On the flip side for lenders of securities, while risks have increased, so have return opportunities. During recent months, widening credit spreads have created the opportunity to increase securities lending revenue. Lenders with appropriate reinvestment strategies – who can navigate through the current market conditions and appropriately measure and manage their potential risks – may be able to increase their lending revenue.

It is critical that lenders ensure the lending program in which they participate is well administered and transparent with the appropriate risk management framework and processes. At a minimum, they should assess the following areas to enhance prudent management and governance of their lending programs:

1. Review lending contracts and collateral guidelines to ensure a thorough understanding of contractual rights in the event of insolvency or collateral issues;

2. Review the approved counterparty and borrower lists including where the counterparty is located, the jurisdiction in which collateral is held, and if possible, whether the counterparty is the ultimate borrower;

3. Review your loan exposures and concentrated credit risks within the approved counterparties and borrowers;

4. Ensure a good understanding of the processes followed by the lending agent in the case of a credit event and determine the potential gaps between valuing the loan and perfecting collateral;

5. Review the general parameters of loan exposures, including average loan duration, any term loans at a fixed rate versus a floating rate and the term length, and the frequency of re-rating term loans. Evaluate whether lending is being undertaken at current risk premiums and whether term loans potentially expose you to interest rate mismatch risks or increased credit risks;

6. Review the security composition of the outstanding loans and the percentage versus the overall portfolio on loan. Any illiquid or hard to replace securities should be reviewed to determine if you wish to recall the loan;

7. Review collateral pools or reinvestment funds to identify potentially illiquid securities and evaluate the impact on your overall position; and

8. Determine if the lending agent is unwinding undesirable positions and how proper collateralisation levels are maintained.

Lenders may also wish to establish a red flag system, whereby the lending agent will inform the lender of particular events such as when an approved counterparty goes into technical default.

The market anomalies may endure for months, therefore, it is critical that lenders regularly monitor their activities and ensure that collateral levels remain sufficient.

Whilst the opportunity exists to benefit from current market conditions, lenders must always acquaint themselves with the issues involved and be cognisant of the risks and ensure they are being appropriately managed.