Hugh Wheelan discusses with pension funds how they approach the lending question
As pension funds look increasingly to extract the optimum value from their assets within minimum risk constraints, the issue of how far down the securities lending chain it is feasible to go has become a major topic of discussion.
PGGM, the Dutch industry-wide scheme for health, mental welfare and social workers with Dfl 100BN (e45bn) is one scheme which over the years has implemented a structured stock lending programme and is currently examining the pros and cons of the direct route.
Ad van den Ouweland, senior investment manager in the equities department at PGGM, comments: “PGGM officially started securities lending in 1995 via the custodian intermediary approach with global custodian Citibank running the program.”
The scheme’s initial step was to begin lending its index funds as Van den Ouweland, explains: These are quite stable and reliable from a borrower’s perspective and allowed us to get acquainted with the lending program itself before we started with the whole package.”
The second stage for PGGM was
to begin lending actively managed
portfolios.
“We only lend a certain slice of these mandates because we have targeted certain areas where we believe it makes sense to be lending. The whole process has been very gradual. For example, in emerging markets which are all actively managed for PGGM the fact they are more risky markets mean they are the final step in any stock lending program. We are at the stage of putting together this part of the program now. We all know what happened in markets like Malaysia, so you have to be careful.”
“Prior to that,” he says, “the active lending step was to offer more regular mandates in the Netherlands, UK or Germany, for example”.
In terms of the money to be made on securities lending, Van den Ouweland says it is very much a supply and demand question.
“We have no guaranteed income stream from lending. If there are enough borrowers in the market we can get decent rates of returns and
vice versa.”
He adds that one of the major factors is loan safety and explains that the scheme has a screening system, working in conjunction with Citibank and the custodian’s risk monitoring division, which looks closely at organisation credibility and the Standard & Poors and Moody’s ratings factor of borrowers.
“This means there are only a certain number of people we work with and we also limit the amounts we will lend to one single borrower.”
Fee negotiations, he notes, are also carried out independently of the custody arrangement between Citibank and PGGM.
The issue of direct securities lending is in the ‘working stage’ at present within the scheme, he says.
“It is a labour intensive game and you have to be on top of the market all over the world 24 hours a day. ‘Operations’ is the key word here and you have to have the required systems in place to manage a stock lending program. Therefore, there has to be a balance between the direct revenue you can get from any program and what you would require for such in-depth analysis whilst taking into account the cost factor of going it alone.”
In terms of the Dutch securities lending market itself, Van den Ouweland says there is evidence that the number of players in the market is definitely increasing.
We have been noticing, that the revenues are certainly getting tighter in the Dutch market and that the market is shrinking. This is a signal that more and more participants are joining this market. A few years ago you could be in a position to put a little more force on setting the loan terms.
“The interesting issue though is when you have enough volume to be making less basis points but still with a huge volume being loaned.”
Tony Watson, chief investment officer at then British Telecom pension fund owned asset manager Hermes £44bn (e??bn), which already manages its securities lending programme in-house, clearly points out the advantages of going it alone: “It’s a question of having more control of the assets and getting the stock back and doing our own stock lending means we can impose our own level of counter-party lending standards. If you’re big enough you can do all of those things and you lend exactly what you want to.”
Watson says the fund has a range of potential counter-party criteria for securities lending such as competence and credit worthiness.
“Once these tests have been passed on an initial and ongoing basis then borrowers become potential counter-parties.”
Other pension fund managers are not convinced however that the stock lending route is one they would like to go down alone.
Geof Pearson, pension fund manager at UK retailer J Sainsbury explains the fund’s original reason for moving into securities lending as the desire to make the assets ‘sweat’ a bit.
The fund first ran the usual route through the scheme’s custodian, The Royal Bank of Scotland (RBS), where Pearson says the limit on the amount the fund could expect to generate was about 1 basis point on operations for
a year.
“Through the custody channel if you have, say, £1bn in assets you can pull in about £100,000 a year. We decided to go to a third party which was Morgan Stanley Dean Witter for the exclusive stock lending rights to our overseas equities because they offered us a guaranteed minimum risk which is far superior to one basis point.”
He explains that Morgan Stanley now goes to RBS – as and when it requires the stock – and he believes that one of the more compelling reasons for using the third party route is the risk buffer: “There is always the possibility of penalties to the fund for late delivery of stock when carrying out securities lending, but the main issue is, of course, collateral risk. If you know the risks in advance then this is not such a problem.”
In terms of the scheme doing the stock lending itself, Pearson believes the ends do not justify the means.
“To me, stock lending is an area where a third party does add value. You have to have the expertise, the contacts and the volume to run a stock lending program and you could make a big mistake if you don’t know what you are doing. For a small amount of income a scheme could easily get into some trouble. I’d much rather sub-contract it to one of the big banks so that if anything goes wrong you’ve got them behind you. They take their cut of the business, yes, but this is the area of investment I’d most rather not do.”

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