3,000
bn in the first quarter of 2005.
2,500 The value of Euro Denominated Sovereign bonds
2,000
on loan differed dramatically from year to year over
the last three years (please see diagram 6).
1,500
After showing a decrease in the value of securi-
1,000 ties on loan, from $500 million in the first quarter
500
of 2003 to $450 million in the first quarter of 2004,
the tables turned and the total value of German
0
Q1 2003 Q1 2004 Source: RMA Q1 2005 sovereign bonds on loan for the first quarter of
2005 was $3,85 bn.
UK & European Bonds on Loan in USD Million
Activity from French denominated sovereign
40,000
UK Gilts bonds decreased between 2003 and 2004, from
35,000
Emerging Market Eurobonds $191 million in the first quarter of 2003 to $12 mil-
Eurobonds & Foreign Corp. Bds.
lion in the first quarter of 2004, but increased their
30,000
involvement to $2,3 bn in the first quarter of 2005.
25,000 UK & European bonds delivered varying degrees
20,000
of securities on loan for the last 3 years ( please
refer to diagram 7). Value of Eurobonds and for-
15,000
eign corporate bonds increased significantly from
10,000 the three years to 2005, from $7,53 bn in the first
quarter of 2003 to $36,01 bn in the first quarter of
5,000
2005.
0
Q1 2003 Q1 2004 Source: RMA Q1 2005
The involvement of UK gilts for the three years to
2005 peaked during the first quarter of 2004, with
Weighted Avg. Spread & Premiums - Total Bonds securities on loan worth $8,9 bn during the first
quarter.
Q1 2005 From here, the amount of UK gilts on loan
decreased to $6,46 bn to the first quarter of 2005.
Emerging market Eurobonds increased their
involvement in securities lending steadily from
Q1 2004 $1,37 bn in the first quarter of 2004 to $2,39 bn in
the first quarter of 2005.
The weighted average spread and premiums for
bonds (please see diagram 8) have delivered mixed
Q1 2003
results over the last three years, starting from 24
basis points for the first quarter of 2003, moving
0 5 10 15 20 Source: RMA 25 on to 19 basis points for the first quarter of 2004
and ending on 22 for the first quarter of 2005.

SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 41

SLMG 2005 ML10 7/9/05 1:10 pm Page 42
Securities Lending Market Guide
Risk, Return &
Performance
Measurement
Three of the most
crucial elements
of securities
lending can be
blended to ensure
an effective
programme, writes
Peter Economou. Peter Economou
State Street
Historically within the securities lending indus-
try, the goal has been to evaluate performance by
developing a set of benchmarks through the gath-
ering and ranking of static performance meas-
ures. However, for benchmarks to be meaningful,
the underlying investment or structure must be
achievable or
replicable. For securities lending, this is highly
problematic because very few clients have identi-
cal holdings, assets on loan,
or collateral reinvestment guidelines. In addition,
the pricing of loans is not transparent as no pub-
licly quoted market exists.
Modern portfolio theory has taught us that
return is meaningless unless it is considered in
the context of the associated risk. In light of this,
prudent investors combine a measure of risk with
the degree of historical return in order to make
intelligent asset allocation decisions about the
future. In securities lending, evaluating perform-
ance on a risk-adjusted basis is crucial if lenders
wish to have as accurate and robust a picture as
possible of their lending programs.
Lending Risk
The first major risk element of the securities
lending transaction arises from the exposure of
the ultimate lender and agent to the various bor-
rowing counterparts. This exposure results from
the risk that a borrower may not return the loaned
securities and that the collateral may be insuffi-
42 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
cient to fully fund the purchase of replacement
securities.
In analyzing this risk, it is important to note that
a collateral insufficiency results in a loss only if
the borrower is financially unable to meet its con-
tractual obligations. Specifically, loss occurs if the
borrower fails to provide additional collateral on a
daily basis as required or fails to return the bor-
rowed securities when required and the subse-
quent repurchase of the loaned securities occurs
at an amount in excess of the pledged collateral.
The standard loan agreement entered into with
borrowing counterparts should enable the imme-
diate termination of open loan transactions if cer-
tain events of default occur.
return is meaningless unless it is
considered in the context of the
associated risk.
Maintenance of a positive net collateral posi-
tion, one in which aggregate collateral value
exceeds aggregate loan value, is key. The adequa-
cy of collateral is a function of the price behavior
of the underlying securities coupled with the
length of time elapsed between the default and
the purchase of replacement securities (the hold-
ing period). Measuring this risk requires that the
price relationships between all securities’ posi-
tions are captured, both loan and collateral, in the
context of an assumed replacement period.
In addition to the length of time elapsed
between the last mark-to-market collateral adjust-
ment and the securities repurchase, the size of
the transactions relative to trading activity and
general availability of the individual securities in
question will affect replacement cost. One
method of accounting for this is by lengthening
the risk measurement period to a level that more
accurately reflects the increased replacement risk
engendered by having to repurchase relatively
concentrated positions.
It should be noted that most lending agents
offer indemnification against broker default, an
accommodation or request that is priced as part
of the income sharing arrangement. Such an
arrangement can serve to mitigate the counter-
part-related risk; however, the level of mitigation
is a function of the credit quality of the agent
providing it.
Reinvestment Risk
In the context of securities lending, the market
SLMG 2005 ML10 7/9/05 1:10 pm Page 43
risk portion of collateral reinvestment risk, or
asset/liability risk, refers to the risk to cash flow
and, secondarily, the collateral pool market value
engendered by market fluctuations. The risk to
spread income arises from the funding of cash
positions on generally an overnight or short-term
basis and the subsequent investment of these
proceeds into securities of slightly longer term.
This is known as duration mismatching. The risk
to collateral pool market value (net asset value or
NAV) is a function of the impact to overall portfo-
lio value due to changes in underlying market
interest rates, credit spreads, and portfolio dura-
tion and convexity.
An additional aspect of market risk that must be
quantified is termed spread duration. This is the
risk that the market spread to a benchmark rate
for a floating rate security may change, resulting
in both an effect to NAV and reduced opportunity
for spread income. In addition to the risk to cash
flow engendered by interest rate and spread
movements, changes to portfolio asset values
resulting from credit migration and default/recov-
ery need to be considered. Specifically, this refers
to the change in the value of an underlying asset
caused by a change in debt rating and, in an
extreme case, by the default of an issuer. Clearly,
events such as these affect portfolio NAV but it is
the impact to cash flow of such changes that is of
concern. An issue that has been downgraded will
command a greater yield, but this will only benefit
the post-downgrade acquirer. Owners of a down-
graded security will receive a less-than-optimal
return, resulting in reduced spread income rela-
tive to that which could have been achieved by
An issue that has been
downgraded will command a
greater yield
holding a comparably rated issue.
Maintaining sufficient liquidity to meet loan
returns (the return of cash collateral to the bor-
rowers upon the return of the loaned securities) is
an important part of the reinvestment manage-
ment process. Generally, liquidity is maintained
through the use of overnight reverse repurchase
agreements or other short-term money market
investments. The former are overnight loans
made to securities brokers/dealers and banks that
are collateralised by securities such as corporate
bonds and asset-backed or U.S. Government
securities. Analysis of these transactions would
be similar to that employed in the lending side of
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 43
Securities Lending Market Guide
the transaction, where market and counterpart
credit risk are focal.
Conclusions
Focusing exclusively on returns may incur an
unwanted and even unknown level of risk, creat-
ing a false sense of security about a particular
lending program and possibly creating incentives
for an agent or collateral manager to take undesir-
able risk. Data from benchmarks are elements in
a much larger equation that needs to include risk
as a measurable component. Only when meas-
urements include the reinvestment or collateral
side of a securities lending transaction can the
beneficial owner develop the necessary insight
into how returns are created and what level of risk
is incurred. Armed with this knowledge, lenders
can set measurement criteria for both risk and
return and exercise control throughout the lend-
ing cycle, including the reinvestment of collateral.
The first step in exercising this control is by ensur-
ing compatibility between the agent’s style – the
manner in which the agent, acting on behalf of
the lender, takes risk and creates returns – and
the lender’s objectives.
As to the issue of whether the return is appro-
priate to the level of risk taken, no one answer
exists. Appropriateness depends on the particular
risk/return profile of the participant. The role of a
risk-adjusted performance construct is to provide
the quantitative tools to facilitate the decision-
making process. By establishing a baseline and
framework through which changes to the
risk/return profile can be portrayed and interpret-
ed, appropriate management decisions can be
made. The risk-adjusted performance construct
does not replace established risk management
practices; rather, it complements and strengthens
them. The tool set developed should be used
both to report and to proactively manage the
process. Risk-adjusted performance measurement
– combining financial results with clear, quantifi-
able and correlated measurements of risk – pro-
vides necessary insight to clients, consultants,
and agents alike.
Peter Economou, CFA, Senior Vice President
Securities Finance, State Street
Economou oversees its equities and fixed income trading
worldwide and manages the asset/liability, liquidity and
risk management functions. Economou played a key role
in developing SLPerformanceAnalyzer®, a risk-adjusted
performance measurement tool.
SLMG 2005 ML10 7/9/05 1:11 pm Page 44
Securities Lending Market Guide
Agent
Lenders
Paul Wilson
JPMorgan
Gene Picone
JPMorgan
As one of the most popular
routes to market, agency lending
has the ability to mitigate risks
and deliver timely reporting.
Paul Wilson and Gene Picone
present the merits of the agent
lender.
Where once securities lending was some-
times undertaken by those considered “brave”, it
has now, by any measure, gained universal
acceptance as a relatively low risk way to gener-
ate incremental returns on securities that would
otherwise lie idle in an investment portfolio.
Today, Pension Fund Trustees that do not partici-
pate in securities lending are likely to be put in a
position of having to justify this position to their
members. So it is not surprising that Pension
Fund Trustees are increasingly turning to securi-
44 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
ties lending agents to assist them in establishing
and managing a framework under which they
can lend securities.
The lending agent’s role is evolving, with pen-
sion funds increasingly asking the agent to
assist them in understanding the risk versus
reward equation for its lending portfolios and to
also assist them in establishing a program tai-
lored and structured to ensure adherence to the
fund’s specific requirements. This process can
be lengthy for a pension fund, as there are
numerous factors to consider, such as markets
and securities in those markets to be lent, bor-
rowing counterparties to approve, borrower and
lending limits, regulatory restrictions, collateral
requirements and cash collateral investment
guidelines. In reality, for most pension funds,
securities lending is an evolution with many
“dipping their toe in at first” and then over a two
or three-year period, gradually evolving to a
broader program.
One key, but often underestimated activity, is
post-program implementation management
such as: monitoring income, information deliv-
ery and reporting, and risk analysis. These are
important as they can validate that the program
and activities are carried out in accordance with
the framework set down by the Pension Fund
Trustee and facilitate a decision to broaden lend-
ing activities.
In an environment where the demands on
Pension Fund Trustees and administrators are
increasing, what are agents such as JPMorgan
doing to help reduce the burden in these areas?
A technical relationship manager
can provide a pension fund with
expertise it may not have and
also works towards maximising
the revenue opportunity
1. Technical Relationship Management
Securities lending is complex. Pension Fund
Trustees and administrators require technical
support to help them understand complex mar-
ket and regulatory issues, as well as provide
guidance around program structure, revenue
enhancement and risk mitigation. JPMorgan, as
a lending agent, has been very active in provid-
ing such support through technical relationship
managers, who not only understand the lending
business but are also highly knowledgeable as to
SLMG 2005 ML10 7/9/05 1:11 pm Page 45
pension funds and their associated issues. A
technical relationship manager can provide a
pension fund with expertise it may not have and
also works towards maximising the revenue
opportunity given the pension fund’s restrictions
and risk threshold. From the lending agent’s
perspective, this can also become a competitive
the agent will hold periodic
performance reviews as integral
to, and a focus point, of
the relationship
differentiator, but what becomes more important
is that the manager becomes a channel for con-
tinuous dialogue with the fund.
As part of the process, the agent will hold peri-
odic performance reviews as integral to, and a
focus point, of the relationship. Typically, these
reviews are similar to fund management per-
formance reviews and focus on the return made,
the sources of the return and the risk taken to
generate the return.
2. Monitoring Income
Once the risk/return framework has been
established, Pension Fund Trustees want to
monitor the revenue and return to ensure the
full potential is achieved. This may not be as
easy as it sounds and can be a little problematic
as there is no universal benchmark (such as the
MSCI equity indices) to compare securities lend-
ing performance against. The issue is com-
pounded by the fact that each lender’s portfolio
available to be lent differs in composition and
the parameters under which each pension fund
chooses to lend also differ. Moreover, the lend-
ability of a portfolio can change, as market con-
ditions change and as borrower demand either
increases or decreases for certain security types
or specific securities.
Also of considerable importance to a pension
fund is whether every loan earned a return
(whether by way of a fee paid by the borrower or
from earnings on cash collateral investments),
as pension fund auditors place great emphasis
on this aspect. A good lending agent will pro-
vide information and facilitate periodic auditing
of records to ensure that the Pension Fund
Trustees can satisfy themselves in this regard.
3. Information delivery and reporting
The provision of quality information and report-
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 45
Agent Lenders
ing can be a key attribute to an effective securi-
ties lending program. Each pension fund will
require different information based upon its own
specific needs, but Pension Fund Trustees often
seek guidance on what a reasonable reporting
regime should be, given their own level of
resources and the level and frequency of over-
sight and monitoring they wish to undertake.
The table below sets out what is considered to
be reasonable, given that most pension funds do
not want or have the capacity to focus on
securities lending on a day-to-day basis.
Information delivery and reporting
Daily Monthly Quarterly
New loan activity Income generated Performance report
Corporate action notices Outstanding loans Risk analysis
Proxy Voting notices - by market Operational risk and impact
Market / regulatory
changes (as needed)
- by borrower Trustee / board report
- by collateral type
Cash Investment report
- Investments
- Yield
- Credit risk
- Interest rate/Gap risk
Source: JPMorgan
Each set of reports is designed to meet some-
what different objectives:
Daily - to allow for the effective and seamless
management of lending activities in order that it does not
impact the general investment activities of the pension
fund and/or the fund managers.
Monthly - how much earnings have been generated and
what exposures the pension fund has assumed to
generate these earnings.
Quarterly - how well has the lending agent performed and
how was that level of performance achieved; market and
economic outlook; key performance indicators are set to
highlight levels of operational efficiency.
4. Risk analysis
Within securities lending, managing and control-
ling risk is a key area of focus for Pension Fund
Trustees. There are a number of different risks a
lender may face when engaging in securities
lending, most of which can be tailored to the
individual pension fund depending on its risk
appetite, so the question of what is “best prac-
tice” for managing and mitigating some of these
risks is not necessarily the same for all lenders.
SLMG 2005 ML10 7/9/05 1:11 pm Page 46
Securities Lending Market Guide
The main areas of risk can be summarised as
follows:
Counterparty Risk – to which counterparties
does the pension fund have exposures and to
what extent;
Collateral Risk – what collateral types are
acceptable;
Cash Investment Risk – how has cash
collateral been reinvested. In so doing, what
credit and interest rate risk has been created;
Operational Risk – is the lending program
designed so as to be transparent to the under-
lying investment process;
Regulatory Risk – is the lending program
designed so as to be in compliance with laws
and regulations specific to the client and/or
pension fund;
Agent Risk – assuming the lending agent has
provided indemnities against various types of
borrower default, is the agent creditworthy;
and,
Program limits – does the program reflect,
and has it been conducted within, the
restrictions and risk framework set down by
the pension fund.
As mentioned, a good lending agent should be
able to work with its pension fund client to help
assure that the potential risks, where flexibility
permits, have been managed in accordance with
the pension fund’s requirements and integrated
into the securities lending program operating
parameters. The result being that the impact of
the inclusion or exclusion of any one of these
permutations has been clearly communicated
and understood.
One risk assessment tool that is being used
It is fair to say that lending
agents today are more than
just administrators
more frequently is Value-at-Risk (VaR). VaR is
used to assess the underlying market risk in a
portfolio over a given time horizon to a specific
confidence level. These are typically only
requested by the most sophisticated pension
funds, and cover not just loan related activity but
also cash reinvestment. In reviewing such
analysis, the pension fund will be seeking to
quantify a specific monetary amount of risk and
evaluate this in comparison to the amount of
return generated. For example: £50,000 of VaR
versus £1,000,000 of earnings may seem to be
46 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
a low level of risk relative to the return, whilst
£500,000 of VaR versus £1,000,000 may seem
unacceptably high. It would be for each pension
fund to determine what is appropriate for it.
It is fair to say that lending agents today are
more than just administrators. The very best are
able to help Pension Fund Trustees to establish
and create a securities lending program and
framework specific to their needs. The furnishing
of experienced and knowledgeable professionals
who understand the pension industry and the
requirements of Pension Fund Trustees, form the
foundation on which a trusting and profitable
lending relationship can be built. Building on
that foundation, the lending agent can work with
the Pension Fund Trustee to assist with monitor-
ing lending activities on an ongoing basis.
Paul Wilson & Gene Picone, Senior Vice
Presidents, JPMorgan Securities Lending
Paul Wilson, Senior Vice President at JPMorgan
Worldwide Securities Services. Wilson is responsible for
new business origination, relationship management
and service as well as product development and prod-
uct management. He is also responsible for foreign
exchange and execution products for JPMorgan
Worldwide Securities Services in EMEA. The Securities
Lending & Market Products team consists of a team of
professionals responsible for profit & loss management,
technical sales, technical client delivery, product devel-
opment and liaison with client management.
Eugene (Gene) Picone, Senior Vice President, Global
Product Manager, Securities Lending for JPMorgan
Worldwide Securities Services and Western Hemisphere
Business Executive with responsibility for relationship
management and business development for Securities
Lending and Market Products. Picone joined Securities
Lending in 1992 and previously spent three years as a
senior product manager focusing on such products as
non-dollar cash management, short-term money man-
agement and foreign exchange. Before joining
JPMorgan, Picone worked at The Irving Trust Company
as a business analyst and Product/Marketing Manager
and was responsible for new product costing and devel-
opment, strategic planning and product profitability. In
addition, Picone is currently the Chairman of the Risk
Management Association's industry committee on
Securities Lending. Lastly, since May of 2001 Picone
has sat on the Board of Directors of EquiLend
Holdings, LLC an industry utility in which JPMorgan
holds an equity interest.
Picone holds an MBA degree from Pace University,
New York, and a BS degree in corporate finance from
St. John's University.
SLMG 2005 ML10 7/9/05 1:11 pm
The Auction
Block
Auction platforms have provided
pension funds with good fortune
in recent years. Luke McCabe
explains what this route to
market is capable of...
Luke McCabe
eSecLending
Page 47
Auctions
Going Once, Going Twice…Sold!
If only it were that simple…
Auction and game theory tell us that bringing
any grouping of objects of real or perceived
value to auction (be they fine art, antiquities or
a portion of the airwaves) is an elegant balance
of both art and science. The goal of any
traditional auction house when they bring a
piece of fine art to market is to extract maxi-
mum value for the owner. While it seems fairly
obvious, on auction day in the securities lend-
ing arena the goal is the same; however, there is
a clear difference. The Lender’s return given
their customised risk parameters, not solely
maximum intrinsic value, should be the ulti-
mate concern of the securities lending manager.
While auctions as a mechanism for extracting
value have been around for centuries, in the
world of securities finance they remain a rela-
tively new route to market. Both phone auc-
tions and exclusive relationships have become
more common in the past two decades; howev-
er, not until five years ago were the two brought
together under one model with eSecLending's
launch of the first Internet-based auction plat-
form. Although much of the market was slow
to adopt this trend, recently there has been a
rapid expansion of auction platforms in the
market including Equilend, SecFinex and even
products offered by more traditional custodial
agents. Importantly, it is not technology that
drives the results; rather technology simply pro-
vides an efficient mechanism for both the dis-
semination and collection of information
between all parties. The structure of the auc-
tion and the organizational philosophy behind
the auction should be the key considerations for
Lenders when they are evaluating a partnership
with a securities lending manager.
Given the current rush in the marketplace to
provide auction solutions for sophisticated
Lenders, one might ask the questions: Why all
the recent attention? What is truly the value
proposition?
The overriding response to these questions
may seem trite and cliché but none the less
true: It is the Lender’s requirement for greater
transparency and control than is afforded by a
traditional agency program coupled with the
never ending search for “alpha.” In order to
achieve these goals, the Lender is faced with
many choices: traditional custodial agent, third
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 47
SLMG 2005 ML10 7/9/05 1:11 pm Page 48
Securities Lending Market Guide
party agent, direct exclusive or the auction
route. When considering an auction, there are
many different styles to evaluate - blind, open,
single stock, etc… the manner in which an auc-
tion is run is an indication of organisational
style and philosophy.
The auction event itself
provides an sunsurpassed view
into the intrinsic value of
each Lender’s assets
Obtaining Transparency
The level of transparency that any auction
platform provides, and the market segment(s)
that benefit from this transparency, will vary
depending on the aim and purpose of the auc-
tion platform. Blind auction processes provide
significant transparency to the Lender, but by
design do not provide the same level of trans-
parency to the participating Borrowers.
This auction style is designed to capitalize on
the substantial market inefficiencies that are
present in many sectors of the securities lend-
ing market and to capture these inefficiencies
for the benefit of the Lender. Auction platforms
with open bidding provide more transparency
for all participants, but they often will not cap-
ture the inefficiencies or greatest price premium
for Lenders. The transparency and control deliv-
ered to a Lender through a well designed,
thoughtfully constructed auction is unparalleled
in the marketplace. The auction becomes a 100
per cent customized event for each Lender. The
auction is designed around each Lender’s
unique assets, risk tolerances and constraints,
whether they are based upon policy documents,
prospectus, regulatory or Board of Director
requirements.
In other words, the rules of the game are
established in conjunction with the client and
then communicated to the market. The auction
event itself provides an unsurpassed view into
the intrinsic value of each Lender’s assets,
unclouded and uncomplicated by other partici-
pants in a queue and the resultant “market rate
pricing.” The Lender has absolute confidence
that the market has returned true value for his
or her assets. To take the concept of trans-
parency to its final conclusion, the Lender ulti-
mately makes the decision to award or not to
award business based upon guaranteed auction
48 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
results. This control throughout the entire
process is what makes Board of Directors
delighted with the transparency of the auction
process: Front end control; Maximisation of
intrinsic value unencumbered by others in a
queue; Post auction award decisions.
Extracting Maximum Returns Within
Customized Risk Parameters
Maximisation of intrinsic value of a Lender’s
assets within the context of their individual risk
parameters requires a fundamental understand-
ing of Borrower demand and experience. By
matching Borrower demand with creative “lot-
ting” or segmenting of the Lenders holdings
unencumbered by traditional custody
limitations, the assets can be best positioned to
be brought to market. Time and time again
experience has shown through proper lotting
that the sum of the parts can far outweigh the
whole; additionally, no single Borrower is the
highest payer across all markets and all asset
classes.
Through an auction, Borrowers are able to bid
aggressively on those segments where they
have the highest demand without being forced
to Borrower less desirable general collateral
securities to access attractive supply. Striking
the right balance and inviting the right
participants to the auction are all critical ele-
ments in the effort to maximise the Lender’s
return. By supplementing the power of the
auction with a competitive multiple principal
borrowing environment, a Lender can secure a
greater premium and increase his or her
options in awarding assets.
Managing the Transition
Post auction is where experience is
paramount. The task of implementing the
program in a timely fashion based upon the
Lender’s award decision is not for the faint of
heart. Here again, experience has shown that
in order to truly maximise intrinsic value for a
Lender the number of principal winners in any
auction often approach double digits.
Synchronisation of the legal, operational and
IT support functions required to implement
and service ongoing the resulting awards, with
potentially multiple custodians, collateral
reinvestment managers, investment managers
and Borrowers in a short two to three week
window is the aforementioned art. Sufficient
expertise in handling transitions at the end of
SLMG 2005 ML10 7/9/05 1:11 pm Page 49

Auctions

an exclusive is the final consideration a Lender
should make, as it is crucial to remember that
as one exclusive agreement comes to a close
and is winding down the new award is ramp-
ing up.
agement discipline to the selection of their
securities lending providers and pair assets and
their routes to market with the proper strategic
partners, the auction can become an important
and compelling solution.

Evaluating the True Opportunity Cost Luke McCabe, Senior Vice President and Head of
Aside from the transitional and operational Relationship Management for eSecLending.
challenges mentioned above, the one considera-
tion most frequently raised as a “con” to exclu-
sives or auctions is opportunity cost. What
happens if a security goes special? It is clear
through actual bidding results that Borrowers
factor a premium into their bids which consid-

A Lender must evaluate the

confidence and track record of
a traditional agent estimate
versus the premium guaranteed
in an exclusive bid
ers a given portfolios’ potential for specials.
A handful of quick examples include European
equities where bids exceed the overall dividend
value of the underlying assets – or - small cap
equities where a significant portion of the bid
represents the Borrower’s belief in the portfo-
lio’s potential for current and future specials.
The nature of an auction, where the bidder plac-
ing the highest value on the assets wins (all
other factors being equal), means the Lender is
realizing the premium of the Borrower that
takes the most aggressive view of the future
market direction. Importantly, the Lender cap-
tures this premium as a result of these aggres-
sive outlooks whether or not the projected level Luke McCabe joined eSeclending in November 2004,
of specials in the portfolio actually materialises. having previously worked for Brown Brothers Harriman
On considering loss of upside, equal consid- global securities lending business for nearly four years,
eration must be given to downside risk of where he served as Vice President of Relationship
underperformance of agency estimates. Management focused on BBH’s non-US client base.
Experienced Lenders realize that agency lending Prior to joining BBH, McCabe worked for State Street
programs don’t only surprise on the upside. A Corporation for ten years in roles including Vice President
Lender must evaluate the confidence and track and Business Head of State Street’s Defined Contribution
record of a traditional agent estimate versus the Services Group and Manager of Emerging Market
premium guaranteed in an exclusive bid. Business and Product Development (Latin America and
Empirical evidence has shown that the auc- Africa). Additionally, McCabe served as the Relationship
tion route to market is not a panacea for all Manger for some of State Street’s largest institutional
Lenders or asset classes. However, for certain clients. McCabe has lived in London, England and
Lenders and asset classes it can truly extract Johannesburg, South Africa. He is a graduate of
more value, oftentimes multiples, than a more Providence College, with a B.S. in Finance. He has also
traditional agency route to market. As Lenders studied international finance at Richmond College in
continue to apply more of an investment man- London.

SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 49

SLMG 2005 ML10 7/9/05 1:12 pm Page 50

Securities Lending Market Guide

An analysis of how integral

Technology technology solutions have
become to ensuring
Matters effective securities lending
programmes

Felix Oegerli is an expert on the impacts of

technology on securities lending. Before found-
ing IFBS he worked on the business side as
deputy global head of Securities Lending and
Repo and global head of prime brokerage at
UBS. He understands the business drivers
which form the core for the definition
of an IT-model. As is the case with any indus-
try, technology is part and parcel of a securities
lending offering and firms who wish to partici-
pate in a lending programme or would like to
replace their current system platform are well
advised to consider some of the available tech-
nology solutions in order to get involved. One
of the primary solutions is FINACE, the securi-
ties finance and collateral management plat-
form from IFBS.

