Stuart Hill, Local Government Super
Stuart Hill, Local Government Super

Australian superannuation funds are keen to dip their toe in the securities lending water after abandoning the controversial practice ever since the global financial meltdown.

Securities lending peaked at the beginning of the global financial crisis and then dropped off dramatically as funds worried about reputational risk.

They felt uncomfortable lending assets to a borrower who could be covering a short position in that security, as the fund could be seen to be betting against itself.

While lining this out Stuart Hill, head of investment operations at Local Government Super added that that was what people used as a default mechanism not to advance their program.

At an Investment Magazine Investment Operations conference, a poll revealed that about 45 per cent of delegates had securities lending programs in place.  About 38 per cent showed a marked disinterest in the practice.

According to Hill, short lending and securities lending was unfairly blamed for worsening the GFC, adding that it was time for funds to re-look at such programs.

“Funds have failed to realise that the federal and state governments are the big lenders into this market which should quash reputation concerns,” he said.

Plus, he added, short covering should not affect a fund since they are generally long term holders of stock.

Simon Martin, head of multi-sector sales and business development at HSBC Securities Services, focussed on counterparty and illiquidity risk and asked whether stock lending was worth it.

He also asked how can a fund could justify securities lending when it’s a non-core activity.

In response, Hill said it’s important to the look at where the risks in securities lending sit. In his view the risk is typically not about default as funds will generally hold cash, and/or other collateral for a value which is at least as high as the securities they have lent out.

“The real risk is how cash and collateral is held and the return on those and the ability to be able to access them in the event of a default.”

“However, putting those concerns in context will pave the way for trustees to move away from reputation concerns which should, in turn, lead to funds generating a valuable return from their assets on top of investment outcomes.”

Mark Snowdon, Asia-Pacific regional head of capital markets, Northern Trust took the argument further saying fund trustees had a responsibility to assess lending programs.

“If you can structure something that meet your funds risk–return objectives, you almost have a duty to consider why you should or shouldn’t lend, “he said.

“There is significant money being left on the table which otherwise could be brought into the fund and used to as investment return alpha.”

As Snowden sees it, securities lending provides liquidity to capital markets – especially if a party is failing in a settlement obligation and it is cheaper to borrow, rather than buy, a particular stock.

“Funds typically have a market neutral or long/short mangers that are already borrowing securities to fund a short position. Thus, I’m not sure I would put securities lending in an ethical bucket as it clearly complies with the fund’s investment strategy.”

Elizabeth Fry has been a financial journalist for more than 25 years and has written for a number of publications, including CFO, The Financial Times and The Australian Financial Review.
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