Decision Time With Securities Lending Programs
By: Mark Fieldhouse
The past several years have certainly been happy days for Canadian plan sponsors with securities lending programs. Mergers and acquisitions, initial public offerings, and a favourable interest rate environment have meant plenty of activity and excellent returns.
Bolstered by a solid track record of enhancing revenues, securities lending has gone mainstream across Canada with pension plans being among the foremost early adopters. The lending of securities is now widely accepted by plan sponsors to offset costs or increase returns to the fund.
The winds of change, however, are blowing across the Canadian institutional investment landscape. The securities lending industry itself is evolving, with its very success leading to increased commoditization of the market. There’s a huge amount of supply of securities for loan, while demand remains steady. Add rising interest rates to the mix, and plan sponsors are faced with some important decisions about their securities lending programs. It’s time to examine the finer elements of the lending arrangements, and make some adjustments to position their programs favourably for the future.
Supply Outpacing Demand
With supply outpacing demand, one of the key challenges facing plan sponsors will be how to work with their agent to make their assets more attractive to borrowers. For some plan sponsors, the time has come to revisit their collateral requirements.
Many Canadian pension plans have cash collateral programs for their securities lending activities. Some funds, however, are not completely comfortable with the reinvestment risks involved with using cash collateral. The risk is amplified, particularly in a rising interest rate environment, which we’re seeing today. For example, when cash is taken as collateral and invested in a variety of instruments, any subsequent interest rate increases will decrease the underlying value of the investment.
Pension plans that are willing to accept a diversified collateral policy will be positioned more favourably than their peers who opt for cash collateral alone. By the same token, plans that limit themselves to federal government debt as collateral might also find that their opportunities are limited in the months and years ahead.
In terms of their approach to collateral for securities lending programs, plans might consider being as flexible as the current regulatory environment will allow. Within the requirements of the Office of the Superintendent of Financial Institutions (OSFI), there are a number of opportunities available, such as using corporate paper or high quality equities as collateral.
At the end of the day, it’s a good idea to speak with your agent and discuss where your plan needs to be with respect to securities lending and risk management.
It’s also important to establish a comfort level that your agent has undertaken the necessary investments with respect to systems and infrastructure, in order to best manage the risks associated with alternative forms of collateral. Leading providers will utilize the latest risk management systems such as dynamic, intraday Value at Risk (VaR) calculations. Such systems serve to provide plan sponsors with peace of mind that their concerns about risk are being addressed.
For plans who don’t adapt to the changing environment, the result may be diminishing securities lending revenues, simply because their assets will be less desirable to borrowers.
It is vitally important that plan sponsors meet regularly with their agent and assure themselves that the provider has the appropriate infrastructure in place to help manage the pension plan’s ongoing needs in the evolving Canadian securities lending landscape.
Mark Fieldhouse is director, technical sales, global products, at RBC Dexia Investor Services.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -