Basic HTML Version
18
|
Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
For U.S. lenders that remain heavily weighted toward
cash collateral, amendments made by the Securities
Exchange Commission (SEC) to the Money Market Rule
2a-7 guidelines have helped to strengthen confidence
in these vehicles. These revised reduced the amount
of illiquid assets that can be held in these funds from
10% to only 5% of portfolio holdings; curtailed the
holding period for weighted asset maturity from 90
to 60 days and added a new measurement limiting
the weighted average life for the total set of portfolio
holdings to 120 days in order to prohibit exposure to
long-term floating rate securities. Requirements for
periodic stress testing and more timely disclosures
were also implemented and run protection guidelines
were set to help better govern fund behavior if the
NAV falls below $1.00 at some future date.
Preference for these highly conservative
reinvestment vehicles remains evident even five years
on from the Crisis. In a 2013 survey of institutional
investors, Finadium asked respondents to pick the
set of reinvestment vehicles they were comfortable
using—allowing them to designate more than one
category. Results of that survey showed that 63% of
participants utilized 2a-7 funds, 50% utilized short-
term repo and only 19% of institutions were willing to
reinvest their cash collateral proceeds into broader
investment types
1
.
Exerting more strict oversight around where cash
reinvestment could take place was not enough
for many asset owners. Many asset owners with
an internal team capable of handling their own
investment program actually insourced this function.
Agent lenders estimated that nearly half their clients
now handle their own reinvestment of cash collateral.
This is a significant change in the lending model and
the first of several “unbundling” trends that we will
discuss in this report. This is illustrated in Chart 10.
Beneficial Owner
Beneficial Owner
Source of Service
Lender
Lender
Oversight of Service
Repo
Source: Citi Business Advisory Services
Chart 10: Shifts in Securities Lending Service Model
Post-GFC: Changing Approach to Cash Reinvestment
Stock Loan
Cash Reinvest
Cash Reinvest
Cash Reinvest
“ What we did to reduce our risks significantly is that we took in our
collateral reinvest through a 2-(a)7-lite structure. This is a low-risk
collateral reinvestment account. It’s easy for us because we’re a
money management firm. We have money market funds and our
own fund managers,” — Asset Owner—Money Manager
“ We used to reinvest 100% of the cash collateral in our program and
now we are down to reinvesting only 50% as our clients insource
this function,” — Agent Lender
“ Pensions and other firms that would not have their own money
market funds are giving very specific instructions to their agents
on what they can do with their cash. They can only reinvest
into U.S. treasuries or agencies. Not even commercial paper is
accepted anymore. Lehman paper was A-rated until it went under,”
— Asset Owner—Money Manager
1. Citi Securities Lending: Bridging the Funding Gap in the Public Sector