The key decision when launching a securities

lending business or replacing the current IT-
infrastructure is whether to buy a vendor sys-
tem or to build the system in-house. The three
criteria’s which need to be analysed is total
cost of ownership, time to market and func-
tional coverage, including the flexibility to
implement client specific requirements. The
total cost of ownership is clearly less expensive
when buying a vendor system. This includes
the development and the maintenance cost.
Also time-to-market would clearly point to buy-
ing a system. A typical implementation of a
securities lending solution takes between three
and six months time depending on the com-
plexity of the business model and the bank's
core IT-infrastructure with which the solution
has to interface. Building an in-house solution
can take between one and three years. This
leads to opportunity cost and also increases
the project risk. However, the vendor system
often does not cover all specific requirements.
Felix Oegerli Furthermore, the willingness of most of ven-
IFBS dors to deliver client specific functions, which
do not become part of the core system, is
rather limited. This is mainly because the cost
of maintaining a lot of different versions can be
50 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
SLMG 2005 ML10 7/9/05 1:12 pm Page 51
very high for vendors. Therefore most of the
large global players are either using an in-
house built system or are using a vendor sys-
tem together with a set of in-house built sys-
tems. The best of both worlds can be offered
using the FINACE solution.
From an outsourcing perspective, it is worth
considering how these technology solutions are
applied, as there is no one-size fits all
approach. Certain solutions are purchased off
From an outsourcing
perspective, it is worth
considering how these
technology solutions are applied
the shelf and are implemented in-house, within
the securities lending participant’s back office.
In other instances the system is white-labelled -
it is purchased by the securities lending partici-
pant, implemented in house and branded as
the participant’s own product. How do partici-
pants determine the best approach when it
comes to the implementation of technology
solutions?
Take the example of the Cantonalbank of
Zurich (ZKB), Switzerland’s third largest Swiss
bank, which in 2003, bucked the trend of the
traditional route-to-market via Switzerland's
two biggest custody banks and implemented a
business model and lending platform, devel-
oped in conjunction with IFBS. The platform
targets the smaller lender who is looking for an
alternative to the custody programmes but who
lacks the critical mass for a securities lending
distribution network of its own. For new
entrants or banks wishing to replace their old
internal systems with the IFBS platform, imple-
mentation times will vary from anything
between three to five months. The idea for the
new platform came after ZKB realised the value
of a securities lending pool and began to
appreciate that many banks do not have critical
mass for a securities lending distribution of its
own and thus offers an outsourcing concept to
other banks. The core of the strategy is IFBS’s
FINACE.
To fully appreciate the involvement of tech-
nology in securities lending, I would urge par-
ticipants to consider the development of the
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 51
Securities Lending Market Guide
securities lending industry and how it came to
rely on technology.
History
If we look back to the late 1980s and the early
1990s, when the international securities finance
market first began to evolve, we can then divide
the development of this market into three
phases.
In the first phase, international securities
lending systems were trade, or transaction-
focused. Volumes and the degree of standardis-
ation were relatively low. Automation was not
that important and the user was happy that the
systems could support the key processes. The
available or newly launched-systems were not
even real-time. Within the international market
place there were very few vendor systems avail-
able, mostly emanating from the US domestic
market, which was proud of the fact that its
system was multi-currency. The first real inter-
national securities lending system to have an
impact on the market was only built in the early
1990s.
In the second phase of securities lending
development, the market began to consolidate
and extend the number of different trading
products. More technology vendors emerged
but, again, they were product-focused and had
some degree of additional automation in the
post-trade processes. The market reaction was
to leverage this technology for efficiency pur-
poses by adding interfaces to internal systems
through internal add-ons. Less emphasis was
placed on the overall architecture and
technologies in place. This often resulted in
patchwork-style results.
The third phase of securities lending began
in the late nineties when businesses were not
concentrating on pure trades but more on
positions across many different trading lines.
In other words, the market was, and still is,
moving towards a more integrated securities
finance and collateral management model. By
the time the Internet hype took effect, some
people forgot that market demand
transformation drives the business model
transformation and not vice versa. Many of the
large players with superior product offerings,
including great distribution channels, are still
making money from the rather opaque and
intransparent markets. However, heavy
SLMG 2005 ML10 7/9/05 1:12 pm Page 52
Securities Lending Market Guide
investments were made into electronic market
trading platforms, which, for some of the
participants, has probably not paid off the way
it was expected to when the internal business
case was approved.
Present
Today, visions and strategies are defined in
conjunction with an understanding of the tech-
nology involved. IT follows strategy and
enables new strategy. Depending on the
business model and the size of an
organisation, the securities lending business is
more integrated into other business lines such
as repo, synthetic finance and maybe even
over-the-counter derivative collateral
management. Integration occurs in the form of
integrated processes or even combined
organisations. One of the key success factors
for a successful integration of business lines is
a horizontal position-focused IT platform.
However, there is no single IT platform
supporting this business model. A variety of
vendor systems are being used, mostly for the
book and records. Very often, in-house
functional add-ons or additional data collection
tools are developed to at least partly fulfil the
business requirements for a consolidated view
on the positions and transactions.
Consequently, a large number of
heterogeneous systems and interfaces must be
supported and reconciled, leading to enormous
maintenance costs and the risk of poor data
quality. Another knock-on effect is that, due to
the complexity and the high testing efforts
required, functional enhancements are
delivered slowly. As the IT structure typically
mirrors the business structure, there is often
no single point of responsibility for changes.
Multiple departments have to be coordinated,
which again is a slow and costly process.
Most of today’s securities lending trades are
agreed over the telephone. Smaller, or from a
profitability standpoint less important, tickets
increasingly are performed using electronic
trading platforms. Trading by way of an elec-
tronic exchange requires a minimum degree of
standardisation. After a rather difficult start the
electronic securities lending exchanges such as
Equilend and SecFinex are slowly gaining
momentum. EquiLend, which was established
in 2001 by a group of major securities lending
players, has certainly added value by allowing
52 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
participants to transact and reconcile through a
secure hub. Whilst these efficiency and stan-
dardisation gains are important, they have not
yet added value to the transparency issue.
Transparency
Transparency is in demand for both lenders
and borrowers and lending is generally a
“demand” market. The borrower knows the
overall trading profit of a securities lending
strategy and will try to borrow securities from
the lender at the lowest rate possible.
I do not believe that we are
going to see a steep increase in
business volumes traded
electronically until the market
demands certain changes
Depending on the supply/demand situation,
the borrower has to pay more or less to the
lender. While there may still be situations
where the borrower is able to get securities
below the benchmark securities lending fees
and rebates, this situation is becoming a rarity.
The lenders are more educated and most of
them understand the strategy behind the bor-
rowing demand. Furthermore, there is more
benchmarking information available in the
market.
Future
Certain traders tend to have short memories
and are therefore susceptible to short-term
trends. The electronic securities lending plat-
forms, which were launched in the midst of the
e-business hype, are focused on increasing
distribution and making more money. However,
between 2000 and 2003 the industry was, for
the first time, faced with decreasing income.
This may have partially shifted the focus of
these electronic market places almost entirely
to efficiency gains and hence cost cutting. It is
important to consider that market demand
transformation drives the business model
transformation and not vice versa. Therefore I
do not believe that we are going to see a steep
increase in business volumes traded
electronically until the market demands certain
changes. Market demand changes can, for
example, be based on tax or regulatory
changes, which negatively impact the spreads
in securities lending.
SLMG 2005 ML10 7/9/05 1:12 pm Page 53
However, I am convinced that in five years
time more than 20 per cent of the securities
lending volume will be traded electronically and
will increase to 50 per cent in ten years time.
The use of standards and open
system technology can
significantly reduce the total cost
of ownership and facilitate the
integration effort
The driver of this increase will not necessarily
be transparency on pricing but rather the
efficiency gains issues. Efficiency refers to
effective distribution, which leads to efficiency
gains in the securities lending trading area. It
also refers to the post-trade processes, which
are becoming more standardised and can be
fully automated.
Requirements
The requirements of technology to support
an integrated, front to back collateral trading
model are substantially higher than for just a
product silo or transaction processing system.
Firstly, the architecture must be scalable in
terms of the distribution of functionality to
servers. This is being achieved via service-
based architectures, which allow multiple
instances of the same services in order to
achieve high performance and availability.
Service-based architectures will also make it
possible to integrate systems across the net,
mainly by using Web-based services.
Transaction processing services for settlement,
audit trail, and accounting should be loosely
coupled using message-oriented middleware as
a separation layer.
Secondly, real-time information has become a
necessity. In cross-product systems, multiple
users with different business intentions may
use the same positions. Only real-time updates
on positions will prevent the overuse of posi-
tions. Counterpart and trading positions must
be kept and updated real-time for risk
management purposes. Real-time profit and
loss figures will provide the required
information to optimise the book and close out
unprofitable transactions or replace them with
cheaper sources.
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 53
Securities Lending Market Guide
Additionally, the data model of such an
application must be designed for maximum
flexibility from the beginning. All existing, but
also new, trade types must be supported. This
includes single security, security versus cash
and security versus security transactions. All
future flows of financial instruments must be
presented as cash flows, which will allow for
cash-for-difference, Total-Return-Swap
transactions and future transaction types.
Additional features, like ‘pluggable’ classes, will
allow for the functionality of the system to be
changed without having to change the core
architecture. This reduces the overall costs and
time-to-market for changes.
The use of standards and open system
technology can significantly reduce the total
cost of ownership and facilitate the integration
effort.
Technology vendors cannot afford to rest on
their laurels. We have to respond to the needs
of the market and come up with inventive and
forward-looking systems to help support the
business models of the future.
The vendors which offer technology solutions
for securities lending offer management and
implementation of IT strategies and solutions,
including customised processes. They can
define the initial project objectives, set the
project scope and agree on how to proceed.
This is the basis for a realistic performance,
time and cost assessment.
Felix Oegerli, CEO, IFBS
Felix Oegerli was born in Solothurn, Switzerland. He
obtained a post graduate degree as a Swiss Federal
Banking expert.
He began his financial services career with UBS,
assuming a variety of roles in Zurich, New York and
London, including: Global head of prime brokerage and
Deputy global head of securities lending and repo.
Oegerli is Founder and CEO of IFBS, a consulting and
solutions firm for the financial industry.
SLMG 2005 ML10 7/9/05 1:13 pm Page 54
Securities Lending Market Guide
Mark Fieldhouse Christopher Jaynes Felix Oegerli
SECURITIES LENDING
PANEL DEBATE
Mark Fieldhouse, Director, Technical Sales and Relationship
Management, RBC Global Services. Fieldhouse has ten
years experience within RBC Global Services. During this
time he has worked in a variety of positions within the
Securities Lending and Finance unit including most recently
Director, Global Sales and Client Relations. Mark currently
has overall management of North American technical sales
for all RBC GS Global Products.
Christopher R. Jaynes, CFA, Managing Director,
eSecLending. Jaynes is responsible for managing the prod-
ucts of the company including the auction process, client
relations and cash management. He is one of the founding
members of eSecLending and was part of the team that
developed their auction model and built the firm's service
capabilities. He is also the President of Old Mutual (US)
Trust Company, eSecLending’s operating arm. Prior to the
founding of eSecLending Mr. Jaynes served as Senior Vice
President at UAM Global Securities Lending.
Felix Oegerli, CEO, IFBS. Felix Oegerli was born in
Solothurn, Switzerland. He obtained a post graduate degree
as a Swiss Federal Banking expert. He began his financial
services career with UBS, assuming a variety of roles in
Zurich, New York and London, including: Global head of
prime brokerage and Deputy global head of securities lend-
ing and repo. Oegerli is Founder and CEO of IFBS, a consult-
ing and solutions firm for the financial industry.
Christopher Taylor, Senior Vice President, is State Street’s
Securities Finance division Regional Business Director
Europe, Africa, & the Middle East. Based in London, Taylor is
in charge of overall business strategies and client relation-
ships in those regions. Prior to assuming his current role, he
served as the division's global co-head of account manage-
ment and client service as well as head of international
business implementation. Since joining Securities Finance
54 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
Christopher Taylor Paul Wilson
in 1991, he has had many responsibilities in the division's
London, Tokyo, and Sydney offices.
Paul Wilson, Senior Vice President at JP Morgan Worldwide
Securities Services. Wilson is responsible for new business
origination, relationship management and service as well as
product development and product management. He is also
responsible for foreign exchange and execution products for
JPMorgan Worldwide Securities Services in EMEA. The
Securities Lending & Market Products team consists of a
team of professionals responsible for profit & loss manage-
ment, technical sales, technical client delivery, product
development and liaison with client management.
Following events from the Maxwell pension fund scandal
in the UK and Enron in the US, what safeguardds do benefi-
cial owners have against fraud and other governance
mishaps when deciding whether to leend their assets?
Fieldhouse: When deciding to lend their assets -- or in any
other financial transaction, for that matter – there is cer-
tainly an onus on the parties involved to undertake the
appropriate due diligence to help ensure where possible
risks are mitigated and their assets are protected.
“there is certainly an onus on
the parties involved to undertake
the due dilligence to help ensure
risks are mitigated and their
assets are protected”
Situations such as the Enron scandal speak to the impor-
tance of a thorough system of checks and balances. One of
the byproducts of these disasters has been a significant
increase in the amount of time and attention being devot-
ed to good corporate governance across the financial land-
SLMG 2005 ML10 7/9/05 1:13 pm Page 55
scape, which has been a positive development. But benefi-
cial owners can also help protect their best interests by
ensuring that they select an established, reputable
provider who has a solid track record, enjoys a high credit
rating, etc. You’re looking for lending agents who, as part
of their routine operations, have mechanisms in place for
validating their internal controls, for example, or whose
companies adopt a Code of Conduct, which helps define
the expected behaviour and standards for employees. At
the end of the day, beneficial owners need to find a way to
balance multiple priorities, including the realization of
returns, operational transparency and, of course, their gov-
ernance obligations. At RBC Global Services, we establish
a partnership where we work with the beneficial owner to
develop a customized program aimed at achieving maxi-
mum returns, but within the framework of corporate gov-
ernance and with adequate attention paid to risk.
Oegerli: I assume that a beneficial owner, unless it's one of
the biggest in the world, should not lend its assets to the
market directly because it needs a lot of specialised skills
including understanding market structures and best prac-
tise globally and the risk associated with more complex
transaction structures. Probably the best safeguard is to
enter into a principal programme or an agency lending
programme with a highly professional and good quality
securities lending specialist. In the case of an agency lend-
ing structure, which typically the large US custody banks
offer, then the answer would be that you may require an
indemnification covering events such as fraud. These
banks have an obligation, much like a trustee to ensure
that you don't end up in a Maxwell situation.
Taylor: Well, Maxwell was some time ago, and a clear dis-
tinction needs to be made between an organised securi-
ties lending arrangement and what occurred in the
Maxwell case – it wasn’t a loan it was effectively a stock
steal. I would state that it is in no way reflective of a prop-
erly organised securities lending arrangement: There was
no authority or approval from the trustees of the plan to
conduct the activity; secondly, there was no contract or
authorisation agreement in place between the plan and the
people borrowing the securities; thirdly, there was no form
of collateral; and fourthly, I don’t believe there was any
compensation paid to the fund for the loan of the securi-
ties. So, in my mind, that event in particular has absolutely
nothing to do with what I would describe as an organised
securities lending programme.
I would point you, and any new participant in the indus-
try, in the direction of the Bank of England’s Securities
Lending and Repo Committee stock borrowing and lending
code of guidance and a publication entitled An introduc-
tion to Securities Lending commissioned by the The Bank
of England’s Securities Lending and Repo Committee and
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 55
Securities Lending Market Guide
representatives from The London Stock Exchange, The
London Investment Banking Association, The British
Banker’s Association and the International Securities
Lending Association. Both publications are an excellent
reference point for new entrants into the market.
“the pension fund should also
examine carefully what indemnity
and other protections the lending
agent is able to offer”
Wilson: In any potential transaction a pension fund is
going to look at the risks versus rewards, and reach a deci-
sion as to whether a framework can be created around
those activities that would, to the greatest extent possible
consistent with obtaining a reasonable return, mitigate
those risks. Our view is that a pension fund should
choose a lending agent which they feel is capable of work-
ing with them to create a framework within which to oper-
ate. Those conversations should include a question such
as “what does the agent do to help manage the risks?” The
pension fund should also examine carefully what indemni-
ty and other protections the lending agent is able to offer.
In assessing those indemnities, the pension fund should
also consider the financial strength and the
capital base of the entity providing the indemnity and
other protections. To provide a quick analogy – if someone
is going to write you a post-dated cheque, the question is
whether you believe you can cash that cheque, at some
point in the future. So it’s not necessarily all about the
potential of the programme, it’s as much about knowing
whether you can cash that cheque if and when you need to.
Within that overall framework, the types of issues that
should be looked at are collateral, counterparties, pro-
gramme limits, cash reinvestment guidelines and how
operational risk is going to be managed. My final com-
ment would be that it is not a case of “‘one size fits all”.
For example, JPMorgan lends for a large number of UK
and other pension funds, all of which have established
different but equally acceptable programme frameworks.
In a typical situation where assets are on loan during a
proxy votting season, how can a fund balance its lending
programme with its corporate governance commitments?
What advice would you give to these funds?
Fieldhouse: Yes, situations such as the one you’ve
described can present funds with seemingly conflicting pri-
orities in the context of their lending programmes. You can
easily see how there could be a perceived tension between
the fund’s fiduciary responsibility to maximize returns with
their corporate governance responsibilities, such as proxy
voting. In these situations, however, the fund is ideally
looking for a lender who will work with them to develop a
SLMG 2005 ML10 7/9/05 1:13 pm Page 56
Securities Lending Market Guide
tailored programme that meets their internal guidelines,
specifically, maximum returns in the context of the individ-
ual fund’s governance obligations. Ideally, the lender and
the fund can work together to arrive at a strategic proxy vot-
ing policy that helps balance and reconcile these objectives.
“It’s important for Lenders to
develop and articulate a corporate
governance policy in conjunction
with their lending program”
Jaynes: While the relationship between securities lending
and corporate governance has received a lot of attention in
the press recently, it is not a new issue or concern. Many
sophisticated Lenders have been successfully balancing
their securities lending programmes with their corporate
governance responsibilities for many years. It’s important
for Lenders to develop and articulate a corporate
governance policy in conjunction with their lending pro-
gram, which achieves their preferred balance between vot-
ing shares and generating securities lending returns.
While this preferred balance will be different from one
Lender to the next their securities lending provider can
manage the lending activity within the context of each
client’s corporate governance commitments as long as the
policy is clearly articulated.
Oegerli: My advice would be to look at the securities lend-
ing potential of that particular stock and decide which, if
any, of the securities should be lent. Further more, corpo-
rate governance commitments can also be defined as the
obligation to maximise returns for investors. If you can
make 200 basis points in a six month period from a spe-
cial situation but you decide not to lend because you want
to vote, then you must decide which is more important, to
make money or to enable the beneficial owner to vote. My
answer would be that if the stock is special and you are
earning a decent lending fee then you should lend unless
you have a very specific interest in this particular company.
But if it's a general collateral deal and the money that you
make does not justify not voting then I would recall or not
lend. In any respect I think any lender should have a trans-
parent policy which indicates the proxy voting behaviour in
regardis to equity lending.
Taylor: The first question I would ask any plan is do you
have a policy? Formulate one if you don’t. Once you have a
policy communicate it to your lending agent. Where this
gets somewhat tricky is that most pensions funds will
appoint multiple investment managers and may appoint
one or more custodians. These custodians may be one of a
number of lending agents and so forth. Communicate the
policy clearly to all parties involved and ensure they under-
56 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
stand their responsibilities. From a lending perspective, I
would say that if issues are sensitive or contentious, then
recall the security. Secondly, if you do wish to vote then
maintain a buffer as a percentage of shares or a number of
shares that cannot be lent and vote on that retained stock.
And again if the issue is particularly contentious then
recall any stock on loan and vote your full entitlement.
Wilson: This has been one of the most topical issues in the
securities lending industry for a number of years. From my
perspective, it is probably one of the most over-debated
issues. I would point all pension funds to the recent
International Securities Lending Association (ISLA) com-
missioned Securities Lending and Corporate Governance
paper. I think ISLA has done a superb job in bringing
together various interested parties within the industry to
give pension funds, in particular, some practical guidance
on how lending and corporate governance can each be
arranged to minimize conflict with each other. In summary,
it is possible for a pension fund to balance proxy voting
and securities lending. What a number of pension funds
do today is look at every situation on a stand-alone basis.
If the fund wants to vote the shares or does not want oth-
ers to vote the shares, the fund recalls the stock. If the
proxy issues are not contentious or otherwise of particular
interest to the fund, then it will consider how much rev-
enue can be gained from securities lending versus how
much economic benefit could be lost through not voting,
and will then make a decision on whether to recall the loan
in order to vote. I believe a pension fund that operates in
this manner is acting in the fund’s best interest.
Collateral and risk management: Cash or non-cash collat-
erral? Which is the most suitable surety a fund should
accept (considering the type of fund) and what is the value
of a cash reinvestment programme?
Fieldhouse: In any discussion about collateral, the bottom
line should be about the lending agent’s ability and expert-
ise to deliver upon the full, intrinsic lending value of the
portfolio – but to deliver upon it in the regulatory and risk
management framework specific to the individual client.
For example, some clients might opt for a non-cash collat-
eral program in order to steer clear of the potential rein-
vestment risks sometimes associated with cash collateral.
Such instances have resulted in some high profile losses in
the U.S. market over the past 20 years.
“Collateral decisions should con-
sider the Lender’s particular asset
mix, their individual risk tolerances
and their specific lending guide-
lines and regulatory framework”
SLMG 2005 ML10 7/9/05 1:13 pm Page 57
Jaynes: There is no single answer for all funds as to the
most suitable collateral to accept or the expected return or
value that a reinvestment programme could add. This is an
individual investment decision that needs to be made on a
client specific basis. Collateral decisions should consider
the Lender’s particular asset mix, their individual risk toler-
ances and their specific lending guidelines and regulatory
framework. These factors can vary significantly across dif-
ferent Lenders so the most suitable type of collateral or the
value provided by a cash reinvestment programme will
change from one Lender to the next.
Oegerli: As a general statement, cash collateral is the most
suitable from a counterparty risk and operational risk view-
point. However, the additional potential market risk cate-
gories associated with cash reinvestments should be man-
aged properly. These additional market risk categories can
be additional credit risks when investing into a rather low-
quality short-term money market instrument or yield curve
risk. Yield curve risk may occur, because a lender can recall
at any time or sell at any time but the cash collateral may
be invested for example for one month or three months in
order to pick up the extra yield in a rather steep interest
rate curve environment. However when acting on such a
yield curve, an investor or beneficial owner should always
ask themselves whether the goal of the securities lending
transaction is to mainly make money out of the securities
lending market or a yield curve speculation. If you are
going to play the curve this should be done within the
overall short-term money market investment strategy of a
beneficial owner or the treasury/ALM function of a bank
acting as principal intermediary.
Taylor: This is an interesting one, causing what is probably
the greatest cultural divides in securities finance business.
This divide has historically been a function of the securities
available for loan and the prevailing regulatory and tax
environments. In Europe, non cash collateral has been the
predominant form of collateral. Non cash is defined as
government bonds, semi government bonds, agencies,
high quality government or agency debt. The list has more
recently moved down to equities and other high quality
corporate securities. Non cash is the predominant form of
collateral in the UK and Europe equity markets and the
transaction is designed to extract the intrinsic value from
the securities that you have available to lend. The US has
taken a different route enforced historically from a regula-
tory perspective. Some of the earlier adopters in this mar-
ket were the ERISA pension plans. The act rules in the US
stated that lenders had to take cash as collateral. Cash was
viewed as the most suitable form of collateral, because in
the event of a default, cash was the most liquid form of
collateral you could have and the most easy applied in a
default situation. A European or UK based investor has
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 57
Securities Lending Market Guide
historically avoided cash, particularly in the equity lending
markets and has thus eliminated incremental revenues
form the reinvest of cash but at the same time has also
eliminated cash reinvestment risk. That cash reinvestment
process contains a twofold risk. The first is that one does
not generate a sufficient return to pay the agreed rebate to
the borrower, resulting in a negative trade. Secondly, in the
process of reinvesting the cash in order to pay the borrow-
er a rebate and generate a spread, the principal (re) invest-
ment is now worth less than the original investment – but
the lender still has a contractual liability to return to the
borrower the full value of the collateral posted at the term
of the trade. Cash can however provide the lender with
what’s termed an above the line return - which can be
attributed not to the loan activity but to the cash reinvest-
ment activity. This additional return (and risk) can be care-
fully managed by buying high credit quality securities in
the reinvestment portfolio and maintaining a very short
duration to minimise the interest rate sensitivity.
“Cash offers a level of flexibility in
the sense that a fund can
customise its reinvesment activities
to its own specific risk threshold”
Wilson: This is a difficult question to answer because, ulti-
mately, beauty is in the eye of the beholder. Cash offers a
level of flexibility in the sense that a fund can customise,
certainly through an agent lender, its reinvestment activi-
ties to its own specific risk threshold. Other types of collat-
eral include government bonds, letters of credit and equi-
ties. It is very difficult to say that one is better than the
other in an absolute sense. Within any programme, having
a spread of different collateral types obviously reduces the
risk further and may permit additional lending opportuni-
ties. Pension funds should establish their risk appetite and
balance that against any indemnities from their lending
agents. In our own experience, few pension funds take
equities as collateral. Typically, when most pension funds
start securities lending they only accept government
bonds. Later, as their comfort level with lending increases,
they may add cash, but perhaps only to be reinvested into
government bond repos and bank deposits. Over time, as
they become more comfortable with the risks and the man-
agement of the programme, they may expand the invest-
ment guidelines and also accept additional types of debt
securities and possibly equities also. There is no simple
answer to the value of cash reinvestment programmes. It
really depends on the investment guidelines imposed by
the client. But on the whole, the return can be in the range
of Fed Funds plus 1 or 2 basis points at the conservative
end, to Fed Funds plus 10 to 15 basis points where the
guidelines are more permissive.
SLMG 2005 ML10 7/9/05 1:13 pm Page 58
Securities Lending Market Guide
Maximum value - how can pension funds ensure they are
getting maximum value from a securities lendinng pro-
gramme, without altering their investment strategy (i.e.
from passive to active)?
Fieldhouse:: Benchmarking the performance of your securi-
ties lending programme can be a challenging proposition
for some, primarily because their peers aren’t shouting out
details of their lending returns from the rooftops. I would
suggest that periodically, funds might want to benchmark
against alternate routes to market for lending returns,
such as ‘third-party’ non-custodial lending programmes, to
help ensure they are earning top returns within the param-
eters unique to their particular pension fund. Yes, there are
certainly some benchmarking options beginning to
emerge, but it’s still a challenging area overall for lenders.
“Pension funds should
not have to alter their investment
strategy to accommodate their
securities lending program”
Jaynes: Pension Funds should not have to alter their
investment strategy to accommodate their securities lend-
ing program regardless of programme type or structure.
Funds can ensure they are receiving maximum value only
by taking an active approach to securities lending and by
incorporating many of the same disciplines and tools into
their lending program that they utilize to select and review
their investment management providers. Historically,
many lenders have viewed securities lending as a passive
decision and as a mandate bundled with their custody
provider. To ensure they are getting maximum value pen-
sion funds should more actively manage and review their
lending programmes and select their providers based on
core competencies and expertise.
Oegerli: Securities lending hardly justifies a shift in invest-
ment strategy. A daily positve Dollar / Euro volatility shift
may generate more money than the annual lending fee of
some programmes so the key is not to align the tactical or
strategic asset allocation to the lending demand. Pension
funds should choose the right distribution channel for
their lending programme. This can include guaranteed
bids from investment banks through auctions or delegate
the lending program to a lending agent, which cover all
securities lending markets, have a powerful distribution
network and are up to speed regarding innovative and
profitable product structures.
Taylor: I think the goal here is that you don’t look towards
the maximum value you could get from the securities. It is
ultimately the optimal value on the basis of the risk and the
return that you look to take. It is simply imprudent to put
58 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
the principal of the securities in your investment portfolio at
risk. What we are talking about here is basis points of
return, and whether that is 5, 10, 15, 20 basis points per
annum, it is still a basis point of return, and not just per-
centage points. Where you can make a difference is in terms
of a peer comparison or a positive tracking error to an index
benchmark. Half a dozen basis points can be the difference
between being top of the second and bottom of the first
quartile, but again it is a basis point of return. You need to
strike a prudent balance and I wouldn’t recommend that
people go aggressively down the credit curve on non cash
collateral just to secure more loans and or at greater spread.
I don’t think that is the purpose of the activity.
Wilson: A pension fund should not change its investment
strategy just to accommodate securities lending. A good
lending agent can produce a reasonably accurate
assessment of the securities lending earnings potential of
a portfolio and adjust the same on a regular basis as
market conditions change and/or the assets held in the
pension fund’s portfolio change. Once the risk framework
for lending is established, the agent can suggest various
techniques that, with a minimal amount of attention, can
help assure that earnings potential is achieved. These
techniques can include simple things such as: (i) where a
corporate action involves a cash or stock alternative, pro-
viding an early guarantee when cash is to be taken; and,
(ii) allowing term transactions, especially on fixed income
holdings, where cash collateral investments can also be
matched to the maturity of the loan.
What legal implications can occur when a custodian pass-
es the pension fund's securities to a sub-custodian in
another market, which does not recognise the law of the
country from where the securities originated?
“your custodian should be well
versed in the intricacies of the
various markets that make up
their network”
Fieldhouse: Ideally, your custodian should be well versed
in the intricacies of the various markets that make up their
network, and they should be in a position to advise their
clients accordingly. Having said that, a good rule of thumb
would be for pension funds to take the appropriate steps
to satisfy themselves that their lending agent has ensured
proper market specific due diligence before entering into a
lending relationship. Again, this speaks to the importance
of a provider’s track record, high quality credit rating, etc.
Oegerli: If on-shore lending in a given market is not
allowed, the delivery of a securities lending transaction is
SLMG 2005 ML10 7/9/05 1:13 pm Page 59
not allowed, notwithstanding the domicile of the lender or
lending agent. If a delivery instruction is sent to the sub-
custodian in relation to a securities lending transaction the
local regulator may not just raise questions but probably
also would impose heavy penalties. However, as a substi-
tute to a securities lending transaction it may be possible
to use derivative structures combined with the sale of the
underlying security to the “borrower”. The most commonly
used derivative structures are the issuance of discounted
warrants (discounted by the lending fee) or a swap trans-
action. However, a swap gives the pension fund the prob-
lem of investing large amounts of cash at, typically, a
Libor-flat interest rate whereas the warrant does not
require a money market investment as the proceeds of the
equity sale are re-invested in the buy transaction of the
warrant. Furthermore Swaps are OTC instruments, and do
not bear ISIN codes and it may be a rather manual task to
include the swap value together with the cash investment
in the net asset value of the fund. Warrants, however, have
a much easier revaluation process because they are typical-
ly listed by the borrower who is issuing the warrant on a
exchange and bear an official daily price. Therefore the rec-
ommendation for a pension fund would be to use the
Warrant structure to get around local securities lending
restrictions.
Taylor: The terminology of securities lending or a stock
loan arrangement is somewhat of a misnomer. Typically
under UK law by lending a security you transfer outright
titles of that security to a borrower or counterpart in
exchange for entitlement of the collateral you receive. Via
the lending authorisation agreement you then replicate all
the rights and entitlements and maintain the economic
interest or exposure of the underlying security. As you
move into international markets, it is very conceivable that
the domicile of the lender, borrower, security type and the
collateral taken, could each be different. For example, a UK
pension fund could lend its Japanese equities to a US
borrower that provides European sovereign debt as
collateral. You could be looking at multiple domiciles for
each transaction – in this case as many as four. You need
to examine the situation very carefully not only from a
regulatory and legal perspective but also from a cross
boarder tax perspective. As a minimum you would need to
examine the cross border tax implications of the securities
you have loaned, the collateral you hold and the jurisdic-
tion in which you hold it.
Wilson: The way we would look at this is fairly simple. At
JPMorgan, before we put any new client entity type into
our programme, or before we lend in any new market, or
before we take any new collateral type, we undertake a
comprehensive due diligence process. We look at the legal,
tax and regulatory implications of all aspects of securities
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 59
Securities Lending Market Guide
lending to help assure that neither our clients nor
JPMorgan are put in an adverse position. We have a dedi-
cated team of people who deal with these issues, working
with local attorneys and tax experts. This type of due dili-
gence helps reduce the possibility of any unpleasant sur-
prises, of a legal or tax nature. A good agent should be
doing this level of research both upfront and on an on-
going basis to help assure that a client’s position is not
compromised by such factors.
What algorithms are employed by custodians/lending
agents when deciding which client's stock to lend?
Fieldhouse: Every lending programme has its own
methodology of allocating loans across the client base.
It’s important that the pension fund satisfy itself that the
process is fair and equitable. They want to avoid any situ-
ation where they might be at a disadvantage compared
with the other funds.
Jaynes: We do not utilize a pool or queuing system in our
programmes, but rather treat each individual client as an
entirely separate book of business. A question which is
often asked regarding traditional lending programs is: “is
the queuing algorithm fair for all clients?” That question
should really be taken further to ask: “is the algorithm
optimal for all clients?” Fair treatment may not necessarily
equate to optimal returns for some or all clients. The ques-
tion should really be: “Are the clients receiving optimal
returns in the queue, rather than are they receiving fair
returns?”
Oegerli: In certain countries there are rules about the fair
securities lending allocation algorithms. These may not be
detailed rules but they require that lending agents have to
have a fair allocation algorithm in place. Most people take
into consideration the size of the current and past posi-
tions and the previous allocations to that position. Certain
systems also take into consideration the historic lending
fees paid to the single account.
Taylor: We have an algorithmic formula. Complex - but it’s
effectively a queue. The formula is based on credit entitle-
ment points. This algorithm is similar to moving up and
down in a queue based on the securities held in the portfo-
lio and the demand to borrow those securities. We have
lend on behalf of ERISA clients in the US for many years.
When lending on behalf of ERISA plans, you need to be
able to demonstrate your have an equitable method of
allocating loans, which is annually certified. No one single
trader or employee can favour one client portfolio over
another. That is a standard agency lending approach, with
most of the large custodians and lending agents employ-
ing a similar type of queuing process.
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Securities Lending Market Guide
You can take other routes to market that may include
some type of exclusive arrangement – a transaction struc-
ture that gives a borrower exclusive access to a portfolio,
typically on an annualised basis for which they pay a fixed
fee agreed at the time the arrangement is entered into.
Alternatively, you can enter an agency programme and take
advantage of the demand for securities as they arise, at the
market rate.
Wilson: Agents who lend for multiple clients must employ
an algorithm and/or process under which loan opportuni-
ties are fairly allocated among all clients. Our systems
have a loan queuing algorithm which, like most algo-
rithms, is fairly complex and takes into account various
client parameters, but which is designed to assure a fair
allocation. (The algorithm becomes meaningless where a
client has, for example, a lending cap of $1 billion and
already has $1 billion on loan.) Notwithstanding these
points, two clients with the same tax rate, holding the
same securities and with similar programme parameters
should expect to get similar earnings.
What are your predictions for the securities lending market
over the next 5-10 years?
Fieeldhouse: Over the next several years, I think it’s safe to
say that we are going to see the continued growth of the
hedge fund industry, and the adaptation of hedge-fund like
strategies, direct or indirect, by traditionally long-only ben-
eficial owners. We will also see continued commoditization
of the industry in certain markets that will lead to an
increased emphasis on efficiencies through technology. In
addition, we’re also likely to see continued consolidation
of service providers around the globe.
Jaynes: I expect a continued and accelerating trend
towards the unbundling of securities lending from custody
mandates over the coming years, and a continued shift by
Beneficial Owners to more actively manage their securities
lending programmes. Lenders are increasingly viewing
securities lending as an asset management and trading
process rather than a back office or operational function. I
also expect to see a continued increase in the number of
Lenders utilizing multiple providers and improved per-
formance measurement tools as more lenders bring an
investment management approach to their securities lend-
ing programmes. From a return standpoint I expect
increased opportunities and a growing acceptance of lend-
ing in emerging markets, particularly those in Asia and
Eastern Europe, over the next several years.
Oegerli: I see further growth of the business in terms of
volumes, but further market consolidation in terms of par-
ticipants. The remaining small to medium players need to
review their business cases, leading to a possible outsourc-
60 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
ing of distribution. Perhaps they cannot afford to run
desks with traders anymore, so they may outsource distri-
bution to a large player. GC prices will increase slightly,
due to higher cost of capital implied by Basel 2.
“I see further growth of the
business in terms of volumes, but
further market consolidation in
terms of participants. The remain-
ing small to medium players need
to review their business cases.”
GC will be mostly traded by electronic exchanges with
integrated post-trade processes. Collateral trading within
an overall collateral management strategy not just cover-
ing securities lending but also repo and OTC-derivatives
collateral will become a core treasury function of large
financial institutions.
Furthermore I predict a strong growth of more complex
securities lending and funding structures which are traded
over the phone and emerging markets in Asia and Eastern
Europe which will grow strongly in the next 5-10 years. This
will add to the volumes and the profitability of the busi-
ness. I am very optimistic about this industry.
Taylor: There are a couple. Firstly, I think you will see
greater transparency in the lending process – transparency
particularly in the pricing. Secondly, we can expect certain
lending activities to move towards alternate type transac-
tions, like swaps.
And thirdly, you will see more of what I call “commoditi-
sation”. You can see it in the US, and to some extent in the
UK and Japan – anywhere there is a very significant supply
of securities and the market is characterised by a relevantly
low percentage of securities on loan.
In the commoditised markets there is an accelerated
trend of transparency as the markets gravitate towards
more efficient and effective way of trading high volume,
relatively, low margin transactions.
Wilson: I think that there may well be greater tax harmoni-
sation across Europe, which will gradually dilute the value
of much of the dividend arbitrage driven activity. The
hedge fund industry is going to continue to grow, which
will drive securities lending demand.
There will be more focus on devising new structures in
new markets, particularly in the emerging market space.
However, with the onset of Basel II, participants will need
a substantial capital base as well as scale and efficiency if
they are to remain at the forefront of the industry. It will be
interesting to watch what happens to those that don’t.
ISJ
SLMG 2005 ML10 7/9/05 1:13 pm Page 61
Ask the experts...
Securities lending service
providers and Pension Funds
answer questions.
JPMorgan
What impact will participation
within a securities lending
programme have on the underlying
investment process and/or
Investment Manager?
David Mitchell
JPMorgan
The short answer is that a well managed and
organised securities lending program should
have little or no impact on the underlying
Investment Managers’ activity.
Securities Lending is designed to enhance
returns and should not negatively
impact the on-going investment activities of a
Fund.
A primary focus of a lending agent such as
JPMorgan is to strive to help assure that the
securities lending process does not interfere
with the investment management process.
