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Key Findings
As a result of this growth, demand for supplies to
cover short exposures or to collateralize synthetic,
derivative or margin loan obligations is rising. Yet,
problems that emerged during the Global Financial
Crisis (GFC) have prompted many asset owners that
provide the pool of lendable supplies used to meet
this demand to tighten controls on their lending
programs in a manner that is both making it harder
to utilize their assets and impacting margins in
these programs.
Markit data (that includes equities, corporate bonds
and global government securities) comparing the
securities lending market at the end of Q1 2014 versus
end-2007 is telling. According to Markit, the pool of
lendable supplies is nearly unchanged at $14.9 trillion
in Q1 2014 versus $14.8 trillion on December 31, 2007.
Yet, utilization rates have dropped from 19% to only
11% of available supply and the value of supply on
loan is down significantly to only $1.6 trillion in 2014
versus $2.8 trillion at the end of 2007. This means
an increasingly large burden of unutilized supply is
sitting in lending programs and not being deployed
into the market.
A change in the core lending approach lies at the
heart of these numbers.
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Pre-GFC, asset owners instructed lenders to adopt
a maximum utilization approach to their portfolio.
In this model, the lender would auction the highest
percentage possible of the asset owner’s general
collateral (GC) and specials. The high volume
of GC loans being done at low spreads would
help build the collateral pool and supplement
the lower volume of special loans being done at
wider spreads. The collateral coming in against
this combined set of loans would then be used to
generate additional return. Cash coming into the
loan programs was sometimes being deployed into
asset-backed securities and structured investment
vehicles (SIVs) that were involved in the sub-prime
mortgage market, leading to issues during the Crisis
period. A backlash to aggressive cash reinvestment
and to this lending approach occurred as a result.
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The Risk Management Association (RMA) estimates
that in 2007, the average securities lending cash
reinvestment portfolio generated a return in excess
of 4% versus only 0.23% in 2013. Lower interest
rates accounted for much of this drop, but more
strict oversight of acceptable cash reinvestment
vehicles also contributed. In 2007, RMA reports that
27.6% of the average cash reinvestment portfolio
was invested in fixed or floating rate commercial
paper and only 2.0% was invested in 2a-7 money
market funds. By 2013, those figures had changed
significantly to 13.6% and 8.5% respectively. Asset
owners surveyed in this year’s report note that they
have either exerted much more direct control over
their reinvestment programs or actually insourced
this capability to perform cash reinvestment on
their own.
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Beyond tightening their reinvestment controls,
most asset owners in equity programs have
de-emphasized any contribution from returns
on their collateral investments and have instead
focused their programs primarily on the intrinsic
value of the securities in their loan portfolio. This
intrinsic lending approach has made low value GC
loans less attractive and shifted the focus of lenders
more exclusively toward the specials portion of the
asset owner’s portfolio. Many equity asset owners’
have gone even further and insisted on a minimum
spread that they would need to obtain to allow any
GC loans.
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Securities lending of GC Bonds which relies on
high-volume transactions has also been hard hit as
a result of changing capital rules that are making it
harder to facilitate these transactions and due to
the extremely low spreads available for this supply
in the current environment. With government bonds
on average only earning spreads of ~5-7 basis points
in G-7 countries, utilization of these high quality
Rapid asset growth is occurring across a set of investment strategies that exist within a
“convergence zone” where traditional money managers, hedge funds and even private equity
firms are creating competing funds that use shorting, derivatives and leverage to help realize
their investment goals. In 2007, the combined set of assets in this convergence zone (including
hedge funds and alternative UCITS and alternative ’40 Act funds) amounted to $2.2 trillion. By
2013, that figure had risen to $3.4 trillion and as outlined in Parts I & II of this year’s survey, our
forecast is for AUM in these strategies to grow to $6.6 trillion by 2018.