Gsl 005

GSL

GlobalÊ Securities Lending

MarketsÊ

Canada, Japan IndustryÊ InsIghtÊ

Traders, ISLA, Pirum ProfIle

J.P.Morgan gslÊ IssueÊ 05Ê Ê Q3Ê 2009Ê Ê Ê Ê Ê Ê

LendingÊÊ TechnologyÊ LandscapeÊ Survey

gBPÊ50Ê usdÊ85ÊÊ Ê

eurÊ60

LendTechÊ 2009Ê

AreÊ yourÊ Ê systemsÊ upÊ Ê toÊ theÊ task?

Plus: CentralÊ Ê Ê Ê Ê counterpartyÊ -Ê Ê launchÊ PrimeÊ brokerageÊ -Ê theÊ borrowsÊ ofÊ tomorrow gslÊ onÊ theÊ road:Ê conferenceÊ round-up

Clever Clogs?

Know your stuff in the Netherlands. GetÊ theÊ up-to-dateÊ facts,Ê trendsÊ andÊ opinionsÊ onÊ theÊ DutchÊ securitiesÊ lendingÊ industry.Ê FreeÊ placesÊ availableÊ forÊ selectedÊ industryÊ practitioners and beneficial owners, Ê registerÊ atÊ gsl.tv/netherlands

The Dutch Securities Lending Summit “Lending for Liquidity” • Risk • Regulation • Reward

NHÊ GrandÊ HotelÊ Krasnapolsky,Ê Amsterdam

ThursdayÊ 8thÊ OctoberÊ Ô 09

PresentedÊ by

GSL |

Global Securities Lending

gsl.tv/netherlands

Confirmed sponsors

Limited sponsorship opportunities available, contact [email protected]

Dutch summit magazine print ad - 16-06-09.indd 40

20/07/2009 10:40

GSLÊ quickÊ quarterLyÊ view

JapaneseÊ marketÊ analysis

GSLÊNe ws

tonyÊ Ê Baldwin, DaiwaÊ Ê SecuritiesÊ Ê Auctions Ê 26 SMBcÊ europe

BrownÊBr othersÊ Harriman,ÊL uxembourgÊ Seminar

kellyÊ Mathieson,Ê J.P.Ê Morgan

canadianÊ market

MarkÊ Fieldhouse,Ê Ê rBcÊ Dexia

Lend an ear A sharp industry player – who remains modestly anonymous - has compared securities lending to an hourglass. At the top, the great (potential) amount of lendable stock on the books of innumerable beneficial owners. In the middle, the prime brokers: fewer in number though still plentiful. At the bottom, the great (again, potential) amount of hedge funds and other end borrowers seeking temporary use of shares. It is an effective image, and the two wide portions of lenders and borrowers keeps in mind a key debate: is it a demand, or supply, driven business? GSL has travelled miles across time zones hearing different views on this question. Some say today’s central issue – as it was 10 years’ ago and will be in 10 years’ time – is supply. Certainly the ongoing quest for lenders to educate beneficial owners

(and some regulators) aims to maintain the securities lending activity of pensions and other funds. GSL’s second Summit in May ensured the views of beneficial owners were fully articulated, and this included a fascinating collusion of opinions over another key question: is this a frontoffice industry? On top of the agent lender and third party models, the magazine has found that institutions that lend shares as principal are also are looking to clarify their understanding of the risks and update their list of viable counterparties. Knowledge is power, or at least a sense of empowerment and confidence. It is this that will keep lending programs on the table, say market commentators at this summer’s conferences. Hedge funds by now may have stemmed the majority of their outflows. Though deleveraging is expected to continue until at least the

next publication of this magazine, their operations will have changed – including their relationship with prime brokers. The issue of segregated assets for these funds’ clients has been a ubiquitous subject of discussion, and the two models for this – working with a custodian or by using an SPV – are established hypothetically at least. At the same time, the central counterparty concept is beyond the hypothetical. SecFinex has launched its central counterparty model with LCH. Clearnet as the clearing house, and rival models are close behind. As you will read in the double-page spread on the subject, the hard work has just begun for these organisations. Yet market practitioners will know that in the historical context of the securities lending, there has been a breakthrough. On the subject of change, GSL would like to pay tribute to David Rule, former CEO of ISLA. He has been an invaluable point of contact for the industry - and this magazine - during the unprecedented market conditions. Z

2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê Ê 1Ê

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CONTENTS

Ê Contents Ê News

andÊ itsÊ relationÊ toÊ securitiesÊ lending.

4Ê| Ê NewsÊ TopÊ industryÊ stories. 6Ê| Ê NewsÊa nalysis MarketÊd evelopmentsÊ inÊAust raliaÊa ndÊ theÊ Netherlands

Editorial:Ê BenÊRo berts [email protected] CraigÊM cGlashan [email protected] KimberleyÊF ergusonÊ [email protected]

8Ê |Ê AcrossÊt heÊ Atlantic QuarterlyÊup datesÊ fromÊ tradeÊa ssociations.

AnthonyÊH arrington, CherryÊRe ynardÊ

People

AccountÊm anagers:Ê PatriciaÊDe ÊLa ÊG rangeÊ [email protected]

10Ê |Ê Executive profile GSLÊt alksÊt oÊK ellyÊ Mathieson,Êo fÊJ PÊ Morgan. Technology

JamesÊOl wenyÊ [email protected] FrontÊCov er:Ê MorganÊM iller

12Ê |Ê GSL'sÊL endTechÊ Survey Results,Êc ommentsÊ andÊ analysisÊo fÊG SL'sÊ surveyÊ ofÊ theÊt radingÊa ndÊ operatingÊ technologyÊuse dÊ byÊ yourÊ peers.

DevelopmentÊMa nager:Ê PeterÊAi nsworth [email protected] OperationsÊMa nager:Ê NicoletteÊWhi ttakerÊ [email protected] ManagingÊDir ector: JonÊH ewson [email protected]

16Ê |Ê CCPsÊ TheÊ launchÊ ofÊSe cFinexÊa ndÊ LCH. Clearnet'sÊo fferingÊ isÊ aÊ watershedÊi nÊt heÊ longÊ debateÊa roundÊ aÊ centralÊ counterpartyÊ

CEO:ÊÊ MarkÊLa tham [email protected]Ê

GSL|

GlobalÊ Securities Lending

18Ê| Ê JapanÊ-ÊL andÊ ofÊ theÊ risingÊs ums AnthonyÊH arringtonÊ analysesÊt heÊse curitiesÊ lendingÊma rketÊ inÊ theÊ secondÊb iggestÊ economy.Ê

2iÊU K 16-17ÊLi ttleÊPo rtlandÊSt reet,Ê LondonÊW1WÊ8BP ,ÊU K T:Ê+ 44Ê( 0)Ê20Ê7299Ê7700ÊÊ F:Ê+ 44Ê( 0)Ê20Ê7636Ê6044 2iÊU SA 410ÊPa rkÊA venue,Ê15t hÊF loorÊ NewÊY ork,ÊN YÊ10022 T:Ê+ 1Ê212Ê231Ê8421 F:Ê+ 1Ê212Ê231Ê8121 ©Ê2009Ê2i ÊM ediaÊ AllÊri ghtsÊr eserved.Ê NoÊp artÊo fÊt hisÊp ublicationÊma yÊb e reproduced,Êi nÊwho leÊo rÊi nÊp art,Ê withoutÊp riorÊwri ttenÊp ermissionÊf romÊ theÊp ublishers.Ê ISSNÊ1759- 0728ÊÊPri ntedÊi nÊt heÊU K

Ê

31Ê |Ê Borrower profile NosterÊ Capital Ê 32Ê |Ê FromÊ theÊ TradingÊ Floor RichardÊ SmitherÊ ofÊ DaiwaÊ SecuritiesÊ SMBCÊ providesÊ thisÊ issue'sÊ insightÊ intoÊ creditÊ riskÊ andÊ otherÊ areas. Conferences

33Ê |Ê GSLÊ LendingÊ ForÊ LiquidityÊ Summit AÊ roundÊ upÊ ofÊ theÊ keyÊ pointsÊ raisedÊ atÊ theÊ MayÊ eventÊ inÊ CanaryÊ Wharf,Ê London. 36Ê |Ê NorthÊ AmericanÊ SecuritiesÊ LendingÊ Forum AÊ roundÊ upÊ ofÊ theÊ JuneÊ event,Ê hostedÊ byÊ DataÊ Explorers. 37Ê |Ê ISLA/RMAÊ BarcelonaÊ conference PicturesÊ andÊ aÊ summaryÊ ofÊ theÊ conference. 39Ê |Ê BBHÊ LuxembourgÊ Seminar AÊ roundÊ upÊ ofÊ theÊ one-dayÊ seminarÊ hostedÊ byÊ BrownÊ BrotherÊ Harriman.Ê 43Ê |Ê GSLÊ SummerÊ Event AÊ splendidÊ timeÊ wasÊ hadÊ byÊ allÊ onÊ theÊ HMSÊ Belfast.

46Ê |Ê CanadaÊ -Ê newÊ developments AÊ newÊ industryÊ bodyÊ hasÊ hadÊ earlyÊ success,Ê bolstering this significant market. 48Ê |Ê DirectoryÊ Ê AÊ listingÊ ofÊ providers. Companies featured in GSL Barclays Global Investors BBH

BlackRock

4

Bear Stearns CIBC Mellon Citi

4

40

21, 22 36, 44

26, 37, 44

Daiwa Securities SMBC 20,32 Deutsche Bank

5, 21, 22, 34

Eurex Clearing

17, 37

eSecLending Euro CCP

Fortis Nederlands ISLA

JP Morgan

14 4

4, 6 4

10, 33

Lehman Brothers 21, 27, 34, 40 LCH.Clearnet

Morgan Stanley NDC

Northern Trust Noster Capital Omgeo Pirum

RBC Dexia

Rule Financial SecFinex

4, 16 21 26 44

17, 21 4

24

26, 44 5

4, 16

SunGard 5, 12, 13, 15, 34, 35 SW1 Capital Wachovia

34 37

IndustryÊIn sight

21Ê |Ê TheÊbor rowsÊ ofÊ tomorrow AnÊup dateÊo nÊt heÊ marketÊ trendsÊi nÊp rimeÊ brokerage. 24Ê |Ê OperationalÊ commentÊ -ÊP irum RupertÊPe rryÊo utlinesÊ theÊ benefits of automated billing. 26Ê |Ê Panel:ÊR epo FourÊi ndustryÊe xpertsÊ assessÊt heÊr epoÊ marketÊ

“There’s a lot of back-slapping between regulators, politicians and the banks as to ‘how clever we are’... it has been the prudence and good regulation that have carried us through this, but most of it has to do with our unique circumstances and good luck" Who said this about which country? Find out, page 6

2ÊÊ |ÊG lobalÊSe curitiesÊ LendingÊ MagazineÊ| Ê2009

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ntNA090

These days, what’s more important than being able to manage risk? Besides breathing?

You have to deal with performance measurement, risk and compliance 24/7. We can help with leading-edge reporting tools and a range of collateral investment options offering different levels of risk and reward. Giving you the freedom to choose based on your risk spectrum. To find out more about a company rated one of the top two securities lenders in the world,* visit northerntrust.com/lending or call Chris Doell at +1 312 444 7177 or Sunil Daswani at +44 (0)20 7982 3850. *International Securities Finance 2008

Asset Servicing | Asset Management | Wealth Management © 2009 Northern Trust Corporation, 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the United States.

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NewS

Ê News Round-up selling - selling borrowed shares to buy back at a lower price - before returning to the lender.

Market Infrastructure SecFinex, the lending platform, launched its central counterparty model for the Euronext markets. LCH. Clearnet is the clearing house.

Securities Lending The European exchangetraded fund (ETF) industry saw a 120% rise in turnover in the last year as the boom in the passive management vehicle. In a report by iShares, ETFs have risen from 2.8% to 10.8% as a proportion of total trading activity in the 12 months up to 30th April 2009. The growth in ETFs starkly contrasts with the decline in the underlying equities and futures that make up – respectively – the ‘in specie’ and swap-based ETFs. The International Securities Lending Association (ISLA), the trade body representing lenders and borrowers of securities in the international markets, appointed Kevin McNulty as CEO from 1st August 2009. Mr McNulty was formerly a managing director at Barclays Global Investors, The Hellenic Capital Market Commission (HCMC) reinstated short selling as of the 1st of June. Greece was one of the last major markets to retain its ban on short Ê4Ê

Omgeo and Euro CCP announced a pan-European equity clearing house on 8th June 2009 for hedge fund transactions. The new service brings alternative managers into the drive to mitigate counterparty risk through a central system, whose trades currently settle over the counter. The system seeks to reduce the inefficiencies with their prime- and executing brokers. The new processing solution will be based on Omgeo Central Trade ManagerSM (Omgeo CTM), which services trades from execution through to settlement. Omgeo and EuroCCP expect to conduct pilot testing of the new model this year and aim for a 2010 launch of the service. The introduction of a CCP in this settlement chain substantially reduces counterparty risk between the prime and executing brokers and thereby also substantially reduces the exposure of the hedge fund to their executing brokers. A CCP also enables more efficient operations by

Top industry stories at deadline. For daily updates go to www.gsl.tv

netting down the number of transactions that need to be settled, according to its supporters. The securities lending industry must become simpler and more transparent if it is going to break into emerging markets, according to Mohamed Moursy of Fortis Nederlands. Speaking at the second GSL Summit held in London, entitled 'Lending For Liquidity', he also added that a central counterparty would increase market transparency and help mitigate risk, although the concept is still "a work in progress". Turn to page 33 for a summary of the event, and log on to www.gsl. tv to see the interview with Mr Moursy. The Australian Securities & Investment Commission (ASIC) lifted its ban on the covered short selling of financial shares on 26th May, although warned that it may reverse the decision if market conditions sufficiently deteriorated. BlackRock bought Barclays Global Investors in a USD13.5 billion deal. The purchase includes iShares, the exchange traded funds arm that had earlier been the subject of a proposed sale to CVC Partners, the private equity firm. The Bank of England would be given sweeping powers over City institutions under a Conservative UK government, according to the Shadow Chancellor.

In the latest statement from the main opposition to divide its policy for regulatory reform from the government, George Osbourne underlined plans for prospective powers for Threadneedle Street to supervise banks, building societies and other significant financial entities. It followed comments from David Cameron, Tory leader, in May calling for the empowerment of the Bank of England instead of a tri-partite system of the Bank, the Treasury and the Financial Services Authority. One twitch of Bank Governor Mervyn King’s eyebrow, said Cameron, would be sufficient for banks to fall in line. The City reacted angrily to The Walker Report, a government-supported proposal for greater controls and disclosure over executive pay. The report, authored by Sir David Walker, ex-chairman of Morgan Stanley International, recommends caps on executive pay, as well as disclosures of salaries that are over boardroom levels, among other measures. London bankers claimed such measures would be overly-bureaucratic and a populist move in an anti-bank sentiment. Gordon Brown praised the report and told Parliament that the regulatory system had to “take into account banks who are prepared to pay high remuneration, but

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Ê RUNNINGÊ HEADER

NewS

that’s got to be a factor in the regulation of the banks”. The Report was also supported by Lord Myners, financial services secretary to the Treasury, who in recent months has been a leading defender of hedge funds against draft EU proposals for regulatory clampdown. Failings of corporate governance had been a significant contributor to the financial crisis, claimed the two men.

Technology SunGard, the IT and software provider, bought ICE Risk from IntercontinentalExchange as risk management continues its ubiquity in the financial markets. ICE Risk is an integrated platform allowing commodity traders information concerning deal execution, market price as well as risk analysis from multiple perspectives. BSI Bank extended its use of 4sight Securities Finance (4SF) to meet the needs of the additional clients it has taken on as the result of its acquisition of Banca del Gottardo. Alberto Mandelli of BSI said: "The system migration was delivered successfully with no disruption to our business and we are very happy with the results of the project''. Data Explorers announced that Transaction Explorer Trader, the pre-trade analysis and rate discovery solution, now lets users compare

their own rates and lending levels against the market, identify opportunities and review possible risks within their positions. The enhanced portfolio tool gives securities lending desks greater flexibility for loading, monitoring and analysing client security lists. ACA Valores implemented the financial tools from 4sight Financial Software, the technology provider for custodians, brokers and intermediaries. The bank uses 4sight Securities Finance (4SF) for its agency lending business, with the system providing cross portfolio availability, collateral management, reporting and risk management.

Borrowers The UK Financial Services Secretary to the Treasury demanded that the European Commission’s controversial draft proposals for alternative funds undergo “major surgery” before they ever come into reality. The draft legislation, which requires approval from the European Parliament and EU countries, was released in April and sought to sketch out the future of regulation for alternative funds operating in Europe. The rules could be imposed as early as 2011 Hedge funds enjoyed their third consecutive month of success in May as fears for the beleaguered sector on the

back of heavy redemption's and regulatory scrutiny gradually ease. All hedge fund strategies except dedicated short bias were up throughout May, with an overall return for the Credit Suisse /Tremont Broad Hedge reaching 4.06%. The average performance for the 7,000 hedge funds, tracked by Lipper, was a positive 5.77%—171 bps above the Index. Monthly performance dispersion among Credit Suisse/Tremont hedge fund strategy indices tightened in May to 751 basis points (bps) after peaking in April at 1,474 bps. May’s reading compared to a monthly average since 1994 of 889 bps. A record 143.81-percentage-point monthly performance difference in May divided the top and bottom performers of the 7,000 actively reporting hedge funds tracked by Lipper. Emerging Markets strategies topped the charts, with an overall return of 6.96%. The lack of unified action by national capital markets watchdogs has led to "regulatory turmoil" that may put the UK´s Financial Services Authority at an international disadvantage, according to David Little of Rule Financial, the consultant. Speaking on a panel reviewing regulatory changes at the ISLA/RMA 2009 18th Annual Conference on Securities Lending in Barcelona, the firm´s head

of securities lending focus believed that the FSA risks being left out in the cold if fellow regulators do not follow its lead in areas such as liquidity guidelines for their banks. The head of European securities lending at Deutsche Bank said that prime brokers will not be bypassed if a central counterparty is introduced. Ben Sofoluwe explained that “if a central exchange was introduced to the stock lending market, hedge funds would still seek the multiple services that a prime broker offer rather than going to the exchange directly”. The point was raised at the second Global Securities Lending Summit in London. He added that the pricing of hedge fund assets was also undergoing a change, with pricing based on liquidity and risk. Turn to page 33 for a roundup of the event.

Repo VTB Capital, the investment banking arm of Moscowbased VTB Group, saw a turnover of RUR61 billion in its repo trading in June, making it the sixth biggest operator in the Russia. The company almost doubled its May figures (RUR35.7 billion) and tripled its April turnover (RUR22.1 billion). Turn to page 26 for the panel debate on the repo market.Z

2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê Ê 5Ê

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Ê

NewSÊ aNaLySiSÊ

UpturnÊ downÊ under On 25th May Australia relaxed its ban on the covered short selling of financial stocks, after numerous delays and extensions to the restriction since it was imposed last September. The ban on the shorting of nonfinancial stocks was relinquished on 13th November and the shorting of financials was extended in March until the end of May. The daily reporting of gross short sales will continue, as will the publication to the market of aggregate short sales the day after trading. But the regulator emphasised that the pressures of the global financial crisis on the Australian economy were still evident, and the allowance of short selling would undergo constant reevaluation Dr Sam Wylie, a research fellow at Melbourne Business School, said that – as with other markets – the imposition of the original ban was perceived as a ‘knee-jerk' reaction by ASIC, the regulator. However, while he was opposed to a ban of short selling generally, there may be some occasions during a financial crisis where a temporary suspension might be needed, particularly when it comes to calculating company credit ratings. “With credit models which determine the cost of borrowing for banks, part of the input for those models is the stock price itself. If a bank experiences a short selling attack, it drives down the share price that drives up the credit spreads. [This] can seriously destabilise the position of banks.” He sighted Macquarie as a bank at serious risk in this way at the time of the collapse of Lehman Brothers. Though part of the official discussion in Australia surrounded the distinction between naked and short-selling, Dr Wylie reminded GSL that some market Ê6Ê

practitioners, such as options traders - who need to be able to short sell to replicate the options and manage their dealer books – must be exempt from a blanket ban on naked shorting. He added that naked shorting up until recently had a “ridiculous” regulation. “Australia has a T+3 settlement. If you were a hedge fund, you could do a naked short sale, and if you could not settle within three days and the fine was something like GBP1,000,” he said. So for a GBP10 million deal, “traders are happy to pay that small fine. Dr Wyllie then explained the unusual system for Australian securities lending. When a hedge fund, or other borrowers, obtains the shares to sell on, the proceeds of the sale is held by the custodian and reinvested in Treasury bills in the overnight money market. The proceeds of this reinvestment are split: so that if the retun on the Treasury bills is 300 bps, 280 will go to the borrower and 20 bps to the beneficial owner - a tidy sum Dr Wyllie defended hedge funds againstthe increased scrubity of their operations from regulators. “There’s a lot of back-slapping between regulators, politicians and the banks as to ‘how clever we are’... it has been the prudence and good regulation that have carried us through this, but most of it has to do with our unique circumstances and good luck." Z

Kangaroo bounce 2008-2009

DutchÊ developments Securities lending is renowned for the potential additional revenues it can generate for beneficial owners, but in this economic climate, Dutch pension funds seem skeptical. “Although they [pension funds] know it is a great way to create extra income and help the market be efficient by providing liquidity, they need to be sure there is absolutely no risk," states Sander Baauw, Executive Director of Equity Finance Europe for Fortis Bank Nederland NV. "We have seen some beneficial owners stopping their programme after the Lehman situation, but recently, however, we have seen them slowly coming back." Of all EU countries, the Netherlands has an extensive occupational pension scheme, with funded schemes covering 91% of the workforce. For this reason, the Dutch system has always been held up as an example on how to maintain a healthy pension system despite an ageing population. The recent realisation as to the the extent of under-funded pension schemes has meant that the Dutch government has had to re-assess their systems, and as a result, a decision has been made to extend the recovery period for struggling funds from three to five years. On 1st April, more than half of Dutch pension schemes were asked to submit recovery plans to

Australia DESLI short index Australia price index

Australia DESLI (lendable) index

DESLI (Short) 1 month % change +7.07 DESLI (Lendable) 1 month % change: +8.04

Jan

Mar

May

Jul

Sep

Nov

Jan

Mar

May

Price index 1 month % change +4.03 SOURCE: Data Explorers

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Ê

acrOSSÊtHe Ê atLaNticÊ

De Nederlandsche Bank- a legal requirement once funding levels drop below 105%. The average coverage ratio of the 650 Dutch funds has increased from 95% at the end of 2008 to 100% in late May 2009. This improvement is due to the general strengthening of the financial markets, along with a rise in bond yields, which have increased by 30 basis points since the beginning of the year. In regards to gaining income from securities lending, Mr Baauw to emphasised that clients are “far more risk adverse then before". "Consequently they are switching to non-cash collateral or they are in a more conservative reinvestment programme.” He also added that his firm's lending programme had not been affected since the lifting of the Dutch short selling ban on the 1st of June. “I think the reason for this is that there were already exceptions to the rule in relation to certain kind of parties - like market makers who were allowed to short the stock. Our collateral profile has not changed since the lift and I do not see the relation between short selling rules in every country and our profile.” The Dutch pension fund industry's continued activity in securities lendingan increasingly important area of financing- makes it a key market under global scrutiny. Z Diary Note: GSL will be discussing these issues with pension funds, other beneficial owners and securities lending practitioners at the GSL Dutch Securities Lending Summit, 8th October 2009 at the NH Grand Hotel Krasnapolsky, Amsterdam.

Ê8Ê

Across the Atlantic Trade association news and comment from either side of the pond.

RMA: Michael McAuley

In my last column, I mentioned the renewed interest in securities lending as another sign that the industry is heading in a positive direction. I based my comments on observations from the Information Management Network Beneficial Owners’ International Securities Lending & Repo Summit in February, where most beneficial owners indicated their plans to continue participating in securities lending. Since then, I have been further encouraged by the number of lenders returning to the market. This is a positive sign for our industry. Many clients that had either stopped or restricted their lending programs are lending again, but they are doing so with more specific lending and cash collateral reinvestment guidelines. We have seen other positive signs of market recovery, including a renewed interest by certain clients with separate cash collateral accounts to make opportunistic purchases of highquality assets as pricing and liquidity begins to improve in the markets. The industry continues to look

forward to a change in the U.S. Securities and Exchange Commission’s (SEC) customer protection rule that would allow US brokers to pledge equities as collateral. This change would help increase participation in securities lending and provide an alternative to cash collateral reinvestment. It would also help reduce the volatility that lenders experience around quarter ends. From a borrower perspective, the ability to pledge equities as collateral would reduce or eliminate financing costs and have potential benefits for the borrower’s balance sheet. RMA and other industry associations will continue to work in cooperation with the SEC and other governmental regulators on these and other changes that benefit our industry. More recently, the Treasury Market Practices Group (TMPG), working with members of the Securities Industry and Financial Markets Association (SIFMA), the Depository Trust and Clearing Corporation and the Fixed Income Clearing Corporation, issued guidelines aimed at minimizing episodes of chronic fails. This action was in response to widespread, chronic settlement failures in the Treasury repurchase market in the fall of 2008. According to the U.S. Treasury Department, among the recommendations was “the adoption of a dynamic fails charge to provide an incentive for the prompt resolution of settlement failures, and with the expectation that the guidelines will contribute to the depth and liquidity of the U.S. Treasury market.” Industry participants are now working to comply with these

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New Rules As David Rule, CEO of the International Securities Lending Association leaves industry representation for regulation (at the UK's FSA) he examines the legal legacy. “Many clients that Following a successful conference have either stopped or in Barcelona, I am delighted to hand over the position of ISLA CEO to Kevin restricted their lending McNulty, who takes over full time from programs are lending 1 August. I have very much enjoyed working again, but they are at ISLA and I would like to offer doing so with more particular thanks to the ISLA Board for specific lending and cash their support, particularly during some challenging times over the past eighteen collateral reinvestment months. One project throughout my time at guidelines" Michael McAuley, RMA requirements. TMPG compliance and other topics surfaced at the recent operations round table sponsored by The RMA Committee on Securities Lending and SIFMA. These topics, along with SEC Rule 204 –T, present many operational challenges for borrowers and agent lenders. As regulation creates new operational needs and challenges, I look forward to greater participation by our Operations and Technology Subcommittee at our own RMA conference on October 13-16 in Miami, Florida, as well as at other industry conferences and discussion forums. Mike McAuley is writing as the Chairman of the Risk Management Association's securities lending committee, he is also senior managing director and chief product officer in State Street Corporation’s securities finance division. Z

ISLA has been the review of the GMSLA – the industry-standard legal agreement for international securities lending, sponsored by ISLA. I am confident that we will publish the new GMSLA 2009 before I move on, following a long process of consultation and discussion. Freshfields have kindly supported the work at no charge. The new Agreement has evolved from the GMSLA 2000 but includes important changes: 1. Changed post-default processes that give more flexibility to the nondefaulting party, based largely on the GMRA 2000; 2. Failure to deliver equivalent securities or collateral is no longer an event of default but can lead to a ‘mini-close out’; 3. Greater clarity about tax issues; 4. Clearer treatment of share loans that have been nationalised, suspended etc; 5. Amended events of default; 6. Inclusion of an agency annex, with reference to ALD processes, and an addendum for multiple principal transactions (‘collateral allocation letter’).

7. Up-to-date UK tax addendum. ISLA will commission guidance notes for the new Agreement. The SLRC netting sub-committee will be seeking supplementary opinions from Counsel in every country that it covers on the effectiveness of the netting provisions of the new Agreement for regulatory purposes. Those opinions are expected by September. Feedback from several major firms is that they intend to replace existing agreements with the new agreement over the next several months. Alongside the GMSLA 2009, ISLA published in April a Protocol that enables firms to replace the provisions governing what happens following a default in existing agreements with the relevant provisions of the new Agreement. By signing the Protocol, firms automatically update any 1994 OSLA, 1995 OSLA, MEFISLA, GESLA and/ or 2000 GMSLA agreements with other firms that have also signed the Protocol.Z Agreements overview The Global Master Securities Lending Agreement (GMSLA – 2000, updated 2009) was intended to replace three sets of guidelines that was specific to certain securities or transactions: the Overseas Securities Lending Agreement (OSLA 1994, updated 1995) used to document transactions by ‘overseas’ lenders involving all kinds of government and corporate paper; the Master Equity & Fixed Interest Stock Lending Agreement (MEFISLA) used by British lenders for all types of other paper; and the Master Gilt Edged Stock Lending Agreement (MGESLA – also known as GESLA) was used for UK gilts. The Global Master Repurchase Agreement (GMRA) was issued in 2000.

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Ê

executiveÊP rOFiLe

Kelly Mathieson, J.P.Morgan The global head of clearing and collateral management talks to Ben Roberts about collateral's contribution to risk management and obtaining a global view. In September, after unprecedented market turmoil shook the financial services industry, J.P.Morgan turned to Kelly Mathieson to oversee the clearance division of the bank’s Worldwide Securities Services business, in addition to her role as global head of collateral management.

“We see our clients focusing on risk management with collateral management as part of that consideration: being more 'pre-trade', either embodied in the decision to invest or a trading position" The additional responsibility has produced “an interesting few months” she says, although in many ways collateral management and clearing complement one another based on the similarity of the bank’s client base. “Clearing and collateral are tied closely together in terms of the activities that are conducted in the financing and lending area, so it’s logical to run them as a complex of businesses under one umbrella rather than as separate entities.” The J.P.Morgan agent lending team is, on occasion, one of her clients.

Mathieson points out the bank’s significant strength both as an agent lender – including engaging in repo - and as a tri-party counterparty, but notes that the two arms are entirely distinct. The tri-party model for securities

lending is not only growing, but has been bolstered by its success in difficult market conditions. The quality of collateral has become a major topic of discussion with lenders, explains Mathieson. “The lenders wanted to know they would

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executiveÊ PrOFiLe

receive the collateral that was expected, so they could do whatever was needed to compensate for what they had lent to the dealer," she says. "We’ve seen a great deal of focus on the eligibility standards for collateral type, the complexity of the eligibility tests and checks of the pricing and valuation processes and the margins taken.” Further, Mathieson has seen a change in how clients view collateral. It is becoming less of a post-trade consideration and now runs in parallel with the loan itself. “Increasingly, we see our clients focusing on risk management with collateral management as part of that consideration: being more ‘pre-trade’, either embodied in the decision to invest or a trading decision. As a

Reflecting on this percentage change, she says: “I don’t see the market reverting to the asset class mix prevalent before September 2008. I don’t think it’s a scenario we will see any time soon.” “Certainly, many of the market participants are speaking among themselves about what kind of industry guidelines will reflect best practice going forward.” For global clients, J.P.Morgan has seen an increase in the number of requests for a platform that gives a similarly global view of collateral. J.P. Morgan’s spending on technology upgrades in the past year, as part of a comprehensive program to re-architect its infrastructure and operations to anticipate client needs, is meeting that demand, says Mathieson. “A total view of collateral will “Clearing and collateral enable people to log into our online are tied closely together function and, in one view, see the in terms of the activities collateral management activity across all their legal entities by region, by that are conducted in the portfolio and grouping of accounts, however they choose to set it up,” she financing and lending explains. area, so it's logical to “Ensuring this on-line system is run them as a complex market-leading is a key area of focus of businesses under one for us. On top of everything else, We can also provide enhanced risk umbrella." management reporting.” She adds that even though client consequence, the concept of collateral may still wish to interact at a regional management has widened,” she or local level, a comprehensive view explains. gives them access to all collateral “Organisations that are transacting information in one ‘enterprise-wide’ in collateral for broader needs, solution. or for appropriate balance sheet When considering markets globally, management, are a growing part of our Mathieson says that a key driver of client set.” repo and collateral management The boom of government bond activity in new regions of the world issuances over the last few months has will be the degree to which clients been reflected in a volatile tri-party are willing to lend and accept local repo market. Due to more risk-averse governments’ issuances as collateral. market sentiment, Mathieson says “As we extend our focus to Latin that the split between Federal Reserve- America, the Middle East and Asia, we eligible securities and non-eligible has are working closely with our clients as changed. In the run up to September they become more comfortable with – 2008, she says, the market split of and/or more interested in – using the collateral was 60% Fed-eligible – now, issuances of a particular country to it is 90%. either lend or accept as collateral.”

With a platform operating in 80 countries today, the system is already robust. For emerging markets, she predicts that a conservative outlook regarding collateral will prevail in the medium-term. “I think the market will continue to be driven toward more conservative collateral types. The quality is based around the price discovery and the depth and breadth of the market of each security type. So, for certain countries around the world, that’s going to gravitate towards the more secure government issuances.” Elsewhere, she has seen an increase in the use of equities as collateral. “We’ve always seen lenders who are willing to accept some equities as collateral. The more actively traded equities have a deep and liquid market, so there’s good price discovery that’s generally paired with fairly robust credit and counterparty information. I believe that’s why we are seeing equities used fairly frequently in securities collateral.” Mathieson notes that ultimately, whether looking at the clearing or collateral management functions, clients are looking for transparency and tools to mitigate risk. They need to be able to assess at any given time their counterparty exposure, and they need to have

“Many of the market participants are speaking among themselves about what kind of industry guidelines will reflect best practice going forward." real-time insight into the underlying securities and transactions that define that exposure. This has been, and will continue to be, a fundamental theme in the marketplace. Z

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LendTech 2009 Landscape Survey

Technology suppliers to LendTech 2009 respondents: ADP Bloomberg BondEdge (Interactive Data) Broadridge Data Explorers Equilend eSecLending IRReS Pirum SunGard Securites Finance Global One

SunGard Securites Finance Global One & Loanet SunGard Securites Finance Martini SunGard Securites Finance Worldlend Some functions were identified as performed by inhouse developers or in-house IT support

The Securities Lending Technology Landscape: What users want... With risk and uncertainty stifling markets the role of technology in reporting, transparency and risk has come under greater scrutiny. LendTech 2009 is an anonymous survey, both for the technology vendor and the respondent. The purpose is to garner the outlook of SecLend technology users and see how the technology vendors are servicing the marketplace as a whole. The survey covered the main areas of a financial institution's infrastructure, from the front office trading orientated technology systems, including analytics, management reports, and auction platforms. Middle to back office is also examined, with special attention to compliance functionality, fee and rebate processing and web interfaces. Finally, ancilliary and support services are analyised, in respect to security, the quality of vendor testing and licence issues. One principal finding is the shortcomings of technology support services has riled users. Many results in LendTech show a plateau of opinion (see Auction Platforms in section b) showing a variety of user opinion about the tools, often at odds with their counterparts in other buyer organisations, showing an inconsistency across the tools provided. The survey examines and defines the technology landscape, where user emphasis current lies. Rating of individual suppliers will be the content of our Global Securities Lending Rankings in November 2009.