To achieve this there are many operating prac-
tices to help assure transparency, but two of the
more pertinent are as follows:
Sales Management
Investment Managers can trade their portfo-
lios without consideration as to whether securi-
ties are on loan. If a security is sold an agent
has a couple of options, either -
a) making a swap, i.e., using the stock liquidity
on its books to reallocate the loan to another
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 61
Ask the Experts
lender so that the loan need not even be
recalled, or b) recalling the securities from the
borrower. The transfer of the loan on the
lending agent’s books to another lender is the
preferred option as the recall of securities is
open to the impact of market settlement prac-
tices and timeframes, plus it also affects the
Borrower, who still has a need for the securities.
Agents with large programs with depth of
supply clearly have a competitive advantage, as
they are able to achieve a very high level of
swaps and a greater stability of supply to the
borrowers.
Asset Servicing
Again, there should be little to no impact on
the Investment Manager.
All income and corporate action entitle-
ments, with the exception of proxy voting, are
retained. A good Agent will assume respon-
sibility to manage the Investment Managers
entitlements and is responsible for calculating
and claiming entitlements from borrowers
based on the Investment Managers’ wishes on
securities on loan.
The result of this is that from instruction to
payment, the fact that the securities were on
loan should be largely irrelevant (i.e. the
Investment Manager will only have to provide a
single instruction regardless of whether securi-
ties are on loan or not).
If a Manager wishes to vote a particular proxy,
securities on loan will have to be recalled in a
timely manner.
David Mitchell, Head of Client Management &
Sales, Securities Lending & Market Products,
EMEA, JPMorgan
Mitchell joined the Securities Lending & Market Products
team in August 2004 as Head of Client Management
and Sales. Prior to this role he was the Client Executive
for JPMorgan Worldwide Securities Services’ continental
European pension, central bank and Middle East clients
having previously gained experience at Relationship
Manager and Team Leader level. He joined the opera-
tions division of JPMorgan Investor Services in March
1987 having also worked for Barclays Bank plc in both
their retail and international divisions.
Mitchell holds a BSc Hons Degree in Financial Services
and is an Associate of the Chartered Institute of Bankers.
He is also a Registered Representative of the FSA for
securities, derivatives and commodities.
SLMG 2005 ML10 7/9/05 1:13 pm Page 62
Securities Lending Market Guide
Ohio PERS
Can cash collateral / cash reinvest-
ment programmes be run in-house,
within the pension fund itself? If the
answer is yes, how is this best
achieved?
Jerry May
Ohio PERS
Cash collateral reinvestment programs can
be managed effectively by the plan/owner. Is
this method the right solution for all plans?
No, but for those who capably manage cash
internally, and have in-house credit expertise,
this type of
program offers several benefits.
The plan has absolute control over the hold-
ings in the account, so there are no surprises.
The plan can also leverage internal expertise
thereby reducing cash management fees
charged by lending agents. Another probable
consideration is diversification of investment
strategies among a plan’s cash collateral man-
agers.
Since the management of cash collateral is
the primary source of risk in an efficiently man-
aged securities lending program, the allocation
of that function to appropriate investment pro-
fessionals deserves a thorough examination.
It is a decision that ought to bear as much
scrutiny as the allocation of other assets to
investment managers; so to allot this asset
class in an optimal manner, all sources of
investment management expertise, including
those internally available, should be considered.
To effectively operate an internally managed
reinvestment program, a constant stream of
communication between the portfolio manager
and the agent lender is a necessity.
62 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
With volatility being a fact of the lending mar-
ket, the communication of cash positions in a
timely manner is a requisite to managing the
cash collateral with some degree of proficiency.
Another decision factor would be the type of
cash collateral that the plan wishes to manage.
With US Agencies historically trading with thin
spreads to the reinvestment rate on cash collat-
eral, managing that type of program would
require a different dynamic than managing
other types of cash.
For instance, with International Equities, the
rebate due to the borrower is typically fixed
based upon the US Fed Funds target rate, mak-
ing the management of cash collateral a bit
more certain than having to meet and exceed a
fluid rebate rate set by the market each day.
In combining the considerations mentioned
above with policies for manager searches the
owner already has in place for other asset class-
es, the plan may decide whether managing cash
internally is the right decision for its circum-
stances.
It is a decision, though, that should be given
the proper amount of diligence and care.
Managing cash collateral internally may just
provide benefits that are of sufficient magnitude
to warrant going in that direction.
Jerry May, Securities Lending Officer
Ohio Public Employees Retirement System
May has been responsible for the securities lending pro-
gram at Ohio PERS since February 2004.
In that role, May is responsible for the direction of the
lending program within designated risk parameters, and
the reporting of those results to the Board.
He is also responsible for the cash management func-
tion for all the plan’s internal short-term funds, as well as
a portion of the securities lending cash collateral.
Ohio PERS currently has over $60 billion in fund
assets, and is one of the top ten largest U.S. public pen-
sion plans.
Prior to joining Ohio PERS, May was responsible for
government and international securities lending at Bank
One, having started and managed the latter program for
Bank One since 1999.
With 14 years of experience in securities finance, May
also held progressive positions at Boatmen’s Trust in St.
Louis prior to joining Bank One in 1997. May earned his
BBA in Accounting from Abilene Christian University,
and his MBA from Ashland University.
SLMG 2005 ML10 7/9/05 1:14 pm Page 63
Anvil
What are the challenges and
advantages of bringing together
the repo and securities finance
functions?
Malcolm Clark
Anvil
Not so long ago securities lending was a back
office function. Over time it slowly emerged and
migrated to the front office, with a close alle-
giance to the repo.
As the securities finance business drew near-
er to the repo remit, the opportunity to unify the
two through technological development arose.
Securities financing and repo can ultimately
support very similar business functions; both
can be used for funding positions.
Although there are clear links and similarities,
the most important thing any effective system
should be able to do is to accommodate the dif-
ferences.
This includes mark to market, settlements,
equities and fixed income, and collateral pool as
opposed to delivery versus payment to name
some of the most important ones.
Once it is possible to accommodate all the
differences, there are significant benefits.
The two most obvious and arguably most
important benefits are collateral management
efficiencies and operational benefits.
There has been a great thirst in the market for
cross-product collateral management, which is
not only a current topic, but was also a strong
motivation for merging both repo and securities
lending into a single system.
Unifying collateral management across both
business lines is beneficial in more ways than
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 63
Ask the Experts
one, but primarily benefit is the increase in effi-
ciency.
Operational benefits are a great influencing
factor, which not only affect the cost, but once
again the efficiency.
Operating one system that supports both
business functions means a vast reduction in
operating costs as well as complexity.
To put it simply: using one system for multi-
ple functions makes life easier.
Although the desire and need in the market is
for a system that supports both business lines,
it must also support single use functionality as
there are businesses that have these require-
ments too.
In order to address the needs of the repo and
securities lending world a securities finance sys-
tems must include good position management
as a key feature.
This allows aggregation of positions and
trades from different books, funds or legal enti-
ties in many flexible ways.
Some of the other features that are important
are: spreadsheet upload of trades e.g. for basket
trading, automatic marking, mass-processing of
transactions, e.g. rerating a number of transac-
tions in one action, interact with electronic trad-
ing markets, both principal and agency trading,
and have high levels of automation.
Malcolm Clark, Director, Anvil
Clark joined Anvil in May 1999 after a successful career
in investment banking. After graduating with a BSc in
Economics from Massachusetts Institute of Technology in
1983, Clark spent nine years with Morgan Stanley where
he became a repo trader. Clark then moved to CSFB and
commissioned a global repo system that was the forerun-
ner of Anvil ARTS. Malcolm was an SFA registered trader
when working for investment banks.
Clark is the director responsible for product strategy -
looking for new opportunities for Anvil in the financial
markets. Clark also directs the sales and marketing of
Anvil ARTS and Anvil Order Management.
SLMG 2005 ML10 7/9/05 1:14 pm Page 64
Securities Lending Market Guide
RBC Global Services does not mean there will not be challenges in
setting up a program, however. For example,
The securities lending marketplace
is an over-crowded one. How can
pension funds and other
institutional investors separate the
wheat from the chaff when
selecting a provider
who can cater to
their unique needs?
Mark Fieldhouse
RBC
The characteristics of a leading provider
include high touch client service, a long-term
commitment to the business, access to the best
technology and the ability to work alongside
the client in a mutually beneficial relationship. It
is true, there are many routes to market for
lenders. In our experience, however, pension
funds are typically looking for a securities lend-
ing provider who can provide ‘all of the above’,
wrapped in an offering that is truly tailored to
their particular situation. The securities lending
environment has really evolved, particularly over
the past several years. Long gone are the days
when a client signed up with an agent and
never revisited the program again. To be seen
as a leader in today’s marketplace, an agent
needs to cultivate ongoing dialogue by under-
taking regular program relationship reviews and
providing the client with frequent market com-
munications. The successful agent will be the
one who can work with the client in a co-devel-
opment environment to help tailor a program
best suited to their needs, balancing the multi-
ple priorities of revenue generation, operational
transparency and risk management.
Such high touch maintenance is key to ensur-
ing clients and agents alike are positioned to
capitalise on any opportunities that might arise.
Of course, it is widely accepted that securities
lending can be an important tool for pension
64 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
plan sponsors to help maximise returns. That
today’s environment can present plan sponsors
with seemingly conflicting priorities when it
comes to establishing a successful securities
lending program. Consider the potential tension
between the plan’s fiduciary responsibility to
maximise returns and their rigourous corporate
governance responsibilities, such as proxy vot-
ing. In situations like this one, it is critical that
the agent and lender work together to arrive at a
thoughtful proxy voting policy that provides an
effective balance of these objectives, in align-
ment with the beneficial owner’s objectives.
That speaks to the real importance of the rela-
tionship.
Lenders would also be wise to select agents
who are committed to continuous investment in
the securities lending business, particularly in
the areas of automation and product develop-
ment. There is so much potential on that side
of the business – great opportunities can be
lost if your agent not on the leading edge. And
perhaps equally important is the whole notion
of creating an ongoing and evolving partnership
with the beneficial owner. This is critical to suc-
cess in the relationship.
As traditional, ‘long only’ beneficial owners
explore alternative investment strategies to
increase performance, this concept becomes
even more important (as beneficial owners
look to their agents to assist them in their
movement into hedge fund or hedge fund-like
strategies).
Mark Fieldhouse, Director, Technical Sales and
Relationship Management, RBC Global Services
Fieldhouse has ten years experience within RBC
Global Services. During this time he has worked in
variety of positions within the Securities Lending and
Finance unit including most recently Director, Global
Sales and Client Relations. Mark currently has overall
management of North American technical sales for all
RBC GS Global Products.
SLMG 2005 ML10 7/9/05 1:15 pm Page 65
Northern Trust
Why borrow securities?
Jacqui Waller
Northern Trust
Demand from the borrowing community
exists for a myriad of reasons but one of the
most common is to borrow securities in order
to cover a short position. No doubt whenever
the term ‘short’ is mentioned, many owners
assume that securities lending is merely a
process to facilitate ‘short selling’.
However, this assumption is not born out in
practice since many short positions occur as a
result of a wider trading strategy, whereby
market participants are aiming to profit from
pricing anomalies between related securities.
‘Pairs’ trading is a prime example of this type of
strategy at work.
In this case, traders will focus on a specific
set of related securities in a sector, such as tele-
coms or autos, and identify a trading price rela-
tionship between the two.
If either one of the securities falls outside of
the historical trading price range, then an
opportunity exists to profit from this anomaly.
Hence, the undervalued security will be pur-
chased and the overvalued security sold with
the latter causing the short market position.
Other examples of these types of trading strate-
gies include ‘merger arbitrage’ whereby market
participants short the equities of the company
launching the takeover bid whilst acquiring a
long position in the target company or ‘index
arbitrage’ where the constituent securities of an
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 65
Ask the Experts
index are sold short versus a long position in
the futures contract of the same index.
Short positions are also attributable to settle-
ment fails, for example when trades are booked
after a market deadline or processed with incor-
rect details. Such fails, particularly if they esca-
late to a chain of failed trades, can prove to be
costly and cause substantial market inefficien-
cies. Hence, from the perspective of a borrower,
paying to borrow the securities for a period of
time is a better proposition than running the
risk of allowing the trade to continue to fail in
the market.
But there are other key factors motivating bor-
rower demand aside from short position cover-
ing. Besides borrowing for financing purposes,
there are situations whereby the lender and the
borrower can benefit from certain transactions
when ownership is transferred temporarily in
order to take advantage of a market event.
One of the most common examples of this is
optional scrip dividend trading where an issuer
offers shareholders the choice of receiving a div-
idend either in cash or by reinvesting it in addi-
tional securities (scrip) at a discount to the
market price.
Jacqui Waller, Investment Strategist, Northern
Trust Global Investments
Waller is a Vice President and Investment Strategist
at Northern Trust Global Investments (NTGI), based in
London where her principal mandate is to maximise
securities lending opportunities for both new and
existing clients. Prior to this role, Waller was responsible
for the management of the Euro and USD cash
collateral funds for the Securities Lending division. She
obtained her BA (Hons) in Economics and Politics in
1994 and is IMC qualified.
SLMG 2005 ML10 7/9/05 1:15 pm Page 66
Securities Lending Market Guide
ABN AMRO Mellon
What is collateral and what forms of
collateral can a pension fund
accept?
Robert Coxon
ABN AMRO MELLON
Collateral is a key element in a securities lending
transaction. For use of a security, a borrower pro-
vides collateral to the lender to secure the borrow-
er’s promise to return the security within an
agreed upon timeframe. Generally, the collateral
requirement for US security loans is 102 per cent
and for International loans it is 102 per cent to 110
per cent, depending on whether the loan and col-
lateral are in the same currency, as well as the
quality of the collateral. The lender performs a
daily mark-to-market to ensure that collateral is
maintained at least at the minimum required lev-
els. The excess collateral, called margin, serves as
a safeguard against counterparty credit risk.
Historically the US securities lending market has
grown up around US Dollar cash collateral, with
most lenders in the UK and Europe preferring to
accept non-cash collateral. However, cash is
becoming more prevalent in Europe as lenders
become more comfortable with the risk associated
with this form of collateral.
For cash collateral loan transaction, lenders will
have set investment guidelines and strategy with
which they will expect the reinvestment manager
to comply. Most lenders’ strategy for collateral
reinvestment focuses upon the preservation of
principal by managing interest rate and credit risk,
and by maintaining the proper liquidity in the
client’s portfolio. Although cash collateral typically
affords the lender enhanced earnings over and
66 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
beyond the intrinsic loan value, issuer default risk,
interest rate risk, and duration mismatch risk have
to be balanced against the potential rewards.
Those lenders uncomfortable with the risks asso-
ciated with cash collateral will opt for non-cash col-
lateral only. Lenders will focus on credit worthi-
ness, liquidity and volatility of the collateral in
determining what is acceptable. Many lenders
either manage and monitor the collateral on a
bilateral basis, dealing directly with the borrower or
outsource this responsibility to a tri-party agent.
Another factor in determining the correct collat-
eral choice is the lender’s prevailing regulatory
environment. Offshore funds based in
Luxembourg, for example, are not permitted to
accept equity collateral, and up until recently UK
mutual funds were only able to accept equities if
they cleared and settled through CREST. German
KAGs, as another example, are highly restricted to
cash deposits, bonds - provided they are admitted
as collateral by the ECB - and EU/EEA (European
Economic Area) listed securities.
With the advent of Basel II, borrowers are
becoming increasingly focused on their balance
sheets and the cost of capital. This is resulting in
downward pressure on the quality of the collateral
and the level of margin borrowers are willing to
give the lenders. Borrowers are pushing for lenders
to be more flexible in the type of collateral they
receive. Collateral flexibility, however, usually
equates to more risk, either in lower margins or
lower credit quality. Lenders will need sophisticat-
ed Value at Risk (VaR) models to determine
whether they really want to accept collateral such
as non-index equities, convertible bonds and
below investment grade corporate bonds.
Collateral has always been an important compo-
nent in the securities lending transaction, used by
sales and relationship managers alike in convinc-
ing the beneficial owners that securities lending is
a low risk business. With Basel II on the horizon,
borrowers will continue to reduce over collaterali-
sation and the quality of the collateral. However,
lenders will need to remain convinced that the
rewards still greatly out weigh the risks.
Robert Coxon, Head of International Securities
Lending for ABN AMRO Mellon Global Securities
Services B.V.
Coxon joined Mellon Bank in 1997 as a securities
lending trader. From 2001 to 2004, he ran the
International Equity and Fixed Income trading desks in
London. Prior to joining Mellon, Coxon served as senior
trader at Prudential Portfolio Manager.
SLMG 2005 ML10 7/9/05 1:16 pm Page 67
State Street
Describe the process for approving
borrowers – who is responsible for
the credit review of borrowers and
how often is it done?
Jay Carty
State Street
Our dedicated borrower credit management
staff works in conjunction with State Street's
Corporate Enterprise Risk Management team at
the outset to review, approve and establish
appropriate credit limits for borrowers. Both the
“credit fit” and “business fit” of prospective
borrowers are evaluated through this process.
Our assessment of borrower creditworthiness
and the resulting credit exposure limits are deter-
mined through traditional analysis including the
following key considerations:
- Industry presence, strategic focus and diversification
- Quality and stability of earnings
- Capital adequacy/financial leverage/asset quality and liq-
uidity
- Stability and reliability of funding, i.e., availability of
external credit support
- Credit quality of affiliated group of companies (if applica-
ble)
- Support by parent/support provided to subsidiary
- Special arrangements, e.g., guarantees, comfort letters,
etc., and
- Quality and completeness of financial reporting.
Credit limits are approved and administered for
each borrower in “risk equivalent” terms, which
are monitored and managed in State Street's pro-
prietary risk system. This unique system allows
credit to be allocated on a counterparty portfolio
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 67
Ask the Experts
basis (across all lending products) based on the
price volatility of the loaned securities relative to
the collateral securing the loan. Our risk manage-
ment staff monitors these credit limits daily to
ensure compliance, as well as monitoring the
ongoing credit quality of each of our approved
borrowers. Formal written reviews of all borrow-
ers occur at least annually, with additional
reviews scheduled whenever there is a change in
a borrower’s financial condition, or due to some
corporate change. Our credit risk management
staff also meets with our borrowers' senior man-
agement on a regular basis to gain additional
insight into their financial condition and business
strategy. Risk in the lending transaction arises
from the potential for a collateral shortfall due to
market moves for a particular borrower simulta-
neous to that particular borrower's default. If the
collateral is cash, a shortfall would occur if the
value of the loaned securities increased in price
in excess of the margin held. If the collateral is
securities, the added risk of a decline in their
value could contribute to such a shortfall.
Indemnification against borrower default can
serve to mitigate this risk. A situation where both
a borrower default and a collateral insufficiency
occur simultaneously - and thus lead to a loss -
should be relatively rare. It should not be
assumed that a default would necessarily have an
adverse effect on collateral coverage, since that
would depend on the nature of the securities
loaned and the collateral received in the context
of the market's reaction to such an event.
Lending agents can mitigate this risk by ensur-
ing that the loans are properly collateralised on a
daily basis, accepting only highly liquid forms of
non-cash collateral, and only entering into lend-
ing agreements with highly rated counterparties.
John Carty, Senior Vice President, Head of Global
Sales, Securities Finance, State Street
Carty is senior vice president and head of global sales for
State Street's Securities Finance division. He is responsible
for overseeing all new divisional sales efforts and activities
worldwide. Prior to assuming his current role, Carty was
responsible for sales and account management in the
Americas, a role in which he managed relationships with
lending clients and prospects in locations ranging from
Canada to Chile. Prior to joining State Street in 1997 as
manager of the division's U.S. sales team, he was with
Mellon Bank/The Boston Company, where he served in
various senior sales management and operational roles.
SLMG 2005 ML10 7/9/05 1:16 pm Page 68
Securities Lending Market Guide
eSecLending
Many lenders are evaluating
securities lending more as an
investment management decision
and utilising multiple routes to
market. What determines whether
it is beneficial for a
lender to utilise
multiple routes to
market?
Christopher Poikonen
eSecLending
Historically, lending has been viewed as an
operational or back office
function; however Lenders are increasingly view-
ing this activity as an investment management
decision with an alpha proposition.
It is a widely accepted practice within the ben-
eficial owner community to utilise multiple
asset managers based upon their core compe-
tencies and particular investment style and
expertise.
When selecting these investment managers,
Beneficial Owners typically perform consider-
able due diligence to ensure they are hiring the
best provider for each asset class consistent
with their risk profile.
These mandates are periodically reviewed and
optimised based on carefully selected criteria.
Lending mandates, however, have historically
been selected passively with little attention paid
to provider performance.
In recent years, we have witnessed a funda-
mental change in the way institutional investors
view their securities lending activities.
Many have adopted a more active approach
and have successfully introduced traditional
investment management disciplines, such as
the use of specialists and multiple managers.
Many of those Lenders that have adopted this
active approach and unbundled securities lend-
ing from the custody function have seen signifi-
68 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
cant increases in revenue while at the same
time have achieved greater control over their
program.
An effective securities lending program is
dependent upon superior trading execution and
sound collateral management.
Logic would then follow that Lenders can
enhance their performance through a selection
of multiple lending providers based upon their
individual core competencies and expertise.
Suggesting that any one Lending Agent or
Principal Borrower is the best solution for all
asset classes and markets, as well as the best
solution for collateral management is counterin-
tuitive.
In fact, utilising a Third Party Agent and/or
Principal Program in conjunction with a
Custodial Agent is often an effective combina-
tion for lenders.
Lenders are now, more than ever, paying clos-
er attention to their lending programs and plac-
ing more pressure on their providers to max-
imise returns while effectively mitigating risk.
By introducing competition and utilising var-
ious routes to market including auctions,
exclusive arrangements and custodial and
third party agents, they can effectively enhance
returns on their lendable assets while at the
same time assume greater control over their
lending activities.
Christopher K. Poikonen, Senior Vice President
Relationship Management, eSecLending
Poikonen’s primary responsibilities include auction
strategy and analysis, and client/borrower relationship
management.
He is one of the original members of eSecLending and
was part of the team that further developed and refined
their auction model and the firm's service capabilities.
Prior to his current role with eSecLending, Poikonen
served as an International Equity Trader with State Street
Global Securities Lending and before that as an Associate
in the Global Structured Products Group of State Street
Global Advisors.
Poikonen received his MBA at the Carroll School of
Management at Boston College and his Bachelor of
Science from the University of Massachusetts -
Dartmouth.
SLMG 2005 ML10 7/9/05 1:17 pm Page 69
BNP Paribas
What impact does securities
lending have on voting ?
Richard Thompson
BNP Paribas
This question, which has become more
prevalent since the release of the Myners Report
and the ongoing work carried out by the
International Corporate Governance Network
(IGCN) amongst others, takes us to the very
heart of the actual structure of a loan of securi-
ties. The securities lending transaction repre-
sents an absolute transfer of title of lent securi-
ties and, as such, all the actual rights associated
with those securities are transferred to the end
borrower. The market agreements that govern
securities lending transaction ensure that the
lender is able to enjoy all the benefits of owner-
ship of lent securities whereby dividends, other
cash distributions or the proceeds of voluntary
corporate actions are ‘manufactured’ by the bor-
rower. However whilst it is easy to manufacture
these ‘economic’ benefits, there is no mecha-
nism for the manufacture of votes. In short, the
lender is not able exercise their vote on lent
stock.
The only way to ensure lenders are able to
vote is to recall securities back from loan before
the relevant AGM or EGM deadline.
However, a blanket approach of recalling all
loans for the purposes of voting throws up new
difficulties, as this is overly disruptive to the
overall flow of securities lending in the market,
negatively impacting both general market liquid-
ity and client lending revenues.
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 69
Ask the Experts
Therefore, to quote Paul Myners from his
2004 report to the Shareholder Voting Working
Group, “a balance needs to be struck between
the importance of voting and the benefits
derived from stocklending.”
BNP Paribas Securities Services recognises
the challenge of striking this balance and is
therefore committed to providing all necessary
reporting in a timely manner to allow our lend-
ing clients to make informed decisions about
whether to recall securities for voting purposes.
In addition to the usual daily reporting suite
of lending activity, lent positions are flagged in
our proxy voting system so our clients have a
clear record of lent positions for forthcoming
General Meetings. This means that clients can
review and, where necessary discuss further, the
economic impact of recalling lent stocks for vot-
ing purposes set against the benefits of voting
on a particular issue.
Clients can also specify ‘buffer’ amounts of
stock that should not be lent, so that clients are
able to vote on a proportion of their holdings
without impacting lent positions.
For those wish to read a detailed review of the
subject, the recent report “Securities Lending &
Corporate Governance” by Spitalfields Advisors
Limited is highly recommended.
This report, commissioned by the
International Securities Lending Association,
has been endorsed by a number of UK market
bodies including the National Association of
Pension Funds.
Richard Thompson, Head of Product Sales -
Global Liquidity Services London, BNP Paribas
Securities Services
As Head of Product Sales, Global Liquidity Services for
BNP Paribas Securities Services, Thompson is responsible
for ‘specialist’ sales for a range of liquidity based products
including principal and agency securities lending. He has
held this role since February 2005.
Thompson joined Cogent Investment Operations in 2001
as Head of Agency Lending, London. Following Cogent’s
acquisition by BNP Paribas Securities Services in 2002, he
assumed global responsibility for agency lending and was
jointly responsible for integrating agency lending into the
global custody platform of BNP Paribas Securities Services.
Having completed his accountancy training in 1997,
Thompson moved into securities lending industry at
Northern Trust where he was part of the product develop-
ment team, specialising in electronic trading.
Thompson holds a joint BSc(Hons) in German, French
and Economics from the University of Surrey.
SLMG 2005 ML10 7/9/05 1:18 pm Page 70
Securities Lending Market Guide
Citigroup
Explain how lending algorithms
work. Are they a benefit to the lend-
ing client and do they provide an
equal opportunity to all participating
clients to lend their securities?
Victoria Bright
Citigroup
Lending algorithms are systemic tools
built within securities lending systems, incor-
porated to fairly allocate new lending opportu-
nities to all holders of a particular requested
security within a lending programme.
If a programme has multiple participants,
the intention is to allow lenders to earn a fair
amount of revenue over time. The design and
operation of these algorithms varies.
At Citigroup, the Securities Lending System
(SLS) incorporates an algorithm, which estab-
lishes lender priority based upon each lender’s
available assets.
From initial inclusion in the programme, the
entitlement and on-loan accumulation are
aggregated fields. The queue is established by
dividing the on-loan accumulation by the enti-
tlement accumulation.
The lender with the lowest percent is moved
to the top of the queue so that this lender will
be next in line to lend the security.
Usually the lenders at the top of the queue
will lend their entire positions then move to the
bottom of the queue, leaving the following
lenders with the opportunity to lend the next
time a request is received for the same security.
Another allocation system commonly used in
lending systems is by percentage. When a
borrowing request is received, each lender is
permitted to lend a percentage of the amount
70 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
required based on the total holding across all
potential lenders.
Again over time, the revenue that can be
earned is deemed to be fair but it is less likely
using this system that a lender will ever lend
his entire position in the security.
One major criticism of lending algorithms is
that lenders can earn considerably higher fees
by separately negotiating revenue on an exclu-
sive basis or by auctioning their portfolio.
Auction providers are keen to point out that
lending algorithms are a disadvantage to being
part of a lending programme.
However, the truth of the matter is that lend-
ing algorithms are used primarily for securities
which are widely available or “general collateral”.
Where a security is trading with any special
value, it is most likely, using an algorithm like
Citigroup’s, that the lending agent will lend
their entire holdings.
When an exclusive borrower is bidding on a
portfolio of securities, he will calculate the
price or return based on the “specials” and
increase the bid by a certain percentage for the
“general collateral” in the portfolio.
In these days of competitive bidding for
portfolios, the methodology for generating the
lending revenue is the same for the agent
lender as for the exclusive borrower.
Victoria Bright, Vice President, Securities Finance
Sales Specialist, Citigroup Global Transaction
Services
Bright manages the European sales initiative for
Citigroup Global Transaction Services’ Securities Finance
department.
In this capacity, she is responsible for bringing both cus-
tody and non-custody clients into the Securities Lending
programme.
She has over ten years experience in the securities lend-
ing and repurchase markets.
Prior to joining Citigroup, Bright was the Repo Product
Manager for Europe at Morgan Stanley, responsible for
the marketing efforts and product development of the
repo trading desk.
Bright holds a Master of Science degree in
International Business from St. Mary’s College of
California and a BA (Hons) in German from the
University of London.
SLMG 2005 ML10 7/9/05 1:18 pm Page 71
CalPERS
How does CalPERS ensure it is get-
ting maximum value from its lend-
ing program, while being mindful
of governance issues and market
forces such as regulation, risks and
interest rates?
Dan Kiefer
CalPERS
CalPERS remains a leader in the securities
lending marketplace by employing a balanced
approach
which seeks to maximise securities lending
returns while maintaining our corporate gover-
nance fiduciary responsibilities. CalPERS views
securities lending as an investment decision
and operates the program under a similar risk
framework.
Since CalPERS first began utilising the auction
process in 2000, our lending program has
become increasingly efficient. The auction
process allows us to efficiently access the mar-
ket and maximise returns. By segmenting large
portfolios into customised packages with exclu-
sive borrowing rights, we are able to pair our
loanable securities with the borrowers’ demand.
Thus, maximising our returns while producing
an environment where both CalPERS and our
counterparties can achieve success. CalPERS
has also been able to capitalize on the
increased demand the prime brokers face from
their hedge fund clients and their own propri-
etary trading needs. Innovation and constant
refinement has been the key to out performing
the returns we earned utilizing the auction for-
mat as route to market in securities lending.
While others may find corporate governance
and securities lending mutually exclusive activi-
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 71
Securities Lending Market Guide
ties, CalPERS strives to balance our Corporate
Governance fiduciary responsibilities with our
responsibility to maximise returns for our fund
members. Externally, CalPERS is active in the
International Corporate Governance Network
and is helping to shape policy as it develops.
Internally, CalPERS continues to demonstrate
our commitment by maintaining watch lists
which restrict securities from being lent in cer-
tain circumstances. Borrowers are monitored
by both CalPERS and CalPERS’ agents to ensure
compliance. The combination of restricted lists,
compliance monitoring, and transparency
allows CalPERS to meet its proxy voting con-
cerns while maximising its securities lending
returns. Again, innovation plays an important
role in our compliance monitoring process.
Securities lending may be an incremental
return activity, but CalPERS treats it as an
investment process. We recognise that some of
the primary investment management disciplines
such as the use of specialists, multiple man-
agers and bid competition makes sense as tools
to utilize maximising returns within the securi-
ties lending market. CalPERS is committed to
continual innovation and refinement of its lend-
ing strategy and process to further improve the
program’s risk/return profile and generate
greater returns for our members while main-
taining our corporate governance responsibili-
ties.
Dan Kiefer, CFA, Opportunistic Portfolio Manager,
California Public Employees' Retirement System
(CalPERS), Sacramento, CA
Kiefer joined CalPERS in August 1993. He oversees the
Securities Lending Program, Credit Enhancement
Program; Fixed Income Quantitative based strategies as
well as assists the director of research with the training
and oversight of CalPERS research staff. As the manager
of the Securities Lending Program, Kiefer provides direc-
tion and oversight for the program and developed an on-
line principal bidding process. While developing the on-
line bidding process, he formed a joint venture with
eSecLending, who assists major institutional investors
worldwide in designing and implementing customized
securities lending programs. As the Opportunistic Portfolio
Manager, Kiefer overseas CalPERS Credit Enhancement
Program and Fixed Income Quantitative based strategies,
as well as sits on both the internal high yield and invest-
ment grade fixed income credit committees.
SLMG 2005 ML10 7/9/05 1:18 pm Page 72
Securities Lending Market Guide
ABP Investments
How do you, as a pension fund,
manage to balance the risk/reward
equation in a securities lending pro-
gramme?
Mark Linklater
ABP Investments
ABP Investments, under the new innovative
skill-based investment philosophy implemented
by Jan Straatman CIO Capital Market, views secu-
rities lending as an alpha generating investment
strategy. To manage the balance the securities
lending program has become part of our capital
markets platform.
The program adheres to
the same rigorous risk management controls as
any of our equity or fixed income strategies.
Asset allocation, compliance guidelines, trading
and administration are all closely monitored on a
daily basis.
Performance is tracked and benchmarked and
adjusted for the level of risk being taken by the
provider or trading strategy.
This information also aids our asset allocation
decisions. We take an active approach to securi-
ties lending and aim to match the best providers
and counterparties with the best assets.
All of our loans are over-collateralised and our
securities lending loan profile is diversified
across many borrowers.
We also look at the asset issues of a securities
lending trade. All of our collateral managers are
tracked for performance and portfolio character-
istics.
The managers are contractually obligated to
adhere to a standardised set of investment guide-
lines and we monitor this on a daily basis. Cash
72 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
collateral reinvestment is a significant source of
return for our program.
We look for collateral managers that can out-
perform our benchmarks within our guidelines
while providing a diversification effect to our
overall collateral pool. The result is a multi strate-
gy based collateral program.
The securities lending desk does not operate in
a vacuum, we report to the same risk control and
investment strategy committees that all of our
investment strategies report to on a weekly,
monthly and quarterly basis.
Securities lending provides ABP a healthy
return given the low level of risk generated by this
program.
ABP’s value-at-risk is monitored program-wide
on a monthly basis. The VaR is relatively small
when compared to the alpha that it delivers.
We are looking further at methodology to fur-
ther stress test the assumptions inherent in our
VAR calculation.
How do you manage to aggregate the risks in a
multi-provider structure?
ABP has a multi-provider structure for both secu-
rities lending and cash collateral reinvestment.
The key to monitoring all of this data is to
require delivery of timely, consistent and accurate
standardised reporting.
All of our providers deliver the same data
points which we then aggregate to build compli-
ance and performance reports.
We calculate most of the ratios and perform-
ance characteristics ourselves to eliminate differ-
ences in calculation methodologies and the
inherent bias of reporting on one’s own program.
Our reporting infrastructure is web-based. The
website is updated daily. More importantly, the
tool has allowed us to consolidate the entire pro-
gram. It has become an integral part of our daily
decision-making and controls process.
Mark Linklater, Head of Global Securities Lending,
ABP Investments, Capital Markets
Linklater has sixteen years worth of investment experi-
ence in M&A and Asset management, both on the sell
side and the buy side. Linklater has been with ABP for
just over three and a half years. He was asked to take
over the securities lending business at the end of 2003,
with the mandate to revitalise and enhance performance.
SLMG 2005 ML10 7/9/05 1:18 pm Page 73
SIS SegaInterSettle
How does one balance minimised
fails with additional income in secu-
rities lending?
Rene Eberhard
SIS SegaInterSettle
Our company has offered clients Securities
Lending & Borrowing services (SLB) aimed at
minimising fails, on the one hand, and generat-
ing additional income for clients, on the other.
Under this service the lender makes securities
available to the borrower for an unlimited period.
When the loan ends , the borrower returns the
securities and pays the
lender a fee. The borrower is required to forward
any income gained from the securities (interest,
dividends etc) to the lender. Settlement driven
SLB can be used to tide over delivery shortages.
SIS assumes full administration of the settlement
in real time and online, acting as Principal.
Hence, SIS is at all times the lenders' and bor-
rowers' counterparty. As the lender and borrower
are never directly connected, SIS effectively func-
tions as the Central Counterparty.
Most wanted securities: In principle, all domes-
tic and foreign securities are eligible for lending.
However, the demand for national and interna-
tional equities is particularly high.
Outsourcing: Our standing as a global custodi-
an ensures that the SLB service we offer is effec-
tive, secure and beneficial to our clients. What is
more, a future SLB participant does not require
any additional installations or resources as all
necessary operational tools are already in place.
High settlement rate: Under the SLB service
the borrower can benefit – within the bounds of
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 73
Securities Lending Market Guide
what is realistically possible – from the maximum
settlement rate, whereby the loans granted are
geared to its requirements.
Additional income: Lenders are able to opti-
mise their securities income via lending transac-
tions without undermining investment flexibility.
Automatic collateral management: SIS operates
a fully automated mark-to-market collateral man-
agement wherein all open loans are daily valuat-
ed and compared with the respective collaterals.
If the amount of collateral falls below the defined
margins, a margin call is automatically triggered
to settle the difference.
The SecLend service has been developed
together with Eurex SecLend. It implies a new
securities lending market with electronic trading
and fully integrated settlement and the adminis-
tration of loans. Unlike phone trading, SecLend
trades are conducted via a central, fully electronic
trading platform. The trader can thereby easily
gain an overview of the market's liquidity and
price structure. Concluded lending transactions
are automatically sent to SIS, where they are con-
verted into settlement instructions. The provision
of collateral is mandatory for lending transac-
tions. This is effected via a release list and auto-
matic GCselect, subject to standardised collateral
baskets.
The lending transaction is initiated by a simul-
taneous exchange (delivery versus delivery) of
collateral for the loaned security. SIS subsequent-
ly manages the mutual claims and obligations
and ensures that value adjustments (mark-to-
market) are performed on the exchanged posi-
tions through margin calls and returns.
Furthermore, SIS calculates the lending
fee/interest and charges it to the counterparty at
the end of the month. In short, SIS' SecLend
service fully covers all needs that can arise in the
context of lending transactions.
René Eberhard, Head of Repo & SecLend Products,
SIS SegaInterSettle AG
After graduating with a law degree from the University of
Bern, Eberhard initially worked in the risk management
and inheritance department of Bank Leu AG, a Swiss pri-
vate bank. In 1994, he joined INTERSETTLE AG as a
risk manager. In 1997, he was put in charge of the SLB
Desk, where he developed the fail driven SLB service.
Following the company's merger with SEGA to form SIS
SegaInterSettle AG, he also took over the Repo Desk in
2001. Since 2005, Eberhard has acted as Head of Repo &
SecLend Products at SIS SegaInterSettle.
SLMG 2005 ML10 7/9/05 1:18 pm Page 74
Securities Lending Market Guide
4Sight Software
What functional features are need-
ed to assist the buy side communi-
ty with running an efficient and
profitable business?
Jason Hayes
4Sight
Beneficial Owners are continuously looking
for ways to improve efficiency and profitability
through automation.
One area where technology is becoming
increasingly important is managing the intrica-
cies of pooling, or in other words lending, the
same security from multiple
funds in one loan.
Functionality such as ‘pooling’ gives
Beneficial Owners the option to lend securities
in bulk to the market while keeping track of the
individual allocations from each underlying fund
for allocation of fees and utilisation reporting.
In addition, it takes care of the sophisticated
daily substitution process required to ensure
that any loans already made are not affected by
the rebalancing of the underlying funds.
Pooling allows the beneficial owner to maximise
their assets creating additional revenue for the
company while minimising the manual process
of reconciling and validating the fund positions
against outstanding loans.
As part of these advances, a flexible collateral
model is also becoming a necessity to deal with
the ever increasing pressure to accept non cash
collateral.
This in turn, leads to the requirement for
functionality that allows each fund or company
to set rules for accepting non cash collateral
including the ability to mitigate their risk by
74 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
requesting collateral of different types by value
or percentage and setting thresholds for each.
Our custodian previously managed the report-
ing requirements for us. How can we benefit
from an internal reporting system?
In today’s regulatory environment, fund man-
agers are asking their lending desks for greater
overall transparency to their business.
Consequently, an increased ability to manipulate
and scrutinise externally provided and internally
held data in an efficient and flexible manner is
necessary in order to satisfy this.
The ability to report on trading volumes, fund
utilization and identify exceptions are some of
the additional functions that a flexible reporting
solution should provide and add value to the
standard report suite already provided by a third
party agent or custodian.
Ease of access is paramount with any applica-
tion and in particular there is strong demand
for a reporting tool which is available from a
web browser.
A tool such as this offers organisations easy
access to the application as well as data, and
the flexibility they need to create and customise
reports either for internal compliance purposes
or to meet the exact needs of external counter-
parties.
In addition, the capability to schedule the pro-
duction of reports automatically within the sys-
tem can greatly reduce trader, back-office and
compliance time.
Efficiency can be improved further by offering
external counterparties access to the same web
reporting tool in the form of a value added serv-
ice where they create, view and manage their
own reports.
In a world where Time equals Money, the cost
savings are great.
Jason Hayes, North American Sales Director,
4Sight Financial Software Ltd
Jason Hayes has worked in the Financial Services indus-
try for over ten years. Specialising in Derivative trading
software and Securities Finance for various financial tech-
nology firms in Stockholm Sweden, Frankfurt Germany
and Toronto Canada. He is currently based in Toronto
Canada as North American Sales Director for 4sight
Financial Software.
SLMG 2005 ML10 7/9/05 1:18 pm Page 75

Company Profiles
Company Profiles

Susan C. Peters, Esq., Chief Executive Officer

eSecLending

Ms. Peters' primary responsibilities within

Susan Peters
Company Brief:
eSecLending is a global securities lending
manager specializing in securities lending on a
third party basis. Our company was established
for the sole purpose of designing, implementing
and administering customized securities
lending programs for the largest and most
sophisticated asset gatherers in the world.
Today, eSecLending is an industry leader in the
management and administration of
auction-based exclusive borrowing
arrangements.
eSecLending's model is based on the premise
that exclusive principal relationships generally
offer greater value and significantly higher
returns to a lender than traditional lending
programs.
Our firm, which has auctioned more than
$500 billion since inception, awards principal
business through an auction process to ensure
greater competition and price transparency for
the Lender’s assets.
eSecLending are global business strategy and
execution. Previously, Susan was COO in
charge of operations and lending strategies and
was instrumental in building eSecLending’s
administrative capabilities. Prior to
eSecLending, she served as Director of Credit
Suisse First Boston's agency lending program in
New York and as Head of Trading for State
Street Global Securities Lending.
Key Services:
Our program offers the following distinguishing
features:
- Disciplined and highly effective
auction process to optimise results
- Individually customized programs
which deliver superior client service
and performance as compared to
traditional programs
- Primary focus on exclusive principal
relationships
- Significant experience managing
auctions and multiple principal
relationship transitions and
administration
- Independence – no existing borrower
relationships or agency business

Key Locations: Key Contacts:

eSecLending, LLC
175 Federal Street, 11th Floor Susan C. Peters, Esq.
Boston, MA 02110 Chief Executive Officer
USA +1.617.204.4530
+1.617.204.4500 speters@eseclending.com
eSecLending (Europe) Ltd. Dan Ahern
Old Mutual Place Executive Vice President & Managing Director,
2 Lambeth Hill Global Business Development
London EC4V 4GG +1 617-204-4501
United Kingdom dahern@eseclending.com
+44 (0)20 7002 6700
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 75
SLMG 2005 ML10 7/9/05 1:19 pm Page 76

Securities Lending Market Guide

Felix Oegerli, CEO, IFBS

Felix Oegerli was born in Solothurn,

Switzerland. He obtained a post graduate
degree as a Swiss Federal Banking expert
He began his financial services career with UBS,
assuming a variety of roles in Zurich, New York
and London, including: Global head of prime
brokerage and Deputy global head of securities
lending and repo. Oegerli is Founder and CEO
Felix Oegerli
of IFBS, a consulting and solutions firm for the
financial industry

Key Services & Products:

Company Brief:
IFBS offers the financial industry a wide range
of consulting services, individual software devel-
opment and standard software solutions. IFBS
has offices in Zurich and New York.
Consulting for financial institutions focused on
the “securities value chain” including securities
lending, repo and collateral management
Individual software development based on the
IFBS Java framework
On the product side IFBS offers FINACE®, a
modular and fully integrated solution in the area
of securities lending, repo and collateral man-
agement and FUNDACE®, the Funds of Hedge
Funds reporting and risk management solution.

Key Locations: Key Contacts:

T: +41 (0)44 218 14 14 Felix Oegerli, CEO, IFBS
F: +41 (0)44 218 14 18 T: +41 (0)44 218 14 14
E: info@ifbs.com F: +41 44 218 14 18
Address: IFBS AG, Buckhauserstrasse 11, www.ifbs.com / info@ifbs.com
CH-8048 Zurich, Switzerland
W: www.ifbs.com
Tom Ricciardi, Managing Director Americas
IFBS AG T: +1 212 332 7144
45 Rockefeller Plaza F: +1 212 332 7145
20th floor
New York, NY 10111
USA

76 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005

SLMG 2005 ML10 7/9/05 1:19 pm Page 77
Avi Stein
Company Brief: JPMorgan's breadth of
capability, financial strength, professional
expertise and seamless operation make it a
strong lending agent to its clients. Its lending
program enables investors to access a broad
spectrum of lending markets, with a diverse
borrower base whilst achieving very
competitive bids for their securities - all of this
in an environment designed not to
compromise the activities of their fund
managers. As one of the founding members of
EquiLend, a global automated platform for
borrowers and lenders, JPMorgan is at the
forefront of technology. JPMorgan is ideally
placed given its integrated lending, custody
and accounting platforms. JPMorgan also
affords clients a broad indemnification against
borrower default.
Key Locations:
New York
212-623-2938
London
(44-20)7-742-0249
Sydney
(61-2)9250 4606
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 77
Securities Lending Market Guide
Avram (Avi) Stein, Senior Vice President and
Business Executive, JPMorgan Securities
Lending and Market Products.
JPMorgan Securities Lending and Market
Product are components of the Worldwide
Securities Services business. Since joining The
Chase Manhattan Bank in 1974, Stein has held
several positions including manager of strategic
planning for the North America sector and vice
president in the bank's loan pricing division,
where he was responsible for product develop-
ment and pricing of wholesale lending prod-
ucts. He was later instrumental in developing
the industry's first use of interest rate caps and
floors for corporate customers. Before assum-
ing his current role, Stein was Managing
Director and Treasurer of Chase Securities, Inc.
(CSI), and also managed CSI's finance division,
which operated the repo and matched book
business. Stein holds an M.B.A. from Harvard
Business School and a Bachelor's degree in
Computer Science from City College of New
York, School of Engineering.
Key Services:
-Discretionary (Agency)Securities
Lending Services
-Directed Securities Lending Services
-Third Party (non custody) Securities
Lending
-Principal Securities Lending Program
(via JPMorgan Securities Ltd)
-Tri-Party collateral management and
Escrow services
-Cash collateral reinvestment services
Key Contacts:
Western Hemisphere
Gene Picone 212-623-2938
eugene.picone@jpmorgan.com
Europe, Middle East, Africa
Paul Wilson
(44-20)7-742-0249
paul.uk.wilson@jpmorgan.com
Asia Pacific
David Brown
(61-2)9250 4606
david.ldn.brown@jpmorgan.com
SLMG 2005 ML10 7/9/05 1:19 pm Page 78
Securities Lending Market Guide
Mark Fieldhouse
Company Brief:
RBC Global Services is a leading international
lender with global securities available for loan in
27 major world markets. RBC Global Services is
a leading international lender with global
securities available for loan in 27 major world
markets. RBC Global Services has recently
been ranked best in class for the
competitiveness of our securities lending
returns and for our operational efficiency. RBC
Global Services is the corporate and
institutional custody arm of RBC Financial
Group and has been serving institutional
investors for more than 100 years, including 23
years in the global custody business. RBC
Global Services is Canada's largest custodian
and ranks among the world's leading providers.
RBC Global Services' success is highlighted by
client satisfaction surveys, in which we are
consistently ranked among the best in the
world.
Key Locations:
RBC Global Services
77 King St West, 35th Fl.
Toronto, ON M5W 1P9
Canada - 1.416.955.5525
RBC Global Services
71 Queen Victoria St.
London EC4V4DE
United Kingdom
44.20.765.36365
RBC Global Services Australia
2 Park Street, Level 17
Sydney, NSW 2000, Australia
61.2.8262.5272
78 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
Mark Fieldhouse, Director, Technical Sales and
Relationship Management, RBC Global Services
Fieldhouse has ten years experience within RBC
Global Services. During this time he has worked
in variety of positions within the Securities
Lending and Finance unit including most
recently Director, Global Sales and Client
Relations. Mark currently has overall manage-
ment of North American technical sales for all
RBC GS Global Products.
Key Services:
RBC Global Services is a world leader in
providing specialized investment
administration solutions for institutional
clients. Our broad range of value-added
services and tailored solutions includes fund
administration services for funds domiciled in
Canada, Australia, Cayman Islands and
Channel Islands, custody, global securities
lending and finance, performance analytics,
transition management, risk management,
hedge fund services, global market
information, treasury and cash management
and analytics, tri-party repo, benefit payments,
Viewfinder Online Services and full
outsourcing capabilities.
Key Contacts:
Mark Fieldhouse
Director, Technical Sales & Relationship
Management, North America
1.416.955.5525 / mark.fieldhouse@rbc.com
Blair McPherson
Director, Technical Sales & Relationship
Management, Europe
44.20.765.36365 / blair.mcpherson@rbc.com
Mr. Trevor Amoils
Director, Technical Sales & Relationship
Management, Asia Pacific
61.2.8262.5272 / trevor.amoils@rbc.com
SLMG 2005 ML10 7/9/05 1:19 pm Page 79

Securities Lending Market Guide

John L. (Jay) Carty, senior vice president and

head of global sales, State Street’s Securities
Finance division.