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Performance Rating of each function: a) Front office trading orientated technology systems Excellent

Good

Adequate Marginal

Poor

Coverage of Instrument types

25.0 %

50.0 %

20.0 %

0.0 %

5.0 %

Analytics (Cash Projections /Settlement ladders etc)

16.6 %

38.8 %

22.2 %

16.6 %

5.5 %

functionality

15.0 %

40.0 %

30.0 %

5.0 %

10.0 %

Cash management /reinvestment functionality

5.2 %

47.3 %

36.8 %

10.5 %

0.0 %

Reporting functionality

5.0 %

45.0 %

35.0 %

5.0 %

10.0 %

Exposure Reporting

15.0 %

40.0 %

20.0 %

10.0 %

15.0 %

P&L reporting

10.0 %

40.0 %

25.0 %

25.0 %

0.0 %

Outstanding positions

36.8 %

31.5 %

31.5 %

0.0 %

0.0 %

Historical Reporting

15.0 %

30.0 %

25.0 %

25.0 %

5.0 %

Management Reports (Averages w/ history etc)

20.0 %

15.0 %

30.0 %

25.0 %

10.0 %

Smart Marking (ability to determine P&L impact of trade)

15.0 %

10.0 %

40.0 %

15.0 %

20.0 %

Stock Location Functionality

15.7 %

36.8 %

31.5 %

10.5 %

5.2 %

AutoborrowFunctionality

5.2 %

36.8 %

31.5 %

10.5 %

15.7 %

Basket Trade Functionality

11.1 %

33.3 %

22.2 %

16.6 %

16.6 %

Ability to tailor system

20.0 %

20.0 %

30.0 %

10.0 %

20.0 %

Derivatives - Swaps,CFD's

5.2 %

15.7 %

36.8 %

15.7 %

26.3 %

42.1 %

15.7 %

10.5 %

10.5 %

Collateral Mgmt

System speed /responsiveness (general use/running reports etc) 21.0 % Web Interfaces (Equilend, Secfinex, Astec, DataExplorers)

5.0 %

35.0 %

30.0 %

25.0 %

5.0 %

Auction platforms

15.7 %

21.0 %

21.0 %

21.0 %

21.0 %

Front office trading orientated technology systems The tabulated results show that the most appreciated feature of these systems was coverage of different types of financial instruments, with a quarter of respondents stating 'excellent' and half describing it as 'good'. Exposure reporting, perhaps the most critical function given the attention to counterparty risk, received a 'good' rating from

40% of respondents. The collateral management functionality and cash management/reinvestment functionality was also approved, receiving 'good' from 40% and 47% of respondents respectively. The system's ability to be customised was mixed, however: an equal percentage delclared this ability to be 'excellent' and 'poor', with 30% calling their system 'adequate'.

Respondent comment: "The report from Global One is excellent, just would like to have the activity report which shows the input date base. The one we have now is little bit different from our requirement."

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Performance Rating b) Middle to back office Excellent Risk management

Good

Adequate Marginal

Poor

10.0 %

30.0 %

25.0 %

25.0 %

10.0 %

19.0 %

33.3 %

33.3 %

0.0 %

14.2 %

Compliance functionality (credit limits, credit rating etc) 5.0 %

40.0 %

30.0 %

10.0 %

15.0 %

Fee and rebate processing

22.7 %

36.3 %

27.2 %

0.0 %

13.6 %

Income processing (dividends & coupon interest)

10.5 %

31.5 %

36.8 %

0.0 %

21.0 %

Corporate action processing

10.5 %

21.0 %

47.3 %

0.0 %

21.0 %

SSI (Standard Settlement Instruction) setup and maintenance 9.5 %

28.5 %

42.8 %

9.5 %

9.5 %

STP functionality SWIFT interface

11.1 %

27.7 %

33.3 %

16.6 %

11.1 %

Web interfaces (eg: Pirum, Loanet, Equilend)

10.0 %

34.7 %

35.3 %

10.0 %

10.0 %

General data interfaces - (Holding, securities, confirmations etc) 31.5 %

26.3 %

10.5 %

10.5 %

21.0 %

Auction platforms

20.0 %

22.0 %

15.0 %

25.0 %

Static data setup & ease of management

The risk management functions in the middle to back office are about acceptable overall, though half of respondents judged the tool to be either 'Adequate' or 'Marginal'. Nearly a third of respondents declared the general interfaces including the viewing and movement of data - as 'Excellent'. However, the auction platforms received a mixed response: while a fifth rated these as excellent, a quarter declared the tool 'Poor', demonstrating perhaps a training gap. Standard settlement instructions stood out as a predominantly 'Adequate' tool, with just over 41% sitting on the fence. In regards to compliance functionality, very few respondents deemed this 'Excellent'. Whilst the majority rated it within two standard deviations of the mean score, 15% of respondents rated it as 'Poor'. Static data setup

18.0 %

and ease of management scored relatively well overall, with 52% of respondents placing it in the upper quartiles of the survey, and 14.2% rating it as 'Poor'. STP functionality/ SWIFT interface returned a widely dispersed statistical spread, with a third deeming it 'Adequate'. There were even sized groups in both the 'Excellent' and 'Poor' columns, both gaining 11.1% of the vote. Web Interfaces scored overall in the top three tiers, with only 20% selecting 'Marginal' or 'Poor' in relation to the question. Income and corporate action processing returned remarkably similar responses, with results predominately sitting in the middling 'Adequate' group. Both groups contained 10.5% of the participants votes in the 'Excellent' column, with just over a fifth of the votes in the opposite end of the scale choosing 'Poor'.

Respondent comment: "Difficult to build accounting feeds off the fee/rebate reporting functionality. Don't use vendors for the other business functions - all done by dedicated in-house systems"

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Performance Rating c) Ancilliary and support services Excellent Good Adequate Marginal

Security

Poor

21.0 %

21.0 %

47.3 %

0.0 %

10.5 %

16.6 %

5.5 %

50.0 %

5.5 %

22.2 %

9.5 %

23.8 %

23.8 %

14.2 %

28.5 %

Efficiency of vendor help desk 23.8 %

14.2 %

33.3 %

9.5 %

19.0 %

Quality of vendor user manuals 15.0 %

30.0 %

25.0 %

5.0 %

25.0 %

Open system compliant?

16.6 %

16.6 %

22.2 %

16.6 %

27.7 %

Licence issues

10.0 %

20.0 %

45.0 %

5.0 %

20.0 %

Support dashboard - ability to monitor daily feedload etc Quality of vendor testing before release of upgrades

For ancilliary and additional services, the security and the service from help desks received the most glowing praise, with more than a fifth calling them 'Excellent'. However, the quality of vendor testing before release or upgrades had bigger opposition: 28.5% described this as 'poor'. We can see the discontent on this issue in the respondent quote to the right. The quality of vendor user manuals was

deemed this as 'Excellent', nearly a fifth deemed it as 'Poor'. With 42% of the response falling into the upper ends of the bell curve, the LendTech landscape lacks a strong view reflecting the market conditions in 2009.

overall, predominantly negative, with 55% of participants placing their votes in the bottom three groups. Open system compliant was another which appeared in bad light - 27.7% ranked this as 'Poor', thereby making it, with testing, the weakest variable in the survey. An interesting dispersion of results was that regarding the 'efficiency of the vendor help desk'. Whilst just under a quarter of respondents

Respondent comment: "Stunningly bad. Still no testing platform provided after four months since go-live."

Salient comments - the user views of the vendor product and service "Professional, reliable, knowledgeable, cooperative, helpful" "Poor" "Unreactive, complex, lumbering technology supplier" "SunGard support is excellent"

"Reliable & resilient" "Reliability" "Good product, Good service." "Top 3 supplier on GSL" "Adequate"

"Development and support" "Reliabilty, proactivity, cost control, efficiency, quality , responsiveness" "Good technology, questionable service" "Poor products, overpriced and inflexible." "Responsive, reliable, effective" "Diversified" "Available, communicative, efficient, helpful, understanding" 2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê Ê 15Ê

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ceNtraLÊ cOuNterParty

The central issue: CCPs

Ê

16th June saw the launch of the first bona fide central counterparty (CCP) in Europe, with SecFinex, the trading platform, and LCH.Clearnet, the clearing house, providing a central hub for the Euronext markets: France, Belgium, Portugal and the Netherlands. The implementation of a CCP comes on the back of wide industry debate accrued with particular momentum over the last few years. On conference panel discussions and within industry articles, market practitioners have been divided as to the cost benefits, operational reality and the overall effect a CCP would have on securities lending. For some, the capital and risk reduction is impossible to ignore; for others, a central platform is alien to the industry’s relationship-based heart. The launch of the system in Paris arrived after many months of developments in the drive in some areas of the markets towards central exchanges. Quadriserv - the US-based connectivity firm - developed an equivalent securities lending platform called AQS, and AQS in January formalised an agreement with The Options Clearing Corporation to launch a centrally-cleared securities lending platform. The same month, Quardriserv announced its agreement with Eurex Clearing to launch a trans-Atlantic CCP. Market practitioners will connect to SecFinex and LCH.Clearnet as either individual clearing members (ICM) or as part of a pool of traders ‘fronted’ by a general clearing member (GCM). GCMs are working not only with their individual clients but also with LCH. Clearnet to add this asset class to their existing general clearing product mix. Peter Fenichel, CEO of SecFinex, told GSL that - a month after the official launch - the company was approaching “endgame” in connecting both individual clearing members and general clearing members. “A key thing at the moment is getting the six or seven big GCMs

middle and back office and technology, which is a question of connectivity.” Fenichel explains that the connectivity for ICMs is more straightforward: after deciding to trade on SecFinex, the firm will fill out the required forms with LCH.Clearnet or another CCP. He adds that the firm has “six of the biggest” GCMs on LCH. Clearnet and is confident that they will be fully operational in the next few weeks. As a consequence of the hard work, Fenichel has witnessed a positive change in market sentiment towards a CCP that seems to have been bookended by the ISLA/RMA securities lending conference in Prague in 2008 and the equivalent Barcelona conference just over a year later.

“When you shift your trading from bi-lateral operations to a CCP you will save risk and capital. Everybody knows that. But markets don't shift on a dime" Peter Fenichel, SecFinex

During the former conference, there were “some big sceptics”, he says. In The hypothetical debate Spain, there were very few sceptics and is over. In June SecFinex more expressed support. launched a central “Out of Barcelona we got huge counterparty model support for what we’re doing because when you shift your trading from with the clearing house bi-lateral operations to a CCP you LCH.Clearnet. As Eurex will save risk and capital. Everybody Clearing clarifies its part knows that. But markets don’t shift on in a different model, the a dime.” Indeed, the CEO emphasises that alternative to the the implementation of a CCP is not a bi-lateral has advanced. ‘big bang’ concept. In the meantime, he says, “people can still trade bi-laterally. connected to the SecFinex and LCH. We’re still doing plenty of business Clearnet system for stock loans, as every day on our private market bithey’re already connected for other laterally.” asset classes," he says. "Ourselves and This increased support has derived LCH.Clearnet are just at the ‘endgame’ from both the demand and supply of that. We’re working hard, we’re beyond the ‘philosophy’ and client sales sides of securities lending. “The lenders would prefer to front a clearing house issues, and it now comes down to the

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than an individual; broker would prefer to have a CCP to save capital and risk; borrowers would like to have the assurance and risk saving,” he explains. “There is no constituent here that doesn’t benefit from CCP but the work that SecFinex has had to do to establish market place linked to a CCP doesn’t just happen overnight.” Nevertheless, at the time of writing there were a few stragglers who had shown support for the system but had yet to elect the preparation needed to transfer to a CCP as top priority. Further, some are still unconvinced of the model entirely. But Fenichel believes the firm has grounds for optimism. “There are a few people have looked at this recently and said: ‘well, we’re not sure this is a good thing for the market as this is not how we trade; we really focus on relationships and have a special way of choosing counterparties’. Those guys will eventually be clients of the system.” Eurex Clearing set out its intentions as a CCP at the beginning of June when it responded to a white paper called 'A Central Counterparty in the European Equity Securities Lending Market' - by the ISLA CCP Working Group. In its response, the clearing arm said it intended to “preserve the key features and characteristics of the current market model for both lending and borrowing counterparts” and aimed to reduce back office complexity regarding reconciliations and other post trade events. The response emphasised the benefits of linking directly to participants’ settlement and custody operations, and that the standardisation within these areas does not imply that the CCP will require standardisation of the securities lending transactions. The first of the two models revolves around cash collateral. The cash is passed on by the CCP to the lender when it is submitted by the borrowers. The second model is based around securities-as-collateral, in which the collateral is held by the CCP, not passed on to the lender.

Thomas Wissbach, senior vice president at Eurex Clearing, told GSL said that the requirements made by ISLA did not come as a big surprise, and that Eurex Clearing “is confident to be able to tick all the boxes”. He added that amid the discussions with ISLA there was an emphasis from the industry body that beneficial owners would be protected. “A CCP model in fact gives more security to the market. However, we found that if the lender is not receiving the collateral, they would require some additional confirmation as to the type of collateral and information as to how to obtain it in the case of insolvency.” He adds that many lenders would seek this second proposed CCP model – where the CCP is holder of the collateral – to avoid paying additional margin to the CCP, which would be at risk from a lender’s reinvestment perspective. He said that Quadriserv would be actively promoting the cash collateral model, but that the Eurex Clearing platform would be open to holding collateral too. “It’s up to the lender which model they choose." He adds that, compared to the advanced questions askedo f S ecFi nex as to data flows, many lenders are still asking basic questions about the CCP. “I think the questions as to how to connect and what reports they receive is a bit further down the road. The discussions have been on a high level basis, just explaining to the lending industry how the CCP works, how margining and collateralisation works." However, Pedro de Noronha of global view fund Noster Capital, told GSL that although a central counterparty would benefit some market participants - and instruments such as credit default swaps - it would not help the securities lending market. One of the competitive advantages of using a top prime broker, he said, was that they are the best at sourcing stock. "We don't think it would be fair for a client of a second-tier prime broker to have the same access as clients of more established prime brokers," he said. Z

Eurex Clearing's response: summary • The CCP will preserve the key features and characteristics of the current market model, offering broad geographical coverage • The automated post-trade services include crossmargining and crosscollateralisation facilities with "flexible but secure" collateral management. • A specific license for securities lending participants will be incorporated into the CCP model on the back of industry feedback • From a regulatory perspective, the CCP can be viewed as a "risk-free" counterparty, meaning the the exposure to a clearing membr to a CCP is not required to be covered with regulatory capital and a zero weighting applies. • The post-trade environment will be simplified, and will act as a single link with different participants on the settlement and custody operations. • The standardisation of processes does not imply a "full" standardisation of transaction terms; though the extent of this standardisation will be based on the liquidity the market wants to keep or create.

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MARKETÊP ROFILE

Japan

Japan’s securities lending market runs contrary to the country’s wider economic plight. Is this the land of the rising sums, asks Anthony Harrington.

2008 securities lending programmes in Japan, Spitalfields notes, was the extremely high fees earned on the 30th September dividend date. Some of the top securities generated earnings for lenders in excess of 500 basis points through the dividend “moment”. According to Len Welter, chief technology officer and head of content at Data Explorers, one of the causes for If the current financial crisis the peak through the dividend season has demonstrated anything, it is that is a rotation out of locally held stocks. securities lending programmes are “People often look to play the dividend very sensitive to the risks that shape arbitrage through the dividend season,” the macro-economic environment. he says. This is a fairly complex play, However, despite a disastrous 2008 for based on “dividend trees” which set the Japanese stock market is concerned out the split between the lenders and and a crash in exports demands, borrowers of the security. “It is all securities lending in Japan has showed about how you play the return between itself to be remarkably resilient. one jurisdiction and another so you The influential “Securities Lending will always tend to see spikes in basis Yearbook” from Spitalfields Advisors, points and lending activity around the notes: “The Japanese securities lending dividend seasons in Europe and Japan,” market has picked up where it left off Welter says. at the end of 2007. Compared to the However, this is a pretty expensive rollercoaster year experienced by many play. Putting down a great deal of other markets globally, Japan could be money with limited returns - and perceived to be relatively calm.” with the current constraint on Admittedly, lendable balances and organisational balance sheets across on-loan balances fell, as they would the world - Welter expects to see this have to, given the scale of market and kind of play being somewhat more foreign exchange movements that have subdued through 2009. Japan, he adds, taken place. But as Spitalfields Advisors favours non-cash collateral. points out, “the shape of the utilisation Japan imposed a short selling ban chart is practically identical,” with on 28th October 2008, and prohibited about 10% of the available universe naked short selling (where the seller of stocks being lent on average. The does not have access to the stocks). numbers peak at around 15% during This initial measure was reinforced on the twice yearly dividend season, which 7th November with a disclosure order always drives up demand by borrowers. that forced any market participant that In all, looking at total lendable was shorting stock in excess of 0.25% Japanese equities of USD280.244 of a company’s market capitalisation, billion, there was a utilisation rate of to disclose its short position. Details 9.97% in 2008 with an average basis were published on the Tokyo Stock points fee of 60.49. Lenders saw higher Exchange website. The restrictions total returns from their securities were lifted on 31st March 2009. lending programmes through 2008 In his outlook for the Japanese mainly because lenders taking cash markets and economy for 2009, Shogo collateral earned higher returns than Maeda, head of Japanese equities those taking non-cash collateral. at Schroders, pointed out that the One particular feature of the contraction in global demand has

had a massive impact on Japanese manufacturers. The country is highly reliant on its export capabilities and has been one of the great “net saving” nations, piling up a surplus of hundreds of billions of US dollars. However, car manufacturers such as Toyota have seen their export orders melt like snow in the desert. However, Maeda argues that Japan is well placed to recover strongly once the global economy picks up. However, Maeda concedes that “investment conditions in the last few months have been as unfavourable as any seen since the bubble burst in Japan at the beginning of the 1990s.” As a result, any remaining idea that Japan constitutes a “safe haven” for investors has gone out the window. Maeda’s optimistic analysis is predicated on the belief that the current weakness in the Japanese economy is “cyclical rather than structural”, and thus could be shallower than in other economies. He points out that Japan’s largest export market is China, which is still expanding, and demand from China could be expected to recover sooner than demand from the US or Europe. Further, Japanese households are not leveraged to the hilt, as is the case in the US and the UK. Despite the global financial meltdown and the short selling ban, financial companies continued to feature heavily in Japanese securities lending programmes. The stocks of Sumitomo Mitsui and Resona Holdings were good earners for lenders in prior years, and 2008. Utilisation rates for Sumitomo, for example, rose from 20% to 30% through 2008, according to Spitalfields and Resona continued to enjoy a utilisation rate of 75%. Mizuho Financial’s stock joined the top ten earners list in 2008 with utilisation rising from a long term average of 15% to 60% by December 2008. Z

18ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009

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ShORTÊ SELLInGÊ STATISTIcS

Statistically speaking An analysis of the short selling markets in US, France, Germany and UK - approximately 95% of market cap for each main exchange. DESLI (Data Explorers Securities Lending Index) methodology is used to calculate change in levels of supply and demad without impact from changes in price, trade volumes or foreign exchange.

US NYSE

120 100 80 60 40 20

UK

DESLI (Lendable) Price index

May

Jul

Sep

Nov

Jan

Mar

May

Jan

Mar

May

Jul

Sep

Nov

Jan

Mar

May

140

80 60 40 20

- All indices benchmarked to 100 as of 2nd January 2008.

DESLI (Short)

Mar

100

- DESLI (lendable): change in percent shares outstanding avalable to borrow.

Statistics and analysis by Data Explorers

Jan

120

- DESLI (Short): change in percent shares outstanding on loan.

Findings - short interest was declining in most markets prior to September 2008 - adjusting for seasonal impacts on securities lending, over the past three months the level of short interest is down roughly 15% across global markets - over the past month the US markets have seen a small increase in short interest but it is still down considerably from the highs in 2008. - even as cash markets have rallied from their March 2009 lows we have seen the lendable remain relatively flat.

140

France

180 160 140 120 100 80 60 40 20 Jan Mar May Jul Sep Nov Jan Mar May

Germany

250 200 150 100 50 Jan

Mar

May

Jul

Sep

Nov

Jan

Mar

May

2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê Ê 19Ê

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MARKETÊP ROFILE

Japan Q+A

Answers from Hidehiko Sakamoto, head of equity finance at Daiwa Securities SMBC. Additional comment from Kazuki Miyazawa, Global Product Planning Department, Daiwa Securities SMBC Co Ltd

Q. How did the short selling ban affect Japan and what is the position now? Was market liquidity affected by the ban?

offering information. Indeed, some short sellers have held back from selling 0.25% or more of outstanding stocks, reducing potential market liquidity and affecting the market’s price discovery function. Short sellers reduced their positions between early March and mid May this year but increased them again in the past several weeks, according to the exchanges’ filings.

HS: Japan implemented the down-tick rule for short-selling in March 2002 and naked short-selling was banned on the 30th October 2008. Additionally, disclosure became necessary for parties engaged in short-selling of more than 0.25% of outstanding shares effective 7th Nov 2008. At the beginning, the Q. What is the position with expiry date was 31st March 2009, but respect to cash collateral? I this was put back to 31st July 2009. understand that Japan parallels Looking at statistics from TSE, the European market in Answers from Hidehiko Sakamoto, ??, Daiwa Securities SMBC Co. Ltd from Kazuki Miyazawa, Global Product Planning Department, Daiwacollateral. Is itAdditional is clearcomment that the short-sell/selling preferring non cash Securities SMBC Co Ltd order ratio did not change after the this position changing? introduction, but the amount of Q. Howorders did theincluding short selling ban affect Japan and is the position now?activities, Was selling non-shortHS: what For securities lending market liquidity affected by the ban? sell decreased. We can see the effect cash pool is the preferred collateral of the announcement that the rule fortype in Japan. have strict HS: Japan implementedand the down-tick short-selling in Most Marchlenders 2002 and introduction is preventing non-shortcollateral requirements 2008. Additionally, which are cash naked short-selling was banned on the 30th October disclosure became necessary for parties engaged short-selling of more thanable to sell. only.inThere are some lenders 0.25% of outstanding shares effective 7th Nov 2008. At the beginning, the expiry accept JGBs as alternate collateral but date was 31st March 2009, but this was put back to 31st July 2009. KM: Holders of a short position of even fewer can accept cash equities. statistics from(in TSE, it is clear that the short-sell/selling order ratio did to aLooking certainatlevel or more principle, I guess the reason for this is due not change after of theoutstanding introduction, but the amount sellinguse orders including non0.25% or more the of limited of tri-party collateral short-sell decreased. We can see the effect of the announcement and that the stocks) are required to report their managers popular in the west. introduction is preventing non-short-sell. short positions and their names to Traditionally, most life insurers '+-/.$))(*& '+-/.$))(*& exchanges$))(*&$3")0#(*&.'+-/.$))(*& through securities firms. to lend their assets free of +/ ) 2(/',-("$-$./-("/(+*. were happy 2(/'+0/,-("$-$./-("/(+*. +*/' $ - #(*& )0$ +%+/ ) - #(*& )0$ +%+/ ) - #(*& )0$  +%+/ ) # Therefore, short sellers have worried     # ! ! # collateral " (unsecured " # basis) but this 0*          about being short squeezed, as  well as   practice  has been stopped following 0)        0&                being resented by the companies they the collapse of the US financial system $,             "/              short, leading  to the possibility that with risk aversion being the main issue +1    

      $"

    

  companies become less cooperative in  for most  

 lenders.     

   

    *     $!  - ,-  4

 

 

 



     

    

   

 

 

 

  

      

Short selling with price restriction (2008-9)

 

    

 

trading value

% of total (left scale)

+%+/ ))$%/." )$ - #(*& )0$

'+-/.$))(*&2(/',-("$-$./-("/(+*.   18

 7,000,000

  14

 6,000,000

 12

 5,000,000

  10

 4,000,000

 8  

 3,000,000

 

 2,000,000



 1,000,000

6 4 2

Q. Are there significant differences between the Japanese market and the US and European seclending markets? What is Japan’s relationship to PASLA and the Asian seclending market? HS: The ratio of callable stock is relatively high since lifers want to maintain voting rights/shareholders’ coupon in Japan. Japanese Securities Lending is based on a master trust bank model as compared to US & European regions where individual fund managers make decisions to lend their portfolio independently. Daiwa SMBC joined PASLA recently so we are not in a position to comment. But Japan Securities Lending is one of the most liquid within Asia, therefore PASLA officials are definitely in consultation with the relevant parties in Japan. Q. What is the relative demand for equities in securities lending programmes versus government gilts?








HS: The bond repo market surpasses the equity repo market in Japan. According to official numbers from Japan Securities Dealers’Association, the outstanding balance of stock borrowing and lending transactions including financing trades is JPY4.5 trillion and that of bonds is JPY80.4 trillion as of the end of May 2009. Z







































0 Nov Dec Jan Feb Mar April May SOURCE: TSE















 

Aug Sep Oct












Jun Jul 




0



 




HS: We cannot of course talk about individual lenders but lenders in Japan are Master Trust Banking companies and Asset Management companies. Life insurance companies are callable lenders.

 8,000,000

  16



Q. Who are the big securities lenders and lending agents in Japan?

20ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009 Source: TSE GSL05 18-38 CM.indd 20

29/07/2009 13:46

PRIMEÊ BROKERAGE

The borrows of tomorrow In the immediate aftermath of the failure of Bear Stearns and Lehman Brothers, many observers wrote off prime brokerage as a concept. Hedge funds faced the serious threat of a default by their prime broker and what it would mean for their business. For many it has been ruinous, with assets tangled up in administration. But now the dust has settled, have the prime brokers been sufficiently adapted and does their future look more secure? Opinion varies considerably on what happened after the collapse of Lehman Brothers and where hedge funds moved their money. What is clear is that the larger prime brokers became more discerning about their client base. Stephan Vermut, founder and managing partner of Merlin Securities, says: “The large prime brokers decided to concentrate more of their efforts on a smaller group of hedge funds. They moved upscale and asked the smaller hedge funds to leave. This was a balance sheet/resources issue rather than a risk management issue. It was a realisation that they couldn’t be all things to all people. It began precrunch, but accelerated post-crunch.” The hedge funds have found this to be true from their side as well. Pedro de Noronha, managing partner at Noster Capital says: “Initially, pretty much anyone could open a prime brokerage account with one of the top 10 prime brokers. Since the availability of credit became an issue

it is not as easy to open an account as prime brokers are only willing to back managers that they believe will succeed, as each manager they take will tie-in capital from the prime broker’s balance sheet and capital is becoming a scarce commodity.” The move to take on multiple prime brokers to spread risk was also a common theme. Vermut says: “On the hedge fund side, there was an increasing realisation of custodial risk. They began to embrace the multiprime concept. Did they have the right prime broker? And were they fulfilling their fiduciary responsibility to have just one?” Many believe that the credit crisis spread mistrust in US institutions, leading many to look to European prime brokers. At the time, it was reported that there was a flight away from big names such as Morgan Stanley, though many hedge funds said they may return once the situation had stabilised. Anthony Byrne, global head of securities lending at Deutsche Bank, believes that the group benefited from this mistrust: “After the Lehmans crisis, there was a move to banking institutions because of concerns with the US broker dealer community. European banks probably saw most of the inflows Byrne continues: “Bear Stearns was the first time hedge funds focused on whether it was conceivable that there could be a problem with their prime broker. There was a significant

Cherry Raynard explores how prime brokers have adapted to market circumstances and the impact on their relationships. shift from the weaker to the stronger prime brokers based on counterparty credit concerns as result of this market development. IFRS7 also had an impact as it forced some funds to disclose details in relation to exposure to financing counterparties including information on rehypothecated assets and maximum potential levels of rehypothecation.” He believes general securities lending and repo was shown to work well through the crisis. For clients of Lehman Brothers clients, all collateral had been realised in two days. The same was not true for prime brokerage. What are the issues now? Now that prime brokers and their clients have had time to observe the post-credit crunch landscape the biggest issue is protecting client assets. In the wake of the crisis some hedge funds divided up their cash balances and moved assets towards individual custodians, but this left the issue of whether it was safer to have assets with one strong prime broker or 50 weaker banks. Syl Chackman, co-head of global markets financing and futures at Bank of America Merrill Lynch, says: “Clients and their investors have concerns around who they custody and clear with, although these concerns are abating there is still the occasional question – are my assets safe? This is a global trend and has affected how this industry will operate going forward. “It is really about counterparty

2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê 21Ê

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PIRUM

PRIMEÊBR OKERAGE

safety and segregation of assets. Solutions like remote companies and escrow facilities are being deployed. How we’ve dealt with it depends on individual clients, regions and regulation.” The extraction of assets from Lehman Brothers is proving a lengthy process – recent estimates have suggested that around USD45 billion of hedge fund assets remain stuck in administration. The new models that have been proposed for prime brokerage involve having a distance from prime broker for assets that don’t need to be financed, so if there is a default, the hedge fund can continue to trade. Two potential models have emerged. The first is where the prime broker partners with a custodian to create a separate custody account that houses all the fully paid assets. The other model uses a special purpose vehicle to hold the assets. Byrne says: “The new prime brokerage model could be nothing changes, which may be an option for those very strong credit institutions, but the overwhelming body of opinion seems to doubt that will happen. The other is to use a custodian as an adjunct to a traditional prime brokerage arrangement. While some brokers are working on an in house custodian or SPV in order to keep the business in house, others are open to working with an internal or external custodian if the customer would like this added protection. External custodians have deep and well established infrastructure, handled the crisis well in most cases and are also more likely to be considered systemically important by government bodies. Deutsche Bank is open to the latter open architecture approach and has already tested its model in the client environment. No prime broker has either model fully in place, though many are close. Hedge

funds are demanding the change so its speedy implementation could give a significant competitive advantage. De Noronha says: “Since Lehmans, our prime broker has been in the process of creating a special purpose vehicle. The only thing that can be taken from you is what is held on margin. Pretty much everything else would be protected and we would be able to access it if there is a situation like the Lehmans collapse again instead of being at the mercy of administrators for years to come.” Elsewhere the prime brokers have also looked in more detail at the cost of funding assets and adjusted their charges accordingly, De Noronha says: “Our prime broker has started to charge on the overnight indexed swap, plus that margin. Therefore if the credit market started having problems, it would be us who would bear the cost. We already have our prime broker sourcing liquidity for us, so this seems fair enough and I wouldn’t be surprised if others are doing the same.” As Chackman points out, “you need to provide leverage, but you have to be able to fund it.” Previously prime brokers tended to price assets at one flat level and didn’t tend to take into account the underlying risk or liquidity of the assets. Now, there is increased focus on ensuring that liquidity is available for the assets held by the prime broker and on which they provide leverage. It is more likely that prime brokers will look at the repo value of assets and devise a sliding level of pricing based on that with the highest, most illiquid instruments the most expensive. However, this may not be a big issue in future. Bank of America Merrill Lynch has seen a move among its clients to holding more vanilla assets. Chackman adds: “Previously, illiquid assets were funded by prime brokers, but the funding sources became very difficult.” The prospect of increased regulation of hedge funds also remains

a challenge for prime brokers. As it is they have seen reporting requirements rise, particularly round short-selling. Vermut says: “Hedge funds need more data and information, particularly on performance and risk. They need more attribution information – where they are generating alpha. It is about allowing managers to do a better job of understanding the nuances and intricacies of their portfolio.” However, Vermut does not believe that regulation will increase significantly once the waves from the credit crunch have died down. He says: “There has been plenty of chatter in Congress, but I believe any legislation passed is likely to be significantly watered down,” he says. “Hedge funds were not the cause of the problems in 2008 and most outperformed the major money managers during the year. Many pointed out the problems at Bear Sterns, Lehmans and the big insurers before anyone else.” So what of the future? Noster believes the prime brokerage model has to survive: “They make our business so much easier. I couldn’t be in business without a strong prime broker.” Also, most do not see the need for a full-scale reinvention of prime brokerage. Chackman says: “Our basic product hasn’t changed. We still provide leverage and access, but it’s how we go about providing those things that has changed.” He continues: “I think prime brokers are really going to need to encompass everything for the client – deal flow, execution, ideas - to ensure prime brokerage remains profitable and relevant.” This will either be done by being big, or by being flexible and accommodating outsourcing and the multi-prime concept. The death of prime brokerage has been widely exaggerated and providing they succeed in implementing the changes to custodial relationships and reexamining their charging structure, hedge funds are unlikely to turn wholesale to other models. Z

22ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009

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GSL05 18-38 CM.indd 23

29/07/2009 13:46

technology

Operations comment: Pirum Rupert Perry of Pirum Systems outlines the significant cost and performance benefits of an automated billing process. Efficient Billing Processing The processing of securities lending bills is a core function of any securities lending operations department. Ensuring bills can are paid on a timely basis (typically within 10 working days of the end of the month) is key to ensuring the smooth running of the business and to avoid any unnecessary and unexpected funding costs. Sending The Bill Until recently, most securities lending bills were delivered in paper form. All of the bills were printed, then carefully separated into the correct pages per counterparty and finally delivered to the intended recipient, either by hand or by courier. In some cases, a single bill could run to more than 5,000 pages, requiring more than two boxes of paper for each such bill! A paper-based billing delivery process is time consuming, error-prone, inefficient (by modern standards) and hence expensive. In July 2009, ISLA issued a new best practice statement recommending that securities lending bills are sent in electronic formats either via vendor platforms or else directly to recipients using ISLA’s own new standardised electronic billing format, as detailed in the best practice statement. Bills sent in a standardised electronic format are not only easier to be handled and sent, they are also easier for the recipient to process in that they can be processed by automated reconciliation tools or easily searched / filtered and manipulated by the recipient. Bills sent via vendor platforms have a number of additional benefits – Firstly, little or no technical work is required for participants already using an industry vendor, because the same data feeds that are used for billing reconciliations can be re-used for the

billing delivery service. Secondly, by configuring automatic bill delivery to pre-defined recipients, a more efficient and controlled process is put in place which minimises the manual effort required from the billing team. It also significantly reduces the risk of sending a bill to the wrong recipient - an easy mistake to make when bills are instead sent manually via e-mail, fax or post. Paying The Right Amount When a bill payer receives a billing statement, the first step is to check whether the amount requested for payment can be agreed immediately or not. This is done by comparing the amount the payer expects to pay, which is calculated using the payer’s own statement produced from their own books and records with the amount on the bill that has been received. Where the amount agrees, payment can be made immediately and these bills are usually paid on time. Where borrowers and lenders have been actively using automated contract compare on a daily basis, any differences between both parties books and records will usually have been fixed over the course of the previous month. While this is generally true, some contract compare differences automatically fix themselves without intervention (eg, a timing difference relating to when a trade settles) while others may never have shown up on contract compare at all (eg, a back dated rate change applied by each party on different days). These differences will still show up as month end billing breaks, despite not appearing on contract compare. Where contract compare has not been actively employed, there will be differences on the month-end bills which require reconciliation and further investigation. While it is possible to reconcile a billing statement by hand, very few bills are actually reconciled this way because of the amount of manual effort required. Most bills are now reconciled via an industry standard vendor platform which automatically compares

the billing accruals for every trade each day. This type of reconciliation will automatically identify the specific trades and dates that are ultimately causing the billing total to disagree. Users from both parties can then focus their efforts on investigating the identified discrepancies to determine who has the correct information. An automated billing reconciliation tool not only identifies the discrepancies, it also lets users prioritise their investigative work by focusing on the largest billing differences first and to communicate what needs to be done to fix each problem to the counterparty. This enables both parties to work through all important differences and agree the final bill to be paid. Conclusion Billing automation, both for sending bills and reconciling them electronically, is the key to timely and efficient processing of bill payments. Billing teams have an understandable tendency to prioritise the processing of bills that are received and reconciled in electronic format, because they are so much easier to process than bills that are received in a non-structured format which cannot be reconciled automatically. When bills are sent and reconciled by hand, they are often paid late if the amount requested cannot be immediately agreed, because the manual reconciliation process is so time consuming. Z Rupert Perry is director of Pirum Systems.

24ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009

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GSL05 18-38 CM.indd GSL pp01-15 GT2.indd 25 15

EDINBURGH • LONDON • TORONTO • SYDNEY

29/07/2009 13:46 5/8/08 12:15:12

Global Securities Lending 2009

PAnEL:ÊR EPO

Panel: Repo 1. Will the quality of bonds be of greater importance for the rest of this year for repo market trading? ASTANIN: Yes, it will. In the period of the global financial crisis the credit risk of bond issuers would be one of the main factors which determine investor’s appetite to buy bonds and use it as collateral in repos. WYLLIE: The quality of the securities involved in the repo transaction dictate whether or not a trade is executed. Participants have remodelled their cash reinvestment programs using a far more conservative approach, where highlyrated, liquid securities are the preferred investment option. There is definitely a flight to quality with a focus on the diversification of repo collateral. Counterparty risk and the value of contract assets are also impacting the amount of repo trading taking place. Volatility in credit markets has reinforced the commitment to enhanced risk management, forcing clients to review portfolio guidelines to determine their appropriate tolerance for risk. BALDWIN: This is not a simple question to answer, as the issue is multi-dimensional. Quality of underlying collateral has always been an important factor in the repo market and will remain so. However, since the beginning of the market turmoil almost two years ago in August 2007, there has been a re-assessment of the relationship between collateral quality, counterparty risks and also liquidity in the underlying asset markets under varying conditions. Going forward, the risk adjusted return is likely to be at more tenable levels for all market participants than was seen just prior to the turmoil as counterparties re-assess the particular areas of the repo market they have both the expertise and appetite for. The most active areas in the repo market are likely to remain in the higher

Our panel debate this issue covers repo trading and the quality and supply of securities are the focus topics...

end of the collateral spectrum. MITCHELL: The quality of bonds will remain of great importance but not necessarily of greater importance for the rest of the year. Those that accept non Government bonds as repo collateral have in most cases adjusted their acceptable criteria and are comfortable with the liquidity and pricing of the underlying issues. 2. Repo trading in government bonds increased to 84.7% from 81% according to an ICMA survey. What areas of corporate bonds might investors consider taking as collateral and what would be the considerations behind it? ASTANIN: Talking about the Russian repo market, it seems that new corporate bonds and Eurobonds of state (or quasi-state) companies such as Vnesheconombank, JSC VTB Bank (Vneshtorgbank), JSC «GAZPROM»/ GPB OJSC (Gazprombank), Savings Bank of the Russian Federation, Joint Stock Company “Russian Railways” and others would be used effectively as collateral in repo. The reason is their very low credit risks. Some of these companies have issued new bonds in 2009 and have announced to do it in the future. WYLLIE: The continued flight to quality is apparent in this recent survey suggesting government backed bonds are still the preferred repo investment. Investors seeking incremental alpha may choose to consider corporate paper providing the underlying security meets the client’s specific risk parameters. An expansion into investment grade corporate bonds but limited to the most liquid, highly rated paper is likely. The determination will still need to be based on other factors such as counterparty risk, collateral quality, liquidity of security and price transparency as the key components of corporate acceptability.

Eddie Astanin is deputy director/chief operating officer at The National Depository Center. He manages day-to-day NDC business processes, responsible for corporate development, technologies, financial and administrative activity. He is on the Boards of Directors of Settlement and Depository Company CJSC and Depository Clearing Company CJSC. Astanin joined NDC in 2004 after holding different positions at MICEX CJSC, including as Director of Government Securities and Money Market Instruments Department.

Tony Baldwin is head of short term interest rates and funding at Daiwa Securities SMBC Europe. The firm is based out of London and its operations are currently split into four different areas: equity, fixed income, investment banking and derivatives.

26ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009

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PAnEL:Ê REPO

BALDWIN: Understanding the collateral quality and the liquidity of the underlying asset market is key to the repo markets and investors are continuing to look at this carefully. The number of corporate bonds that are eligible for central bank operations has increased (on a temporary basis)

Yvonne Wyllie serves as head, securities lending for RBC Dexia’s Market Products and Services group. She is responsible for the overall strategic direction of the securities lending business globally, including product management, trading and operations. She has over 15 years’ experience in the securities lending business with RBC Dexia, and has served in a number of roles including trading, relationship management, business development and product management.

Gareth Mitchell is EMEA head of securities lending trading at Citi. He joined Citi in January 2000 from Deutsche Bank where he managed European bond lending for the custody securities lending area. Throughout his career, Gareth has participated in numerous industry groups, including the Bank of England Gilt Repo Sub-Committee.

and this provides an element of comfort for the banking system and repo liquidity overall. Government (including supranational, agencies, government guaranteed etc) issuance is increasing as deficits increase in the West. Therefore the mix of collateral available in repo markets is also changing from its previous balance. Most rational investors will concentrate on the sectors of the market where they have most expertise and therefore confidence regarding valuation of collateral. Any inability to assess valuation or opacity in underlying credit of corporate bonds is likely to be a hurdle some investors will be unable get over.

“The tri-party model is recovering well and has many positive advantages over less automated types of repo” Tony Baldwin, Daiwa Securities SMBC Europe MITCHELL: The ‘flight to quality’ affected the repo market just as it affected all bond markets. As liquidity in corporate bond markets reduced dramatically, the willingness of investors to receive such bonds also suffered as it became very difficult to price the collateral. Corporate bond liquidity has improved this year and some investors have looked at improving their returns by accepting corporate bonds as collateral. Investors, in specifying the acceptability of collateral, will at a minimum take into account the type of the bond (structured/ non structured), ratings, pricing age, concentration and margin requirements. 3. Some claim the ‘unsecured’ forms of financing will decline in favour of the relative security of repo transactions. How do you assess this view as trading volumes start to

increase a little again – does it bode well for the repurchase market? ASTANIN: There are quite developed legislation, risk management and unified automated technologies on the security market. That is why it helps market participants and investors to run liquidity using repos, reverses, securities lending, collateral management. We see that Russian banks have appetite to provide securitisation business into the market. Also it sounds good that after the global financial market impact in the second half of 2008 to the first quarter of 2009 the Russian market turnover has started growing again. It means that some signs of market stabilisation and recovery have appeared. But we are aware that there is quite high level of uncertainty about the global economy perspectives. That is why we expect high level of volatility in the market. It may impede repo market recovering. WYLLIE: The repurchase agreement market, which was severely impacted after the demise of Lehman Brothers in September last year, is showing signs of recovery as institutions and investors seek secured lending in an attempt to reduce risk. As volumes improve and credit markets stabilise, repurchase transactions will regain favour among participants and continue to play a vital role in financial markets. The unsecured form of lending will further decline as the focus in today’s environment continues to dedicate stringent risk management practices and collateralisation of all underlying exposures. Regulators will seek to encourage more secured lending while restricting unsecured. BALDWIN: The focus and reliance by money markets on “unsecured “ forms of financing will likely decline going forward for a number of reasons. The Basel II accord creates an international standard to be used in creating regulations about how much capital market participants need to put aside to guard against the risks in the financial markets. Naturally, under these guidelines unsecured

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lending is ascribed a higher risk than secured lending such as repo. As such the provision of unsecured financing is much less efficient from a capital perspective, compared to the secured lending environment. Equally, risk considerations have come to the fore after the turmoil and are unlikely to abate in the near future, therefore further strengthening the case for a further move toward repo (and other secured financing) markets. New participants (typically cash lenders) to the markets are also likely to favour repo, given the 100% credit risk inherent in the unsecured forms of financing. Finally in the midst of the crisis the unsecured money markets froze, whereas the repo markets (although strained) remained active in higher quality collateral. This should give investors confidence in the robustness of the repo market. MITCHELL: The past two years has forced cash lenders to re-assess their exposures to banks and financial institutions and look at risk mitigation. Repo provides an extra layer of protection if a counterparty were to default. Due to this we have seen a number of new entrants to the repo market and many more considering how to get involved, especially from the corporate sector who have traditionally relied on unsecured bank deposits. Repo is a more complex product than unsecured bank deposits. Legal agreements need to be negotiated with each counterparty. Systems are required to control the trading, trade monitoring, collateral margining etc. Experienced staff are needed to transact the trades and Risk/Credit staff need to understand the product. All of this can look onerous and the expense can outweigh the benefits. This has lead Citi to launch their Directed Agency Investment Service (DAIS) which allows participants to easily enter the Repo market without investing in all of the above. 4. The repo market has been a leader in the use of electronic trading, including occasionally through

a central counterparty or on an ATS – which has potential benefits in reducing certain risks. But what percentage of trades will remain, irreducibly, on a bilateral, relationship basis? ASTANIN: At the moment we can estimate it only theoretically because the repo market with CCP has not launched yet in Russia’s financial market. However we feel there is quite strong market demand for this service and we are on the way. We expect that the MICEX Group will offer this service to the market participants by the end of 2009. In this case we think that the repo market with CCP will get 75-80% market niche in short-term. WYLLIE: Repo is still traded in large volumes over the counter (OTC) which can lead to increased levels risk. However, these risks are still within acceptable levels and will not reduce the execution of trades completely between counterparties on a bilateral level. The “Know your client” rule along with relationship based trading will continue to represent a large percentage of the overall repurchase market. However, we anticipate CCP and ATS will continue to garner a larger role in the repo markets as dealers begin to expand their businesses, minimize risk and create greater price transparency. BALDWIN: As ever it depends on the strength of the counterpart whether they be CCP or bilateral.The bonds in CCP are generally those that are most liquid in the cash and repo markets. Collateral that is a little more “credit driven” and esoteric is likely to remain within the bilateral arena, where finer details of repo transactions can be negotiated between counterparts on a case by case basis. ATS increases the ability to straight through process repo trades and this is essential in a market with increasing volumes. MITCHELL: Electronic trading has by far the majority of very short term trades, which are the highest volume, but to date most trades over a week still go direct or through a broker. There is

nothing to suggest that this will change in the near future. The relationship and information flow probably outweighs the reduced cost of using an electronic trading system. Settling trades via a central counterparty not only reduce certain risks but has balance sheet benefits as well. 5. Is the repo market a good indicator as to the wider leverage activity, or not, in the market? ASTANIN: I think that the repo market is a good indicator of leverage activity. It depends on many factors, but definitely illustrates the growth of participant’s trading activity and is a good indicator of market recovering WYLLIE: Since the collapse of Lehman Brothers, banks have cut credit and increased capital ratios resulting in reduced overall repo activity. Globally, with the increased government regulations worldwide, banks have been deleveraging their balance sheets, causing the pronounced contraction in repo markets. As a result, they no longer have the same lending capacity and must focus their efforts on strengthen their liquidity ratios. BALDWIN: There are many measures of leverage available and repo activity has been used as one such estimation in the past. With money markets distilling towards secured forms, repo volumes should increase in the future. However, these increasing volumes may mean the repo market activity is no longer a viable measure of leverage, especially as rehypothecation and the general efficiency of the market in recycling collateral will create an overstated (due to multiple counting) measure of leverage. MITCHELL: The repo market is one indicator of leverage activity but there are other ways that leverage can be obtained. Therefore it may be misleading to look at this in isolation. Most banks and broker dealers are being forced to reduce balance sheets and deleverage their trading books. Repo’s advantage of being on the whole a very liquid market has perhaps

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allowed banks & broker dealers to reduce their repo book size a lot quicker than some other books and therefore show reduced balance sheets. Levels of leverage have been focused on as an important measure of risk and whilst it shows there is more capital at risk it does not give a true measure of the actual riskiness of the positions. 6. The share of total business conducted on repo desks that was accounted for by securities lending fell from 21.7% to 12.5%, in just a few months, according to the December 2008 ICMA survey. Do you see the repo market changing in its relationship with securities lending? ASTANIN: At the present time the Russian legislation does not recognise securities lending as a market practice. For that reason all trades concerning securities lending and borrowing are based on the repo technologies, since the Russian repo market is well regulated. In the second half of 2008 we saw huge volumes of repo especially with the Central Bank of the Russian Federation. The reason was cash liquidity, not lending though. Talking about declining securities lending volumes on the whole I suppose that one of the reasons was short-trading bans which regulators put on the markets including the Russian market. The other reasons may be rocketed credit risks of issuers and the deficit of reliable collateral for repos. WYLLIE: The percentage drop in non-cash security lending activity was also evident in the repurchase markets. Hedge funds continue to deleverage and reduce positions since the credit crunch started in 2007. Overall, banks have tightened and shorten the term structure on which they will conduct business with them. As a result, 15% more hedge funds were liquidated in the first half of 2008 than in 2007 and an entire decade of easy credit are being unwound. Problems surrounding cash based collateral management programmes are now encouraging some securities lending clients to

seriously consider other program like non-cash options that reduce risk. This will nevertheless have an effect on the repo markets with a decrease in requirements for firms. BALDWIN: The December 2008 ICMA survey followed an extremely volatile period in the market, after the collapse of Lehman Brothers. This period saw some lenders withdraw from the market completely as they re-assessed their lending models. Since then lenders have been returning to the market, albeit with generally tighter collateral and re-investment criteria. Securities lending is an integral part of the repo markets and will continue to be so in the future. MITCHELL: There are a number of reasons why the securities lending business with repo desks has reduced and it is more that the securities lenders have changed their relationship with the repo market rather than the other way round. Post-Lehman, many lenders reviewed their securities lending programs and in some cases completely pulled out. Those that remained altered their lending and cash reinvestment guidelines to reduce risk. Cash that was raised by lending bonds and reinvested into various short term money market instruments has reduced as focus is now more on the risk of the reinvestment asset. 7. How do you assess the success of tri-party repo? ASTANIN: According to the MICEX Group strategy we are going to offer the tri-party repo service to the market in 2010-2011. We believe there is quite strong market demand for this service. WYLLIE: Triparty repo is a vital component of financial markets, providing liquidity for both dealers and investors. Last year, investment banks funded up to half their balance sheets through short term repo. The structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman. The illiquidity in September

was so severe that creditors lost confidence that they could recoup their loans by selling collateral. Those events highlighted that there are certain gaps in the tri-party repo process that need to be addressed and certain levels of risk management that still need to be enhanced. The Federal Reserve is in talks with banks and securities firms about changing how transactions are processed to reduce risks in the over USD5 trillion-a-day repurchase market. The changes include a central clearing system, which is similar to the European model. The flexibility of the European tri-party repo market, which allows users to switch between different types of collateral, helped ease funding strains last year. BALDWIN: Tri-party volumes took a significant hit post Lehman. The tripartite model is recovering well and has many positive advantages over less automated types of repo. The success of the tri-party repo should be measured in its ability to adapt in the new market conditions and opportunities in collateral markets. This includes the usage of triparty methodologies within CCP models. The signs for the tripartite model in repo are encouraging. MITCHELL: Tri-party repo has transformed the repo market over the last 10 years. The ability to trade in large size against a pool of collateral would have been operationally very difficult to manage and expensive. Counterparties are able to specify sophisticated collateral parameters to aid risk management and triparty agents offer reporting tools and file downloads to monitor all aspects of the trades. Standardised collateral baskets and the ability to re-use collateral will increase triparty use over the next few years. In the past there has probably been more focus by the triparty agents on the collateral giver rather than the collateral receiver. This has or is being addressed now with more functionality for collateral takers to specify acceptable collateral in much more detail. Z

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PROFILE

Borrower profile: Noster Capital Pedro de Neronha, managing partner at Noster Capital talks to GSL What is Noster Capital’s involvement in lending and/ or borrowing securities – what strategies does it serve? Noster Capital is a Global Value Fund which invests in both long / short strategies along with other asset classes. We are frequent users of lending desks in order to source borrow. Do you have a single – or multiple – prime broker set up? We operate a single prime broker setup, Goldman Sachs being our sole prime broker. We feel it is very important to have one prime broker as it makes the whole admin side of the business easier to run. We understand though, the reason why bigger funds have more than one prime broker, but if your prime broker is strong there are not many reasons to look elsewhere. Some have speculated that the traditional prime brokerage model has broken – some say it has just merely changed, such as with increased demand for client asset segregation and issues around rehypothecation. How would you describe the situation now and your relationship with brokers? We don’t think the model is broken, it is simply being reshaped as there were some flaws that became apparent after the Lehman collapse. Goldman has been constantly improving its risk management procedures to avoid the issue that surfaced last fall. The prime brokerage model needs rehypothecation, its almost the bread and butter of their business. Funds who use extreme leverage cannot expect to have their assets segregated. But there are several ways

for underleveraged funds to have assets segregated in times of financial stress. We believe the model will become stronger and better after this crisis. How will the brokerage model evolve? We think more regulation is inevitable, and the fact that bank leverage will be more limited in the future will self-impose more restrictions on many funds. Is a central counterparty the right way to go for securities lending and borrowing – will it benefit your activities? There are definitely markets that would benefit from a central counterparty, the CDS market being one as it would help mitigate the inherent credit risk that exists in every transaction, and it would make banks balance sheets easier to read. However, we don’t believe that a central counterparty for securities lending would be beneficial at all. One of the competitive advantages of having a Prime Broker like Goldman is that they are the best at sourcing borrow.

What is your outlook for the rest of this year – will regulation, or market circumstances, dominate? Candidly, what matters to us is the market and the economy. There is nothing that we can do regarding increased regulation (which will come, as our industry will certainly be taken as the scapegoat). But our fiduciary duty is to make money for our investors and that is precisely where we focus all our energy. We don’t think our business would be materially impacted by increased regulation, as we take very little leverage overall and our business is nimble and straight forward. Z

“If your prime broker is strong then there are not many reasons to look elsewhere” We don’t think it would be fair for a client of a second tier prime broker to have the same access as clients of more established prime brokers. 2009Ê |Ê GlobalÊ SecuritiesÊ LendingÊ MagazineÊ |Ê Ê Ê 31Ê

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TRADInG

From the trading floor

Credit risk is, to many, still the talk of the town post Lehman. But market risk managers have also had their fair share of issues to contend with. Here, Richard Smither, head of structured portfolio trading at Daiwa Securities SMBC in London, explores how securities financing is going ‘back to basics’.

methods, using a value-at-risk approach, were notably compromised. This was thanks to the breakdown of historic correlations, unprecedented price volatility and marked collapse in liquidity. A number of asset classes suffered wide bid offer spreads, not just in relation to asset backed securities that were typically marked-to-model. As a result, managing market risk became an intense process (to put it mildly) through the daily re-pricing of certain securities to reflect lack of market liquidity and altering margin rates to reflect increased price volatility. The result of this action added to the Credit risk managers should, one overall de-leveraging effect on hedge hopes, be in demand like never funds looking to survive not only huge before. The change in emphasis to performance losses but forced selling counterparty credit risk in securities and investor redemptions. lending markets following the collapse Whilst risk exposures have of Lehman Brothers is, after all, well remained high in recent months, when documented. Put simply, credit risk measured using historic time series became the key consideration not just data, it is clear that some liquidity for securities lenders, but also hedge has, thankfully, returned to the market. Hedge funds that survived funds and investors. Naturally, all concerned were anxious to ensure their the crisis have stabilised capital bases and activity in securities lending has capital and assets were secure from returned, albeit at far more modest future bankruptcy events. But let’s spare a thought for market levels of leverage. Since the take off of the European risk professionals too. Following hedge fund market in the late 1990s, the events of late 2008, traditional

leverage has undoubtedly increased year on year as pressure for yield has resulted in prime brokers offering more capital efficient margin frameworks through recognition of portfolio offsets and risk based/ scenario margin platforms. With less leverage now employed, however, demand for aggressive margins has diminished. As a result, we have seen a return to a more traditional approach to collateral using a basic margin grid framework at higher base levels. Funds caught by the double hit of falling asset values and rising collateral calls are now more concerned with certainty of their margin framework. Unsurprisingly, funds are prepared to pay higher rates in exchange for stability of margin through term facilities or grace periods in mutual termination clauses in derivatives transactions under ISDA contracts. Securities financing now has the feel of a more ‘basic model’, with leverage provided for securities primarily trading on main exchanges. Appetite for lending against more esoteric securities has diminished with prime brokers continuing to focus on asset liquidity and price transparency. Z

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GSLÊ SuMMITÊ -Ê REvIEw

The tour so far London - Lending for Liquidity Summit, May GSL’s second Summit in Canary Wharf, on 14th May, developed the themes covered in the first Summit with an emphasis on the relationships involved in securities lending and – in particular – addressed the concerns of beneficial owners. Roy Zimmerhansl turned from panellist at the first Summit to conference chair, and presided over two discussions. Before the debates, Mark Faulkner from Data Explorers gave a ‘State of the Industry’ overview, and James Clunie of SWIP delivered an academic view of securities lending and short selling. In particular, he pointed to an abundance of studies that indicated that markets that banned short selling were generally less efficient regarding price discovery. The first panel comprised of beneficial owners - in the form of Sarah Nicholson at Aviva, Joyce Martindale of Railpen and Nina Moylett at PruCap – and service providers: Sonja Spinner of Mercer Consulting, Jane Milner of SunGard and David Lewis of JP Morgan. Mr Zimmerhansl began by reiterating the importance of the supply side when generally there is a focus on the industry as demanddriven. He added that market turmoil has caused a lot of beneficial owners to consider stopping their lending programs but cannot due to the loss that would incur, particularly in trying to liquidate cash reinvestment positions. David Lewis of JP Morgan concurred with this and said many trustees would be looking at the maturities of their reinvestments. “It’s the mark-to-market loss which is the issue,” he said. “If you have to move it will have to be a big check. People don’t really want to do that, so they will stay where they are and ride out

Clockwise from top left: Roy Zimmerhansl, conference chair; Ben Sofoluwe, Deutsche Bank; Mark Faulkner, Data Explorers; Simon Luhr, SW1 Capital the storm.” Mr Lewis was adament that securities lending was a front office business and said the reinvestment element is now occasionally called an ‘investment management overlay’. Sarah Nicholson explained that Aviva had been in securities lending for more than forty years, and the industry had definitely developed from a back office activity to something more front office. She explained that her company’s business began to change 18 months ago “in recognition of the value securities lending could offer clients”. “We looked at the skill sets involved - the collateralisation, the ability to price and raise cash - and recognised those skills sets as key to a lot of the investment strategies that our fund managers were looking for,” she said. She added that securities finance and stock lending was integral to the global client solutions of the firm. “The process of extracting the liquidity premium within the assets that the long only fund managers hold is

very much seen as a core investment strategy. Just as a fund manager might buy an asset to extract the credit risk and the premium with that, secuities lending is there to extract the liquidity risk. “If you’re going to hold UK gilts for 20 years, make them work: extract the short term liquidity and generate the additional returns.” Nina Moylett at PruCap explained that her firm restructured five or six years ago to make securities lending a stand-alone business capitalised by the parent company. “We spent a lot of time working with our underlying funds to identify the risks of securities lending and to make clear through indemnity where those risks sit,” she explained. “I think over the past 18 months that’s been the biggest positive from our programme, so where things did get tricky, we were extremely clear as to where those risks were sitting.” To the question as to whether securities lending is a front office activity, Joyce Martindale of Railpen

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replied: “Yes, with a caveat.” She explained that the fund lends through a custodian which includes customised agreements. She added that the fund spent a long time saying ‘what if ’regarding the default of a major broker. To the same question, Sonja Spinner said: “I think the answer to that is that the ones that weren’t now are particulrly when lending against cash.” She added that the average Mercer client is a pension fund between USD5,000,000 and USD4 billion and said many of the conversations she had had recently with them concerning securities lending had been negative ones, particularly where they had not understood the risks. Risks have devloeped partly, she said “where trustees have made decisions invested in pooled funds; so they haven’t been appointed the agent and haven’t been in control of the securities lending program - that’s[instead] been their asset manager. I think there have been some asset managers who’ve made some very interesting decisions on behalf of their clients and its going to cost the mandates.” David Lewis asked Spinner if trustees had been “asleep at the wheel” regarding their responsibilities to understand risk. She denied this, and pointed out there had been some cash reinvestments that did respond to the market and adequately manage those changes. However, she added, “I’ve seen cash reinvestment pools which are 70-80-% in illiquid ABS. That’s difficult.” She said though it might be in the mandate to invest in this way, whether this should be the reality is questionable. An audience member pointed out that – contrary to the tone of the discussion – cash reinvestment does not always equal loss. Mr Zimmerhansl agreed, and pointed to a slide presented by Mark Faulkner that showed that 97.9% of US pension plans took cash collateral. “That puts it into a context, because 97.9% haven’t lost money,” he said.

Jane Milner, a market specialist at SunGard, said the firm has been at its busiest for while in entering discussions with clients as to the systems they are using. “At this point in time, when we might feel that there might not be a lot of activity in terms of the investigation of solutions, we are perhaps busier at this moment than we have been for some considerable time.” On the second panel, Mr Zimmerhansl explained that he had asked the speakers to put forward views as to how the future will look based on current market changes. Ben Sofoluwe of Deutsche Bank explained that he would look to the future by looking at the last six to eight months and assess the trends he has seen. Firstly, he said the issue of segregated accounts for hedge funds was climbing the priorities list. Fewer hedge funds would be leaving assets with a broker, and pointed out that the USD45 billion of so worth of assets still tied up in Lehman Brothers was a reminder of the danger of default. Instead, two new and similar models for separate accounts have emerged. The first is for a hedge fund to place client assets in a segregated account with a custodian to fully protect investors. The second model segregates assets in a similar way but through an SPV. “There’s a huge competitive advantage for the prime brokers - and the hedge funds that sign up with these brokers - that have this model set up. They can prove to the investors that assets are segregated in the event of a default and would have no problem in removing the assets. So in the future I don’t believe any hedge funds will be able to go to their investors without insuring their with a prime broker which has this particular model.” The pricing of hedge fund assets was another sea change, he said. A few years ago, he said, “you just wanted to bring a hedge fund on, price their assets at one flat level and you weren’t too interested in the underlying asset, the liquidity, risk profile... financing

your balance sheet was a secondary consideration. But as we’ve talked about today, the bank model is broken, there’s no interbank lending, so it’s all about balance sheet. Up to about 18 months ago balance sheet was just a term thrown around by accountants, but it seems everyone is talking about it now.” He added that market players are looking at the underlying assets and the repo values, and now have a sliding scale of pricing: the highest will be the illiquid securities, level all the way down to the least risky and liquid. Mr Zimmerhansl asked Mr Sofoluwe as to the benefits of added transparency to the market. Mr Sofoluwe said: “There are a lot of prime brokers that don’t want transparency for the reasons of protecting spreads, but there are a lot of regulators who want it. The argument will run and run.” Simon Luhr of SW1 Capital said that the market has changed dramatically over the last 18 months and it has affected prime brokers. “The difficulty right now is: how do you make the transition?” He said he was not convinced as to the SPV model for segregated assets, and said those who are pitching this idea tend to be those without custodians. “I think more and more from a hedge fund point of view will be looking for a tri-party arrangement. If we’re leveraging and pledging securities as collateral, we don’t want to pledge them into a bank that then goes down.” On the subject of ETFs, Mr Luhr said the swap-backed funds expounded by db-xtrackers had the best tracking performance, and countered an argument from the audience that the ‘in specie’ ETFs gave a clearer view during a market fall-out what an invetors was investing in. “If you look at db-xtrackers, all swap-backed, they’re bang on TER. BGI are miles off. Some China indices that aren’t swap-backed were 60% off their benchmark index.” Z

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PEOPLE

GSLÊS uMMITÊ REvIEw

ThoughtsÊa ndÊ observationsÊ fromÊJa neÊ Milner,Ê SunGard,Ê SecuritiesÊ FinanceÊ StrategyÊ andÊ Marketing whatÊwe reÊyo urÊ overallÊim pressionsÊ ofÊt heÊe vent? IÊthi nkÊi tÊwa sÊti mely,Ê wellÊstr uctured,Êa ndÊ asÊ aÊd iscussionÊb ased,Ê local,Ê halfÊ dayÊ eventÊ itÊ offeredÊa Êfor matÊ welcomedÊ byÊ marketÊ participants.ÊTheÊtop icÊofÊL endingÊfor ÊL iquidityÊi sÊ certainlyÊÔ ofÊtheÊmomentÕ Êa ndÊr esonatedÊwel lÊ withÊtheÊa udience,Êd rawingÊoutÊgood Êa udienceÊp articipation.ÊTheÊSummi tÊa ttractedÊa Ê sizableÊa udienceÊfr omÊa Êcr ossÊsecti onÊofÊtheÊ securities finance community, and I believe it setÊa Êgood Êp recedentÊfor Êfutur eÊevents. wasÊt hereÊm uchÊ evidenceÊofÊt heÊ fallout from the financial crisis in the generalÊm oodÊa tÊt heÊe vent? The financial crisis is never far from anyone’s mind,Êb utÊtheÊgener alÊmood Êwa sÊoneÊofÊr eliefÊ thatÊtheÊwor stÊi sÊp erceivedÊtoÊb eÊover ,Ê combinedÊwi thÊtheÊna turalÊop timismÊofÊma nyÊi nÊ thisÊma rket.ÊTher eÊwa sÊa Êfeel ingÊtha tÊtheÊÔ letÕ sÊ waitÊa ndÊseeÊwha tÊha ppensÊnextÕ Êconcer nsÊ areÊgr aduallyÊb eingÊa ddressed,Êsup plyÊa ndÊ demandÊi sÊsl owlyÊr eturning,Êb ringingÊwi thÊi tÊa nÊ increasedÊa bilityÊtoÊi nvestÊi nÊtheÊfutur e.ÊThi sÊi sÊ resultingÊi nÊtheÊr ecommencementÊofÊhi ringÊi nÊ someÊq uarters,Êa ndÊtheÊconsi derationÊofÊa dditionalÊi nvestmentÊfr omÊa ÊsystemsÊp erspectiveÊtoÊa ddressÊnewÊma rketÊcond itions.Ê whatÊwe reÊt heÊh eadlineÊ topicsÊ discussedÊa ndÊh owÊwe reÊ theyÊ Ê approached? TheÊhea dlineÊtop icÊwa sÊma rketÊl iquidityÊa ndÊ theÊp artÊtha tÊsecur itiesÊl endingÊp laysÊa sÊa Ê vitalÊsour ceÊofÊl iquidityÊtoÊtheÊwi derÊma rkets.Ê TheÊÔ StateÊofÊtheÊI ndustryÕ Ê addressÊ gaveÊ statisticsÊonÊwha tÊha sÊha ppenedÊtoÊsup ply,Ê demandÊa ndÊsp readsÊover Êr ecentÊmonths,Ê andÊga veÊa Êsomewha tÊscep ticalÊvi ewÊofÊ whatÊi sÊseenÊb yÊsomeÊa sÊÔ greenÊshootsÕ ÊofÊ recovery.ÊJa mesÊCl unieÊga veÊa Êga llopÊthr oughÊ theÊhi storyÊofÊa cademicÊ researchÊ intoÊshor tÊ selling,Êa ndÊconcl udedÊtha tÊtheÊr ecentÊb ansÊ hadÊd emonstratedÊonceÊa gain,Êtha tÊther eÊi sÊ noÊevi denceÊtoÊsup portÊtheÊb adÊp ressÊwhi chÊ shortÊsel lingÊp eriodicallyÊr eceives.ÊT woÊp anelsÊ thenÊfocused ÊonÊd ifferentÊa spectsÊofÊwha tÊ needsÊtoÊha ppenÊtoÊfuel ÊtheÊr eturnÊofÊl iquidityÊ throughÊl ending. youÊpa rticipatedÊin Êt heÊÔS ecuritiesÊ Lending – a Front Office Investment?’ panel,Êwh atÊwe reÊ theÊ dominantÊ themesÊfr omÊt hatÊ cameÊ out? Much of the focus was on beneficial owners andÊhowÊi mportantÊi tÊi sÊfor ÊthemÊtoÊha veÊ an understanding of the wider benefits of theÊl endingÊp rocessÊi nÊor derÊtoÊr emainÊful lyÊ engaged.ÊTheÊvi ewsÊofÊi nsuranceÊcomp aniesÊa ndÊp ensionÊfund sÊwer eÊr epresentedÊ

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alongÊ withÊ thoseÊ ofÊ aÊ custodianÊ lender.Ê TheÊ presenceÊ onÊ theÊ panelÊ ofÊ aÊ representative of a legal consulting firm highlighted the unusualÊ timesÊ thatÊ weÊ areÊ facing,Ê andÊ thereÊ wasÊ discussionÊ aroundÊ theÊ questionÊ ofÊ Ô whoÊ ownsÊ theÊ riskÕ Ê andÊ theÊ divisionÊ ofÊ responsibilityÊ between beneficial owners and their lending agents/advisors.Ê TheirÊ discussionsÊ questionedÊ whetherÊ theÊ recentÊ focusÊ onÊ riskÊ (inÊ particularÊ cashÊ re-investmentÊ risk)Ê wasÊ dueÊ toÊ lackÊ ofÊ transparencyÊ onÊ behalfÊ ofÊ theÊ agents,Ê or beneficial owners being caught ‘asleep at theÊ wheelÕ .Ê RegardlessÊ ofÊ whereÊ blameÊ lies,Ê theÊ unprecedentedÊ recentÊ eventsÊ certainlyÊ broughtÊ intoÊ sharpÊ focusÊ theÊ needÊ forÊ greaterÊ transparencyÊ andÊ furtherÊ educationÊ ofÊ theÊ risks and rewards of securities finance. TheÊ secondÊ panelÊ wasÊ aroundÊ whatÊ theÊ futureÊ mightÊ holdÊ forÊ SecuritiesÊ Lending,Ê wereÊ thereÊ anyÊ startlingÊ orÊ contentiousÊ predictions? ThisÊ wasÊ anÊ interestingÊ panel,Ê primarilyÊ madeÊ upÊ ofÊ marketÊ participantsÊ fromÊ theÊ Ô buyÕ Ê side.Ê ItÊfo cusedÊ onÊ whatÊ changesÊ thereÊ mightÊ beÊ toÊ theÊ existingÊ businessÊ models.Ê TheÊ questionÊ ofÊwhether Ê theÊ PrimeÊ BrokerÊ isÊ deadÊ wasÊ debated,Ê withÊ theÊ outcomeÊ thatÊ theÊ modelÊ wasÊ notÊ entirelyÊ brokenÊ butÊ wouldÊ needÊ toÊ evolveÊ asÊ aÊ resultÊ ofÊ fall-outÊ fromÊ theÊ LehmanÊ default.Ê

Ò The topic of Lending for Liquidity is certainly Ô of the momentÕ and resonated well with the audienceÓ Jane Milner, SunGard ItÊa lsoÊ consideredÊ whetherÊ theÊ introductionÊ ofÊ centralÊ counterpartiesÊ willÊ speedÊ theÊ transitionÊ fromÊ bi-lateralÊ tradingÊ toÊ anÊ exchangeÊ tradedÊ model.Ê TheÊ consensusÊ wasÊ thatÊ thisÊ wouldÊ provideÊ furtherÊ choice,Ê asÊ opposedÊ toÊ aÊ mainstreamÊ change,Ê andÊ thatÊ theÊ increasedÊ transparency,Ê reductionÊ inÊ bi-lateralÊ riskÊ andÊ balance sheet efficiency that a central counterpartyÊ promisesÊ wouldÊ beÊ welcomed.Ê AnÊ interestingÊ predictionÊ was thatÊ GCÊ lendingÊ inÊ majorÊ indicesÊ willÊ moveÊ intoÊ theÊ worldÊ ofÊ ETFsÊ versusÊ aÊ swapÊ ratherÊ thanÊ traditionalÊ stockÊ loan.

TheÊ needÊ toÊ investÊ inÊ solutionsÊ toÊ manageÊ theÊ securitiesÊ lendingÊ process more efficiently is a perennial discussion;Ê didÊ thisÊ getÊ muchÊ airÊ timeÊ atÊ theÊ event? ThisÊ wasÊ notÊ directlyÊ onÊ theÊ agendaÊ forÊ theÊ event,Ê however,Ê theÊ needÊ forÊ greaterÊ controlÊ andÊ transparencyÊ wasÊ touchedÊ onÊ inÊ bothÊ panelÊ sessions.Ê ClearlyÊ recentÊ marketÊ eventsÊ meanÊ thatÊ thereÊ isÊ aÊ closeÊ eyeÊ onÊ theÊ costÊ situationÊ whenÊ lookingÊ atÊ futureÊ investmentsÊ andÊ projects.Ê TechnologyÊ andÊ automationÊ canÊ driveÊ costÊ savingsÊ soÊ evenÊ thoughÊ thereÊ isÊ aÊ downturn,Ê technologyÊ isÊ stillÊ aÊ highÊ priority.Ê AsÊ solutionÊ providersÊ weÊ haveÊ beenÊ extremelyÊ busyÊ duringÊ theÊ lastÊ sixÊ toÊ nineÊ months,Ê whichÊ mayÊ seemÊ strangeÊ givenÊ currentÊ marketÊ conditions,Ê howeverÊ firms recognise more today than ever before howÊ importantÊ itÊ isÊ toÊ continuallyÊ reviewÊ andÊ expandÊ technologyÊ inÊ orderÊ toÊ giveÊ themÊ anÊ edge. How does SunGard’s participation at events such as this benefit your customers?Ê DidÊ youÊ comeÊ backÊ withÊ lotsÊ ofÊ ideasÊ forÊ newÊ developments? OneÊ ofÊ theÊ mainÊ reasonsÊ weÊ goÊ toÊ eventsÊ suchÊ asÊ thisÊ isÊ toÊ takeÊ theÊ pulseÊ onÊ theÊ marketÊ andÊ toÊ seeÊ inÊ whichÊ directionÊ weÊ needÊ toÊ evolveÊ andÊ enhanceÊ ourÊ products.Ê WeÊ believeÊ thatÊ weÊ areÊ headingÊ inÊ theÊ rightÊ directionÊ butÊ thereÊ isÊ alwaysÊ roomÊ toÊ listenÊ andÊ learnÊ fromÊ leadersÊ inÊ theÊ market.Ê WeÊ continueÊ toÊ workÊ closelyÊ withÊ clientsÊ toÊ provideÊ solutionsÊ toÊ supportÊ theirÊ ongoingÊ andÊ newÊ businessÊ developments. www.sungard.com/securitiesfinance

29/07/2009 13:46

GSLÊS uMMITÊ -Ê REvIEw

New York North American Securities Lending Forum, June The North American Securities Lending Forum in New York, hosted and organised by Data Explorers with GSL as media partners, covered an impressive breadth of subjects and began with a closed workshop for beneficial owners. Kenneth Read of Data Explorers delivered opeining comments, and Len Welter, the firm’s head of content, gave an overview of the securties lending market, the impact of the short selling bans and the appetite to lend using extracts from Data Explorers’ voluminous store of information. Counter to the last GSL Summit that began with beneficial owners, the first panel was dedicated to the borrower community, and contained a highly experienced set of speakers: Dan Grogan of Millenium Management, Spiros Maliagros of Tiedman Investment Group, Alan Pace of Citi, Andre Stern of Oxford Asset Management and Shawn Sullivan of Credit Suisse. At this time of the year, with markets rising steadily and the hysteria around short selling and the ‘shadow’ banking system declining, it was important to keep the momentum going with regard asking the searching questions about the securities lending industry and continue to widen the debate. This was achieved in New York with one particular panel featuring the Federal Reserve and the SEC. These two bodies underlined their support for securities lending – though there is a sense in which this is the high point of securities lending’s fame, and that it

may once again nestle into the machine of capital markets. One subject touched on by these regulators - in the discussion ‘Regulation and its implications for securities finance and capital markets was the fabled uptick rule. Gene Gohlke from the SEC surprisingly admitted there was not a great deal of empirical data to work from in assessing the use of this measure, but what they had showed that – as expected – blocking the buy-backs of short sales until the share price increases is not a useful or sufficient parameter. But – equally as expected – the court of public opinion will inevitably think differently, and a clamp down on short sellers was inevitable. So although there was lot of agreement on the panel as to the necessity of keeping channels of communication between securities lending and the regulators, it was clear that a repeat of the talk might make the presence of a politician mandatory. The discussion ‘Does this industry get the press it deserves?’ saw Dan Wilchins of Thomson Reuters acting as moderator with a journalist from the Financial Times, Anuj Gangahar, among the panellists. Indeed, he, along with Rob Chiuch of CIBC Mellon, Michael McAuley of RMA and Martin Maosbacher of Intermarket Communications. The panel assessed the coverage of securities lending in the press that has often been yoked with articles on hedging and short selling. Indeed, the journalists made the best points concerning the mid-point at which journalists and industry professionals need to work closer together, with the latter needing to emerge from behind the curtain a little more. “Does the industry get the press it deserves?” asked Mark Faulkner to round up. “Yes. So get involved more with the media.” Z

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cOnFEREncES

Barcelona ISLA/RMA conference, June The ISLA RMA 18th Annual Conference on International Securities Lending at the Hotel Arts in Barcelona covered many of the key issues for the industry. Increased momentum in the areas of electronic trading and central counterparties, as well as newly-minted regulation in a number of markets, meant that it was a timely conference for international discussion. In an overview of the Spanish market, Benoit Dethier, head of business development at JP Morgan in Madrid said: “Securities lending is definitely a topic that is talked about more”, although it is still a rather closed market internationally as around 70% of Spanish assets held by Spanish companies. Gareth Mitchell at Citi said: “The ratio of general collateral to specials is 5:1; in other markets it is 10:1. There was always a significant amount in non-cash collateral. Europe followed the US in setting up collateral reinvestment.” In a discussion on electronic trading platforms, moderator Christopher D Fay of Wachovia Global Securities Lending, in London, said: “The question was: is there enough borrowers and lenders?” Sharon Walker, managing director of EquiLend Europe, revealed that at her firm, “the liquidity is increasing, as we offer a number of trading styles” and said the firm had 4,000 offers yesterday for ‘warmer’ stocks. “More participants are coming to the platform,” she added. Peter Fenichel, CEO of SecFinex, said: “The question has been, is it enough to bring people together? In the last couple of years, eliminating bilateral risk and reducing capital should be on everyone’s mind. “When markets are less opaque,

they are more efficient. There is a trade-off: maybe electronic trading is less than 5%; there will be more electronic trading in a year’s time depending on the tools’ efficiency. “Equity finance is going through lots of pressure points. The prime broker model is under threat surrounding cash equities and derivatives. These challenges need to be looked at objectively rather than through a rear-view mirror.” Gregory W. De Petris, cofounder and chief strategic officer at Quadriserv – a platform that is soon to launch a central counterparty with Eurex Clearing, said: “We started with a basic premise. From a lender’s point of view, they want stability and returns. Borrowers want access to collateral and lender stability, and make sure the things people worked out in OTC can be transferred.” The keynote speaker was Juan Andres Yanes, deputy chief risk officer, Grupo Santander, who delivered a presentation entitled “Risk Management Today”. He pointed out that we have rarely focused on risk

in a full view. In the past people might have focused on loans or trading risk orientation, but people rarely knew the overall. Risk management must become part of the decision making process, he added, and that the financial crisis was partly spurred by traders buying and selling instruments they didn’t know anything about – “sometimes they were not even reported”. He added that once a risk appetite level is defined, it must be stuck to, regardless of the return. While credit rating agencies were undergoing scrutiny from international regulators, Yanes believed that the dependency on such a third party, and fall out, was not because rating agencies didn’t do their job, but rather too much reliance on them. He added that a firm’s reputational risk is not significant with small errors, but big errors can add up to a big economic risk. “We have to have the ability to accept that across all levels that risk limits change on a daily basis, he said, and added later: “Risk managers are not goalkeepers – they must have a free role

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Scenes from the Eurex party on the Wednesday night in the field.” “I see ourselves as risk managers as having two roles. Firstly, when we define an amount of risk and expected loss, our role is how to diminish prospective loss. Secondly, how to manage the capital deployment. He said there were several key points for the future of the risk manager’s role. We should be able to challenge any position. Risk managers also need recognition at board level. We have to think on a customer level. We must be either prudent or proactive. We should never be ‘behind the wave’. In the panel debate around central counterparties, one audience member asked of the concept: ‘When will we be able to see the price information?’ Peter Fenichel of SecFinex said that for a member of the market we are clearing the volumes will be made public and we will publish the 10 biggest practitioners. In the panel ‘Changes in Regulatory Requirements Affecting Securities Lending’, moderator Christopher J Bates, a partner at Clifford Chance in London opened by saying that the short selling restrictions opened up a consultation and review of the practice. “It’s a philosophical point: most people say short selling is good. The issue is often: ‘we can live with

rules, but please can we have consistent rules?’ Michael Treip, technical specialist in the market monitoring department at the UK’s Financial Services Authority, said: “We genuinely see shorting as legitimate and valuable and an important facility. The second point is that if we seek to interfere, we must justify the intervention on a ‘net benefit’ basis.” He added that the FSA also believed shorting could be used abusively. “We accept that higher risk strategies [might entail] a greater chance of naked short selling.” Rodrigo Buenventura of the Comision Nacional del Mercado de Valores in Madrid, expected that there would not be any harmonisation for trading rules in Europe in the near term. “We’ve had a ban on naked short selling, we have not seen the Spanish market hampered by the ban.” He described naked shorting as having “infinite leverage, as you’re not putting anything up as funding”. Wayne Smith, deputy head of trading and market infrastructure/ regulatory policy and international affairs division at the Authorite des Marches Financiers in Paris, explained that France was in between Spain and the UK on naked short selling, and traditionally was concerned about

settlement disruption. He added that rules of disclosure for short positions made sense. “It’s an appropriate response [by the regulators]. Short selling is poorly understood; disclosure will help people.” David Little of Rule Financial said that banks are undergoing the “biggest strategic rethink” with many thinking “what is my capital markets arm for?”. He added that the FSA has been trying to get banks to take account of the risks they are taking, but the time scale to comply is “extremely challenging”. One of the best talks came from Julian Pittam, managing director at Data Explorers in London who, with the aid of Data Explorers statistics, gave an overview of the annus horribiilis that hedge funds have faced. The results showed that assets under management have dropped from USD2.6 trillion two years ago to around USD1.8 trillion today. Further, there were 190 hedge fund blow-ups in the US last year, with 112 in the UK. Singapore dropped the most in terms of percentages, with 17% of hedge funds exiting the market. Most interesting was around the fees paid to prime brokers. The statistics also showed that in healthy markets, many prime brokers stayed competitive by reducing fees. Now, the primes hold more of the cards, and will stop doing the services they had done for free. Hedge funds, in turn, have seen outflows as previously stated, but with prime brokerage fees going up. Z

David Rule talks to GSL.tv

38ÊÊ |ÊGlob alÊS ecuritiesÊ LendingÊ MagazineÊ| Ê2009

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e-Mail: [email protected] Website: www.icbi-events.com/kp4078gslad 27/07/2009 16:55

BBH LUXEMBOURG SEMINAR

Luxembourg - Brown Brothers Harriman In a June seminar in Luxembourg, Brown Brothers Harriman offered its guests “Perspectives on Securities Lending” and aimed to clarify the key issues surrounding the industry. Beneficial owners had the opportunity to reflect on the current and historic issues that have impacted the industry and how these lessons could be used to shape their programmes going forward. A Historical Perspective The seminar began with a look back on the history of securities lending and the wider financial shocks in the last 15 years that have shaped the market. Chris Donovan, Managing Director and Head of Global Securities Lending at BBH, said she works under the adage of the philosopher George Santayana: ‘Those who do not learn from history are doomed to repeat it.’ “It’s certainly been an extremely interesting time from my perspective,” she said. “In many ways it does offer an opportunity to reflect a bit and ask the question – is this something new? Or, as a question put to me recently, is this déjà vu?” She explained that in 1994, when several notable players were forced to take losses from collateral reinvestment, the market themes were as today: an emphasis on mitigating collateral, counterparty and reinvestment risks. In 1994 and 2008, concerns surrounded structured assets: More recently with specialised investment vehicles and asset backed securities; in 1994, with inverse floaters. “We found that many beneficial owners did not fully understand the investments that comprised much of their collateral pool. They did not understand the importance of asset liability

management, meaning the risks associated with investing long and short term liabilities,” she said of the tumult in 1994. “There was a lack of appreciation as to how securities lending revenue was derived: what percentage was generated from the reinvestment of cash collateral, and what percentage from the demand to borrow the security.” In 1995, the losses from investing collateral in commercial paper issued by Columbia Gas, and the default of Barings, reintroduced in discussions the respective topics of counterparty risk and borrower default. “From a lending perspective, the theme from Barings was interesting,” she said. It was a case in which it was “the parent company that defaulted, not the counterparty to which many entities were lending. “If your contractual counterparty did not go into default, you could not call a default under the terms of your lending agreement. That was the year that highlighted the wisdom of crossdefault provisions. For those that lived through Barings it was clear that cross default provisions, though not present in industry standard contracts, were critical for lending programmes.” The default of Lehman Brothers mirrored Barings, she said, as it was a parent company to many subsidiary counterparties, and highlighted the necessity of cross-default provisions. In summary, she said: “Securities lending makes a lot of sense when constructed appropriately and with the right provider. What history has told us is that details matter. It’s quite important that you understand the philosophical approach of your lending agent, and you understand the risk. The risks, when properly understood, can be mitigated.” What now for Luxembourg Funds? Michèle Eisenhuth, a partner at the Luxembourg office of Arendt & Medernach commented on the results of CSSF Circular 08/356 and the impact of its guidelines on securities lending activities for UCITS funds. Issued June

2008, this administrative circular is the long-awaited follow up to the prior Circular 91/75, and includes additional provisions which resulted in clarifying questions being raised to the CSSF. “It is interesting to note that the circular requests that not only the counterparty but the lending system used by the fund be subject to prudential supervision rules equivalent to those provided by EU law,” she says. While the previous circular demanded that funds receive collateral at least equal to the global value of the securities lent, the new rules state that funds only need to receive collateral that corresponds to 90% of the global valuation of the securities lent. UCITS funds were previously only authorised to receive cash or state guaranteed securities, but the scope of eligible collateral has been expanded to include (i) all types of liquid assets, (ii) some state guaranteed bonds, (iii) money market funds, (iv) bonds which are guaranteed or issued by first class financial institutions, (v) shares that are traded in regulated markets and comprised in a main index, as well as (vi) UCITS investing in bonds and/ or shares mentioned in (iv) and (v). Collateral should not be issued by an entity affiliated with the counterparty, nor safekept by the counterparty except

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BBH LUXEMBOURG SEMINAR

if the collateral consists of securities segregated from the assets of the counterparty. Further, the new regulation includes a provision where counterparty risk may not exceed 10% of the UCITS assets if the counterparty is a credit institution and 5% in the other cases, but has no restriction as to the scope of the securities lending transactions. “Before the new circular, funds were only authorised to enter into securities lending transactions for 50% of the aggregate market value of the securities in the portfolio and the limit was 30 days - this is not the case any more.” The new Circular has also introduced rules regarding the reinvestment of cash collateral. CSSF clarified that alternative funds have a choice: they can either follow the rules of CSSF Circular 02/80 regarding UCIs pursuing alternative strategies or follow the rules of CSSF Circular 08/356; however, they cannot choose to follow certain provisions of one and certain of the other. Further a fund must ensure that investors can still exercise voting rights during a loan period. The CSSF also clarified that it is the responsibility of the fund manager to decide whether it is appropriate to include additional risk considerations for potential investors in the prospectus if the fund engages in securities lending - though if the fund engages in cash reinvestment this must be included. A Beneficial Owner’s Perspective Furio Pietribiasi, managing director of Mediolanum Asset Management, explained that his firm has been involved in securities lending for a number of years, with the initial intention to generate added value for investors with the minimum risk. While lending agents offer several securities lending models, including the classic custodian and third party models, each has its strengths and weaknesses, making it critical that risk be continually assessed. Over the years, the securities lending market has continued to develop and become increasingly specialized. As the market keeps changing, it be-

comes more and more important that beneficial owners work with the right team, ensuring a programme can still be enhanced within the same structure and a fund can work to optimize the programme for its own clients. “Why still lend?” he asked. There are two key questions. First, is it in the interest of investors? Second, will it give the right risk-reward for investors? He added that securities lending provides the opportunity to generate additional value for funds as they depreciate in declining markets. A fund is required to do the best it can for its clients. “In many cases, securities lending is a given: nevertheless it must be done with the correct balance of risk and reward.” Back to Basics Keith Haberlin, Head of BBH Securities Lending, EMEA, outlined the key considerations when deciding to initiate a lending programme. Most important is for beneficial owners to determine their goals from securities lending. “Are my goals to generate incremental returns from my portfolio at low risk, or to offset custody fees?” he asked. “Or are my goals more ambitious – do I want to use securities lending as a means of generating alpha for my portfolio? Second: ‘is securities lending appropriate for my portfolio, given my asset mix?’ “Different asset types will have different demands from borrowers and lending some asset types will require the acceptance of a greater amount of collateral risk to gain an acceptable level of return. Some have decided that - based on their asset mix - securities lending probably isn’t viable, while for some with more attractive portfolios, it is worth the risk.” Third, ‘is my lending agent’s philosophy consistent to my own objective?’ Securities lending agents have different styles and approaches to the business, and may support varied routes to market. A third party lender may be more flexible than a traditional custodial lender. An auction platform has the benefit of a guaranteed return, but beneficial owners might shy away from

the concentration of counterparties, as well as the yielding of private portfolio information. Fears of counterparty risk have also surfaced regarding an ‘exclusive agreement’ with a single broker. His last consideration for a new market participant was: ‘how well protected am I?’ “A number of issues have come to light after the real live stress test of the Lehman Brothers default some key differences among securities lending contracts, in particular among indemnification provisions. So details really do matter.” He explained that securities lending is a “classic risk-reward business.” The returns you can generate are inextricably linked with the level of collateral risk you’re prepared to take. Z

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Global Securities Lending 2009

GSL SUMMER EVENT

London - GSL summer event, HMS Belfast Sponsored by

GSL’s Summer in the City BBQ proved a great success, with more than 80 members of the international global securities industry enjoying the soirée. As guests arrived, they were ‘piped’ on board- a traditional welcome preserved from the HMS Belfast’s war time roots. The threat oreception followed by a barbecue. A jazz trio provided on board entertainment and the variety at the bar added to the relaxed and informal atmosphere. Guests were also free to roam the ship to find their sea legs, and from the captain’s seat marvel at the spectacular views of the sun setting over London and the Thames.

Future suggestions for networking events always welcome! Thanks to all the guests, the Belfast crew, and a special thanks to the sponsors Rule Financial. Z

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Global Securities Lending 2009

GSL Summit|

Global Securities Lending

Back to school Is it possible to have a securities lending programme which balances the need to enhance fund returns with risk-controlled policies and procedures?

In September GSL will host a ‘Back to School’ summit in London for beneficial owners, their custodians and agent lenders, consultants and legal advisors, focusing on lending policies, safeguarding contracts, reporting and processes. In May, at the GSL “Lending for Liquidity” summit, a beneficial owners’ head of investment operations emphasised the importance of consultants, practitioners and advisors such as lawyers, in creating a robust lending programme. “Our pension fund currently has no in house fund management expertise. Our model involves employing the best in the business to undertake our securities lending, whilst we monitor and check their progress. We see securities lending as a relatively low risk low return income, because we initially spent a lot of time, effort and money with consultants

For speaking and sponsorship opportunities please contact: Jon Hewson [email protected] Tel: +44 (0) 20 7299 7700 Please visit

GSL.tv to register

ironing out the risks and evaluating the ‘what if’ scenarios”. Legal agreements gain importance as risk increases; “Because we had been advised to go through all the minor details when it was calm, when last September (Lehman’s collapse) happened, were able to go to our custodian with the signed agreement, and we found that we were in fact covered”. The latest GSL “Back to School” summit is being held at the Four Seasons Hotel in Canary Wharf on 10th September, 2009, and will seek to discuss the questions: will liquidity return when lenders see renewed processes? and, which practices does the industry need to adopt in order to move forward?

Date thursday, 10th September 2009 Location Four Seasons Hotel, canary Wharf, London 1:30 Pm Registration/coffee 5:00 Pm Drinks Reception 28

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MARKET PROFILE

Canada - new developments The new industry body in Canada takes a significant step to improving communication and a ‘unified’ voice for the country’s industry. Anthony Harrington gains market insight.

Canada has faired better than most economies through the current global downturn, though the Canadian equity markets saw some very big falls through 2008. The S&P composite index lost more than 37%, according to Spitalfields Securities Lending Yearbook for 2008, beginning the year at 13,833, and ending it on 8,637. The turmoil caused a proportion of beneficial owners to pause and reevaluate their lending programmes, and a limited number withdraw some or all of their assets. However, the consensus among industry participants is that there is plenty of reason for optimism going forward and those who withdrew assets or froze their lending programmes have virtually all either already recommenced securities lending, or are well down the road to do so. Perhaps the most significant event for the Canadian securities lending industry - the global crash aside - has been the formation of CASLA, the Canadian Securities Lending Association on 27th April. As James Slater, senior vice president, capital markets, at CIBC Mellon explains, CASLA was founded by the four major players in the Canadian market - CIBC Mellon, State Street Corpora-

tion, Northern Trust and RBC Dexia - who between them have more than 80% of the Canadian securities lending business. “The aim was to provide the industry with a coherent, unified voice on issues of importance both globally and in dealing with local regulators,” he

“Advisory firms and pension funds are all looking to come back into the market, and, on the Canadian side, there were very few funds that even paused” Patrick Avitabile, Citigroup comments. The organisation is in the process of recruiting members from all sides of the securities lending business, including custodian banks, beneficial owners, asset managers and broker dealers. The founders expect to move to the election of a board within the next year to 18 months. One of CASLA’s aims is to enhance the public’s understanding of securities lending. It also seeks to continue

to work closely with regulators and others to ensure an efficient and secure marketplace. The four founder members initially came together as an ad hoc committee to work on specific projects of specific importance to the industry. Don D’Eramo, vice president, regional business executive, at State Street’s Canadian Securities Finance Division says that one of the first successes the committee had was to widen the scope of what the Canadian regulator calls “qualified securities”, ie securities that may be placed into a securities lending programme. Prior to the committee’s approach to the regulator towards the end of 2007, beneficial owners could only lend from a prescribed list of exchanges. This disadvantaged Canadian agent lenders by comparison with say, US agent lenders. The committee was able to get the regulator to broaden the criterion to include securities from all recognised exchanges, a change that went through in December 2007. In January 2008 the committee had another success, with the elimination of withholding tax on cross border arms length payments. “This is a very exciting period. We now have a web site and we have issued an open call for potential members to make themselves known,” he says. Mark Fieldhouse, one of the four founding CASLA Directors and Regional Head, Technical Sales Global Market Products, at RBC Dexia, says that one of CASLA’s objectives will be to give the industry a strong Canadian voice. “Once we have attracted a market wide membership base, we will get a much clearer understanding of what the market as a whole would like us to work towards,” he says. Len Welter, chief technology officer and head of content at Data Explorers,

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MARKET PROFILE

that it is not about chasing alpha. It is all about establishing your criteria and what you are comfortable with as a beneficial owner,” he comments. One of the trends in securities lending in the US is the move to electronic trading platforms, which is seen as an efficiency play. However, according to Mark Fieldhouse, Canada already has a highly efficient market, which takes most of the steam away from the push towards electronic trading. The collateral is all held through a central depository which has a pledging capability, so that makes it very easy for participants to exchange collateral efficiently, without having to resort to a trading platform. This means that the chief advantage a trading platform would bring to the market would be price discovery. “Some participants would like the resulting price discovery, but not everyone wants the most transparent pricing. The talk will go on, but it is not a slam dunk that Canada will go the electronic trading platform for seclending,” Fieldhouse comments. Slater says that the Canadian market for seclending is now definitely on the rebound, having absorbed the impact of the global crisis and has begun to grow again. “Looking forward, I am very positive about the future for this market,” he concludes. Z Canada DESLI short index Canada price index Canada DESLI (lendable) index

140

“The talk will go on, but it is not a slam dunk that Canada will go to the electronic trading platform for securities lending” Mark Fieldhouse, RBC Dexia DESLI (Data Explorers Securities Lending Index) methodology used to calculate change in supply and demand levels without impact from price trade volume or foreign exchange prices. All indices benchmarked to 100 as of January 2008. Short – change in % shares outstanding on loan Lendable – change in % of shares available to borrow

DESLI (Short) 1 month % change -0.62 3 month % change -9.00 6 month % change -21.88 52-week high: 125.97 (30th Jan 2009) 52-week low: 88.68 (5th June 2009) DESLI (lendable) 1 month % change: +0.50 3 month % change: +1.49 6 month % change: +0.10 52-week high: 109.1 (8th Aug 2009) 52-week low: 99.76 (20th March 2009)

120 100 80 60 40 20

Jan

Feb Mar

Apr May June July

Aug Sep Oct Nov

Dec

Jan Feb

Mar Apr May June

SOURCE: Data Explorers

says that the “short base” (the top 500 names by market capitalisation) across the Toronto Exchange fell a further 19.4% since January 2009. However, when one considers just the universe of stocks available to borrow, declines are less severe, being no more than 1.5%. James Slater says that as of the last week of June, there was some CAD894 billion assets available on loan in the Canadian market, and the balance for assets actually out on loan was CAD107 billion. Of this approximately CAD90 billion had non cash collateral provided while CAD17 billion, or 16% of the market, was secured on cash collateral. (By way of comparison, Slater says that the US market is between 96% and 98% cash orientated.) The average fee for non cash loans was around 30 basis points. Patrick Avitabile, global head of equity trading at Citibank, says that around September 2008 there were some very extensively reported household name pension funds that pulled out of the securities lending market. However, he argues that the media treatment of this overstated the scale of the withdrawals across the universe of beneficial owners in both Canada and the US. “Our securities lending programmes had some clients pause and reevaluate their participation in securities lending programmes, but the last few months have seen a distinct pick up. Advisory firms and pension funds are all looking to come back into the market now, and in fact, on the Canadian side, there were very few funds that actually even paused in their seclending,” he says. Part of the reason for this is that unlike the US where cash collateral is widely used, and where issues with cash investment pools was highly publicised, Canadian Beneficial Owners whose primary form of collateral is non-cash felt very comfortable with the range of collateral they take. This includes government securities and provincial securities as well as equities. “The view by many beneficial owners, post the alarm caused by the crash, is

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DIRECTORY

consulting MX Consulting is a Securities Financing focused IT consultancy offering innovative business solutions. Experts in project management, Global One, 4Sight, Swift and STP solutions, software development, system migrations and back office outsourcing for the securities financing industry. In 2008 MX Consulting managed the trading system migration of Global One to 4Sight at a large asset manager, built a web-based proprietary payment, exposure and currency management system at a broker-dealer and also concluded a large Swift messaging project for a third-party agency business.

For over 10 years Rule Financial’s specialists have been working alongside their counterparts at the world’s top banks and hedge funds, helping to lower costs, improve productivity and extract the maximum value from IT investments. Our expertise in the management of change, project delivery and complex technology solutions has helped us build long-term relationships on a solid track record of success. Our prowess in system design, testing and rapid application development has earned us a powerful reputation. This means that at Rule Financial we have a thorough understanding of what the front, middle and back offices each require from their systems and processes, thanks to our practical experience and capability across the broadest spectrum of domains. Buy-side or sell-side, in both arenas we’ve attracted some of the best in the City to our doors.

W: www.mxcs.co.uk C: Adrian Morris Head of MX Consulting M:07879 475105 E: [email protected] C: Richard Colvill Senior Consultant M: 0777 1928113 E: [email protected]

C: David Little, Head of Securities Finance A: 101 Moorgate, London EC2M 6SL UK T: +44 (0)20 7826 4444 E: david.little@rulefinancial.com W: www.rulefinancial.com

Data Services Data Explorers is the leading global provider of market information and consulting services to the securities financing industry and the largest provider of global shortside intelligence to investment managers. Our products provide market professionals with quantitative measures of securities lending, performance and risk. We are based in New York and London and collect data from over 100 of the top security lending firms representing over 75% of the global securities lending market. On a daily basis we process more than 3 million transactions from over 22,000 funds. On 1 December 2008, this included over 220,000 fixed income and equity assets worth more than USD11 trillion in lendable value of which over USD3 trillion was out on loan.

New York A:75 Rockefeller Plaza New York, NY 10019, USA T: +1 212 710 2210 London A: 2 Seething Lane London, EC3N 4AT, UK T: +44 (0)207 264 7600

Securities Lending eSecLending is a full service securities lending agent and administrator of customized securities lending programs. Their program has been adopted by many of the world’s largest and most sophisticated asset gatherers including pension funds, mutual funds, investment managers and insurance companies. They are a third party industry specialist providing lenders with customized programs, high touch client service, comprehensive risk management, and superior risk adjusted returns. The firm takes a highly consultative approach with their clients by structuring separate, non-pooled programs and utilizing a competitive auction to determine the optimal route to market for their clients’ lendable assets. Having built their business to incorporate investment practices such as the use of specialists, multiple-managers, unbundling, price transparency, and competition, their approach ensures best execution and also provides clients with greater control over their programs, allowing them to more effectively monitor and mitigate risks and counterparty relationships. Additional information about eSecLending is available on the company’s website, www.eseclending.com.

Northern Trust Corporation (Nasdaq: NTRS) is a global leader in delivering innovative and customized Securities Lending programs to clients whose assets are custodied at Northern Trust and elsewhere. Northern Trust Global Securities Lending is a leader in the industry, operating trading centers throughout the United States, Europe, Canada and Asia to take advantage of markets throughout the world 24-hours a day. Northern Trust’s Securities Lending program is consistently recognized as a top lender; continuously outperforms the RMA’s Aggregate Composite; holds top positions at industry organizations; provides superior relationship management and technology; and maintains a strong 28-year track record.

T: US +1 617 204 4500 T: UK +44 (0) 20 7469 6000 C: Christopher Jaynes E: [email protected] W: www.eseclending.com A: 175 Federal Street, 11th Floor Boston, MA 02110, USA A: 1st Floor, 10 King William Street, London, EC4N 7TW, UK

Chris Doell Senior Vice President Head of North American Securities Lending Client Service +1 312 444 7177 Sunil Daswani Senior Vice President Head of International Securities Lending Client Service +44 (0)20 7982 3850

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DIRECTORY

technology 4sight Financial Software is a leading supplier of innovative software solutions to the C: Judith McKelvey Securities Finance, Settlement & Connectivity markets with offices and clients worldT: +44 (0) 207 043 8319 E: [email protected] wide. 4sight Securities Finance (4SF) is a flexible modular solution that empowers financial institutions of all sizes, from the smallest direct lender to the global custodian, C: Jason Hayes broker or intermediary on an agency or principal basis. 4SF contains market leading T: +1 416 548 7922 functionality that provides greater automation, faster trading, improved risk manE:[email protected] agement, and enhanced relationships with clients and counterparties. It supports C: Peter Sanders borrowing, lending, repo, swaps and collateral management across the equity and T: +61 (0) 2 90378416 E: [email protected] fixed-income markets and provides 24 hour continuous operation, inter desk trading, a ‘global book’, real-time value dated position keeping and a powerful web reporting W: www.4sight.com module, allowing full front to back office processing.

A:EquiLend Europe Ltd. 14 Devonshire Square, London EC2M 4TE UK T: 44-207-426-4426 C: Michelle Lindenberger E: michelle.lindenberger@ equilend.com A: 17 State Street, 9th Floor New York, NY, 10004 T: US- +1 212 901 2224

W: www.eurexseclend.com T: +41 58 854 2066 F: +41 58 854 2455 E: [email protected] Eurex Zurich Ltd., Selnaustrasse 30, Zurich, CH-8021, Switzerland

EquiLend is a leading provider of trading services for the securities finance industry. EquiLend facilitates straight-through processing by using a common standards-based protocol and infrastructure, which automates formerly manual trading processes. Used by borrowers and lenders throughout the world, the EquiLend platform allows for greater efficiency and enables firms to scale their business globally. Using EquiLend’s complete end-to-end services, including pre- and post-trade, reduces the risk of potential errors. The platform eliminates the need to maintain costly point-to-point connections while allowing firms to drive down unit costs, allowing firms to expand business, move into different markets, increase trading volumes, all without additional spend. This makes the EquiLend platform a cost-efficient choice for all institutions, regardless of size.

Eurex is one of the largest derivatives exchanges and the leading clearing house in Europe. Wherever you are located, we provide you with access to the benchmark futures and options market for European derivatives. Eurex also offers short term funding products, such as Eurex Repo. Eurex Repo is among the forerunners in providing integrated trading and clearing for repo transactions. Eurex’s latest innovative marketplace is called Eurex SecLend. Eurex SecLend. Europe’s leading investment banks participate as borrowers in the Eurex SecLend marketplace, acting as principal brokers, dealers and intermediaries. They all benefit from Eurex’s leading state-of-theart trading and processing services. For Eurex, service and technology innovation is not just a buzzword. New trends are being transformed into inventions through the adoption of advanced trading practices. Find out more on www.eurexseclend.com.

T: +44 20 7220 0961 F: +44 20 7220 0977 C: Rupert Perry E: rupert.perry@pirum. com A: Pirum Systems Limited 37-39 Lime Street London, EC3M 7AY W: www.pirum.com

Pirum provides a full suite of automated reconciliation and straight through processing (STP) services supporting Operations within the global securities finance industry. The company’s on-line SBLREX service encompasses daily contract compare, monthly billing comparison, mark-to-market & exposure processing, pending trade comparison, income claims processing and custody reconciliation. Subscribers to Pirum’s services significantly increase their operational efficiency and reduce their risk by using Pirum’s solutions, as staff are able to focus on fixing the exceptions instead of using their time to check and process routine business. These automated processes are more scalable and risk controlled too, allowing significantly higher volumes to be managed without corresponding increases in operations headcount.

Visit SunGard at www.sungard.com

With annual revenue of USD5 billion, SunGard is a global leader in software and processing solutions for financial services, higher education and the public sector. SunGard also helps information-dependent enterprises of all types to ensure the continuity of their business. SunGard serves more than 25,000 customers in more than 50 countries, including the world’s 50 largest financial services companies.

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eSecLending is raising the bar in securities lending by providing lenders with

• High-touch client service • Comprehensive risk management • Customized programs • Optimal risk-adjusted returns

As a leading securities lending agent, we take a consultative, highly customized approach when it comes to structuring lending programs for our clients. Unlike traditional models, where many lenders’ portfolios are grouped together and their securities wait to be borrowed on a best efforts basis, we utilize a competitive auction to determine the optimal route to market for their assets. Based upon results from the auction, we manage clients’ portfolios either through exclusive arrangements for specific portfolio segments or on a discretionary basis, where securities are lent individually. We focus on maximizing intrinsic returns in accordance with each client’s specific risk tolerances. Having built the program to incorporate investment practices such as the use of specialists, multiple-managers, unbundling, price transparency and competition, our approach ensures best execution and also provides clients with greater control over their programs, allowing them to more effectively monitor and mitigate risks and counterparty relationships.

United States +1.617.204.4500 Europe +44 (0) 207.469.6000 [email protected] www.eseclending.com

BENEFICIAL OWNERS SURVEY 2009

Overall Winner

Securities Lending Manager of the Year Global Custodian Securities Lending Survey

Globa Secur

Awarded Top Rated & Best in Class 2009 in $10B+ I 2008 in North America

Award Best i

European Securities Lender of the Year eSecLending provides services only to institutional investors and other persons who have professional investment experience. Neither the services offered by eSecLending nor this advertisement are directed at persons not possessing such experience. Securities Finance Trust Company, an eSecLending company, and/or eSecLending (Europe Ltd.), authorised and regulated by the Financial Services Authority, performs all regulated business activities. Past performance is no guarantee of future results. Our services may not be suitable for all lenders. eSecLending (Asia Pacific) - Registered office of Securities Finance Trust Company (incorporated in Maryland, U.S.A.), the liability of the members is limited.

Generating risk-adjusted returns

On this occasion, we are happy to say “no” to our clients.

through intrinsic value lending and conservative cash collateral reinvestment has been the foundation of our program since inception. This approach has ensured that our

No Losses. No Liquidity Restrictions. No Collateral Impairment.

program has navigated the recent market turmoil without exposing our clients to liquidity restrictions or losses related to impairment of collateral or counterparty default.

BBH Global Securities Lending Custody Accounting Administration Transfer Agency

Securities Lending Foreign Exchange Brokerage Fund Distribution

W W W. B B H . C O M / S E C U R I T I E S L E N D I N G

Outsourcing