Carty is responsible for overseeing all new divi-

sional sales activities worldwide. Before he
assumed his current role, Carty was responsible
for sales and account management in the
Americas. Carty joined State Street in 1997.

Jay Carty

Company Brief: State Street

lends securities in more than 35 markets around
the world via a global network of trading
locations — providing customers with around-
the-clock opportunities as well as regional
expertise and experience. State Street has pro-
vided securities lending services since 1974, and
has developed an industry-leading approach to
risk and return management. Its securities
lending program is available to all institutional
investors worldwide, whether their assets are
held in custody at State Street or elsewhere.
State Street Corporation is the world's leading
specialist in providing institutional investors
with investment servicing, investment
management and investment research and
trading. With $9.6 trillion in assets under cus-
tody and $1.4 trillion in assets under manage-
ment, State Street operates in 25 cou tries and
more than 100 geographic markets worldwide
and employs 20,100 people worlwide.

Key Locations: Key Contacts:

Boston Boston (North America)
617-664-2444 Jay Carty, SVP, Head of Global Sales
jlcarty@statestreet.com/617-664-2444
London
44-20-7864-7357 London (UK and Europe)
Chris Taylor, SVP, Regional Business Director
Tokyo ctaylor@statestreet.com/44-20-7864-7357
813-5404-5240

Others: Hong Kong, Los Angeles, Milan, Tokyo (Asia Pacific)

Montreal, New York, Sydney, and Toronto. Francesco Squillacioti, SVP, Regional Business
Director
fsquillacioti@statestreet.com/813-5404-5240
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 79
SLMG 2005 ML10 7/9/05 1:19 pm Page 80
Securities Lending Market Guide
Securities Lending Glossary
Accrued interest: Coupon interest that is earned on a bond from the last
coupon date to the present date.
Agent: A party to a loan transaction that acts on behalf of a client. The
agent typically does not take in risk in a transaction. See “Indemnity.”
All-in dividend: The sum of the manufactured dividend plus the fee to be
paid by the borrower to the lender, expressed as a percentage of the divi-
dend of the stock on loan.
All-in price: Market price of a bond, plus accrued interest. Generally round-
ed to the nearest 0.01. Also known as “dirty price”.
Basis point: One one-hundredth of a percent or 0.01%.
Bearer securities: Securities that are not registered to any particular party
and hence are payable to the party that is in possession of them.
Beneficial owner: A party that is entitled to the rights of ownership of prop-
erty. In the context of securities, the term is usually used to distinguish
this party from the registered holder (a nominee, for example) that holds
the securities for the beneficial owner.
Benefit: Any entitlement due to a stock or shareholder as a result of pur-
chasing or holding securities, including the right to any dividend, rights
issue, scrip issue, etc. made by the issuer. In the case of loaned securities
or collateral, benefits are passed back to the lender or borrower (as appro-
priate), usually by way of a manufactured dividend or the return of equiva-
lent securities or collateral.
BMA: The Bond Market Association – is a US-based industry organisation
of participants involved in certain sectors of the bond markets. The BMA
establishes non-binding standards of business conduct in the US fixed-
income securities markets. Formerly known as the Public Securities
Association or PSA.
Buy-in: The practice whereby a lender of securities enters the open market
to buy securities to replace those that have not been returned by a borrow-
er. Strict market practices govern buy-ins. Buy-ins may be enforced by
market authorities in some jurisdictions.
Buy/Sell, Sell/Buy: Types of bond transactions that, in economic substance,
replicate reverse repos, and repos respectively. These transactions consist
of a purchase (or sale) of a security versus cash with a forward commit-
ment to sell back (or buy back) the securities. Used as an alternative to
repos/reverses.
Carry: Difference between interest return on securities held & financing
costs:
Negative carry: Net cost incurred when financing cost exceeds yield on
securities that are being financed.
Positive carry: Net gain earned when financing cost is less than yield on
financed securities.
Cash-orientated repo: Transaction motivated by the need of one party to
invest cash and the need of the other to borrow. See also ‘Securities-orien-
tated repo’.
Cash trade: A non-financing purchase or sale of securities.
Clear: To complete a trade, i.e. when the seller delivers securities and the
buyer delivers funds in correct form. A trade fails when proper delivery
requirements are not satisfied.
Close-out (and) netting: An arrangement to settle all existing obligations to
and claims on a counterpart falling under that arrangement by one single
net payment, immediately upon the occurrence of a defined event of
default.
Collateral: Securities or cash delivered by a borrower to a lender to support
a loan of securities or cash.
Contract for Differences (CFD): An OTC derivative transaction that enables
one party to gain economic exposure to the price movement of a security
(bull or bear). Writers of CFDs hedge by taking positions in the underlying
securities, making efficient securities financing or borrowing key.
Corporate action: A corporate event in relation to which the holder of the
security must or may make an election or take some other action in order
to secure its entitlement and/or to opt for a particular form of entitlement
(see also equivalent).
80 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2005
Corporate event: An event in relation to a security as a result of which the
holder will or may become entitled to: a benefit (dividend, rights issue
etc.); or securities other than those which he held prior to that event
(takeover offer, scheme of arrangement, conversion, redemption, etc). This
type of corporate event is also known as a stock situation.
Custodian: An entity that holds securities of any type for investors, effect-
ing receipts and deliveries, and supplying appropriate reporting.
Daylight exposure: The period in the day when one party to a trade has a
temporary credit exposure to the other due to one party having settled
before the other. It would normally mean that the loan had settled but the
delivery of collateral would settle at a later time (although there would also
be exposure if settlement happened in reverse). The period extends from
the point of settlement of the first side of the trade to the time of settle-
ment of the other. It occurs because the two sides of the trade are not
linked in many settlement systems or settlement of loan and collateral
take place in different systems, possibly in different time zones.
Deliver-out repo: “Standard” two-party repo, where the party receiving
cash delivers bonds to the cash provider.
Delivery-by-value (DBV): A mechanism in some settlement systems
(including CREST) whereby a member may borrow or lend cash overnight
against collateral. The system automatically selects and delivers collateral
securities, meeting pre-determined criteria to the value of the cash (plus a
margin) from the account of the cash borrower to the account of the cash
lender and reverses the transaction the following morning.
Distributions: Entitlements arising on securities that are loaned out, e.g.
dividends, interest, and non-cash distributions.
DVP (Delivery versus payment): The simultaneous delivery of securities
against the payment of funds within a securities settlement system.
ERISA: The Employee Retirement Income Security Act, a US law governing
private US pension plan activity, introduced in 1974 and amended in 1981
to permit plans to lend securities in accordance with specific guidelines.
Equivalent (securities or collateral): Meaning that the securities or collater-
al returned must be of an identical type, nominal value, description and
amount to those originally provided. If, during the term of a loan, there is a
corporate action in relation to loaned securities, the lender is normally
entitled to specify at that time the form in which he wishes to receive
equivalent securities or collateral on termination of the loan. The legal
agreement will also specify the form in which equivalent securities or col-
lateral are to be returned in the case of other corporate events.
Fail: Failure to deliver cash or collateral in time for the settlement of a
transaction
Free-of-payment delivery: Delivery of securities with no corresponding pay-
ment of funds.
G7: The Group of Seven, i.e. US, France, Japan, United Kingdom, Germany,
Italy and Canada
G10: The Group of Ten, i.e. US, France, Japan, United Kingdom, Germany,
Italy and Canada, the Netherlands, Sweden and Switzerland
General Collateral (GC): Securities that are not “special” (see below) in the
market and may be used, typically, to collateralise cash borrowings. Also
known as “stock collateral”.
Gilt-Edged Securities (Gilts): United Kingdom government bonds.
Gilt-Edged Securities Lending Agreement (GESLA): see Master Gilt Edged
Securities Lending Agreement.
Global Master Securities Lending Agreement (GMSLA): The Global Master
Securities Lending Agreement has been developed as a market standard
for securities lending of bonds and equities internationally. It was drafted
with a view to compliance with English law.
Gross-paying securities: Securities on which interest or other distributions
are paid without any taxes being withheld.
Haircut: Initial margin on a repo transaction. Generally expressed as a per-
centage of the market price.
Hedge fund: A leveraged investment fund that engages in trading and
hedging strategies, frequently using leverage.
Hot/hard stock: A particular security that is in high demand in relation
to its availability in the market and is expensive or difficult to borrow.
SLMG 2005 ML10 7/9/05 1:19 pm Page 81
Hold in custody: An arrangement under which securities are not physically
delivered to the borrower (lender) but are simply segregated by the lender
in an internal customer account.
Icing/putting stock on hold: The practice whereby a lender holds securities
at a borrower's request in anticipation of that borrower taking delivery.
Indemnity: A form of guarantee or insurance, frequently offered by agents.
Terms vary significantly and the value of the indemnity does also.
Interdealer broker: Agent or intermediary that is paid a commission to
bring buyers and sellers together. The broker's commission may be paid
either by the initiator of the transaction or by both counterparts.
Intermediary: A party that borrows a security in order to on-deliver it to a
client, rather than borrowing it for its own in-house needs. Also known as a
conduit borrower.
International Securities Lending Association (ISLA): A trade association for
securities lending market practitioners.
ISMA: The Zurich-based International Securities Market Association is the
self-regulatory organisation and trade association for the international
securities market.
London Investment Banking Association (LIBA): The principal trade associ-
ation in the UK for firms active in the investment banking and securities
industry.
Manufactured dividends: When securities that have been lent out pay a
cash dividend, the borrower of the securities is in general contractually
required to pass the distribution back to the lender of the securities. This
payment “pass-through” is known as a manufactured dividend.
Margin, initial: Refers to the excess of cash over securities or securities
over cash in a repo/reverse repo, sell/buy-buy/sell, or securities lending
transaction. One party may require an initial margin due to the perceived
credit risk of the counterpart.
Margin, variation: Once a repo or securities lending transaction has set-
tled, the variation margin refers to the band within which the value of the
security used as collateral may fluctuate before triggering a margin call.
Variation margin may be expressed either in percentage or absolute cur-
rency terms.
Margin call: A request by one party in a transaction for the initial margin to
be reinstated or to restore the original cash/securities ratio to parity.
Mark-to-market: The act of revaluing the securities collateral in a repo or
securities lending transaction to current market values. Standard practice
is to mark to market daily.
Market value: The value of loan securities or collateral as determined using
the last (or latest available) sale price on the principal exchange where the
instrument was traded or, if not so traded, using the most recent bid or
offered prices.
Master Equity and Fixed Interest Stock Lending Agreement (MEFISLA): This
was developed as a market standard agreement under English law for
stock lending prior to the creation of the Global Master Securities Lending
Agreement.
Master Gilt Edged Stock Lending Agreement (GESLA): The Agreement was
developed as a market standard exclusively for lending UK gilt-edged
securities. It was drafted with a view to complying with English law and
has a legal opinion from Queen’s Counsel.
Matched/Mismatched book: Refers to the interest rate arbitrage book that
a repo trader may run. By matching or mismatching maturities, rates, cur-
rencies, or margins, the repo trader takes market risk in search of returns.
Net paying securities: Securities on which interest or other distributions are
paid net of withholding taxes.
Open transactions: Trades done with no fixed maturity date.
Overseas Securities Lenders’ Agreement (OSLA): Developed as a market
standard for stock lending prior to the creation of the Global Master
Securities Lending Agreement.
Pair off: The netting of cash and securities in the settlement of two trades
in the same security for the same value date. Pairing off allows for settle-
ment of net differences.
Partialling: Market practice or a specific agreement between counterparts
SECURITIES LENDING MARKET GUIDE 2005 INVESTOR SERVICES JOURNAL 81
Securities Lending Market Guide
that allows a part-delivery against an obligation to deliver securities.
Pay-for-hold: The practice of paying a fee to the lender to hold securities
for a particular borrower until the borrower is able to take delivery.
Prime brokerage: A service offered to clients – typically hedge funds – by
investment banks to support their trading, investment and hedging activi-
ties. The service consists of clearing, custody, securities lending, and
financing arrangements.
Principal: A party to a loan transaction that acts on its own be-half or sub-
stitutes its own risk for that of its client when trading.
Proprietary trading: Trading activity conducted by an investment bank for
its own account rather than for its clients.
PSA Public Securities Association: The former name of the BMA.
Rebate rate: The interest paid on the cash side of securities lending trans-
actions. A rebate rate of interest implies a fee for the loan of securities and
is therefore regarded as a discounted rate of interest.
Recall: A request by a lender for the return of securities from a borrower.
Repo: Transaction whereby one party sells securities to another party and
agrees to repurchase the securities at a future date at a fixed price.
Repo rate: The interest rate paid on the cash side of a repo/reverse trans-
action.
Repo (or reverse) to maturity: A repo or reverse repo that matures on the
maturity date of the security being traded.
Repricing: Occurs when the market value of a security in a repo or securi-
ties lending transaction changes and the parties to the transaction agree
to adjust the amount of securities or cash in a transaction to the correct
margin level.
Return: Occurs when the borrower of securities returns them to the lender.
Reverse Repo: Transaction whereby one party purchases securities from
another party and agrees to resell the securities at a future date at a fixed
price.
Roll: To renew a trade at its maturity.
Securities-orientated repo trade: Transaction motivated by the desire of one
counterpart to borrow securities and of the other to lend them. See also
Cash-orientated repo trade.
Shaping: A practice whereby delivery of a large amount of a security may
be made in several smaller blocks so as to reduce the potential conse-
quences of a fail.
Specials: Securities that for several reasons are sought after in the market
by borrowers. Holders of special securities will be able to earn incremental
income on the securities by lending them out via repo, sell/buy, or securi-
ties lending transactions.
Spot: Standard non-dollar repo settlement two business days forward. This
is a money market convention.
Substitution: The practice in which a lender of general collateral recalls
securities from a borrower and replaces them with other securities of the
same value.
TBMA/ISMA Global Master Repurchase Agreement (GMRA): The market-
standard document used for repo trading.
Term transactions: Trades with a fixed maturity date.
Third-party lending: A system whereby an institution lends directly to a
borrower and retains decision-making power, while all administration (set-
tlement, collateral, monitoring and so on) is handled by a third party, such
as a global custodian.
Tri Party: The provision of collateral management services, including mark-
ing to market, repricing and delivery, by a third party. Also known as
escrow.
Tri Party Repo: Repo used for funding/investment purposes in which the
trading counterparts deliver bonds and cash to an independent custodian
bank or central securities depository (the “Tri Party Custodian"). The Tri
Party Custodian is responsible for ensuring the maintenance of adequate
collateral value, both at the outset of a trade and over its term. It also
marks the collateral to market daily and makes margin calls on either
counterpart, is required.
SOURCE: SPITALFIELDS ADVISORS
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