Securities Lending Handbook 2011

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The financial crisis of the last two years may have changed securities lending irrevocably, finds Craig McGlashan, but some of the lessons being learned could result in a better, more transparent industry

Securities lending has rather predictably come under fire since the financial crisis, with a number of headlines about beneficial owners leaving their programmes and in some cases suing their providers, and of course the various concerns that have been raised about short selling.

However, as is the case with the poor distinction made by the mainstream press between uncovered or “naked” short selling and covered shorting, the picture around the current state of the securities lending market is not so simple.

“As we are coming out of this crisis, we see very positive indicators that we are looking at being able to move forward,” says Sunil Daswani, head of sales and relationship management at Northern Trust. “But it is very important as we do move forward to look at what has happened over the last two years and learn from the experience. I think, most importantly, you look at securities lending as a business and the first thing is that it is actually a major driver of market liquidity.”

Indeed, many lenders have not only seen beneficial owners who had previously

left their programmes return, but in some cases have even attracted new business. Daswani has seen a similar story at Northern Trust, which has doubled the size of its client servicing team, although the exact look of the programmes has in many cases changed. He explains: “Some lenders have increased parameters on their lending activities, changing the risk/return balance, while others have focused on the ‘intrinsic value’ of lending, whether by lending more in lucrative markets or asset classes or reviewing the different asset classes available to lend.”

Guy Knepper, head of securities lending in CACEIS Group’s dealing room, has seen a similar situation. “I would say we never had a problem as our client base was quite contained when the crisis emerged,” he says. “We actually witnessed the situation where more clients joined us during the crisis. The existing clients asked us to give them a bit more detail about collateral policy and management, the mark-to-market techniques and so on, and we gave them comfort as our collateral parameters are quite conservative – we only take cash and government bonds as collateral.”

Most of the lawsuits which have arisen as a result of the crisis have revolved around the reinvestment of cash collateral – in mortgage-backed securities for instance – rather than the actual practice of securities lending. Indeed, one of the major topics that has arisen at the regular securities

lending summit held this year by Global Securities Lending

Beneficial Owner & Pension Fund | Securities Lending Handbook 2011

The Securities Lending Landscape


3



magazine has been that regulators have been putting securities lending under close scrutiny. One such example is the State of New York Insurance Department, which in January issued guidance to insurer members suggesting that less than 5% of total assets should be available to lend.

However, many attendees at the summits made clear their concerns that the business has been put under scrutiny when in fact it is the area of cash collateral reinvestment that should be looked at more closely. In addition, many lenders have already allowed their beneficial owners to have flexibility around various factors within their programmes, without any prompting from the regulatory side.

“The degree of investment risk that you take on will depend on the customisation of the programme that you set up and hopefully the ability of an agent, should you use one, to be able to set that up accordingly to what you want,” explains Daswani.

Another major factor that brought securities lending to the front of many people’s minds were the issues that arose around short selling during the financial crisis, with many blaming the practice for driving down banks’ balance sheets and putting them out of business. Has this concern rubbed off on beneficial owners, who may not want their stock used to fuel such an industry? Perhaps, Knepper suggests, but the flexibility that can be introduced to programmes can alleviate any of these concerns.

“Case-by-case lenders who view a certain trade as being a very directional short on some securities, of course they have the right to refuse some

trades and they will do it,” he says. “We have witnessed some situations where heavily shorted stocks were in client portfolios and we approached them and they told us, ‘No I do not want to feed that short’. So they still have that flexibility to refuse some positions that we offer them.”

Like all areas of the financial services industry, securities lending was affected by the crisis and the overall picture may look quite different when the dust has finally settled. But many of the stories that have appeared around the industry in the mainstream press have been debunked, and indeed a large number of industry participants are looking to the future with optimism. n

“We actually witnessed the situation where more clients joined us during the crisis”

Guy Knepper, CACEIS

4


Contents Features

2 The Securities Lending Landscape

Craig McGlashan examines how the last two years have shaped

securities lending 6 Owning the Benefits

Chris Hitchen CEO of Railway Pensions Trustee Company, provides his

view on the benefits of securities lending

8 Experts’ Panel: The Dash for Cash

Cash collateral reinvestment has been one of the major talking points

in securities lending since the financial crisis.

12 Short of Demand

Short selling, a key source of demand for securities lending, has come

under scrutiny from regulators across the globe - here we look at

the actions taken by the US Securities and Exchange Commission

16 Exchange-traded funds Now more than 10 years old, are beginning to offer a new source of

supply for the securities lending and borrowing industry

20 Collateral Management, Efficiency and Optimisation

How technology can play a role in ensuring efficient and

optimised collateral management, with SunGard

22 The Securities Lending Industry Awards 2010

Round-up of the 2010 Awards and the ceremony at the Dorchester,

London in July

24 GSL Summits Road Report

26 Beneficial Owners’ Guide to Securities Lending

in association with Data Explorers

40 Market Leader Profiles

An alphabetical directory of the best pactitioners:

BBH, CITI, Comit, Deutsche Bank, eSecLending, ING, JP Morgan, RBC

Dexia, SecFinex, State Street, Sungard

Supplement editor: Brian Bollen([email protected])

Reporter: Craig McGlashan ([email protected])

Head of sales: Trish Jane Holst ([email protected])

Account manager: Eradat Munshi ([email protected])

CTO: Peter Ainsworth ([email protected])

Manging director: Jon Hewson([email protected])

Publisher: Mark Latham ([email protected])

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© 2010 2i Media All rights reserved. No part of this publication may be reproduced, in whole or in part, without prior written permission from the publishers. ISSN 1744-151X.

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Owning the Benefits

The CEO of Railway Pensions Trustee Company, Chris Hitchen, provides his view on the benefits of securities lending

Chris Hitchen, chief executive of pensions administrator rpmi and the Railway Pensions Trustee Company, considers the attractions of securities lending from a beneficial owner’s perspective

For a man who confesses that the first time he really heard of securities lending was in connection with the infamous Robert Maxwell and his Mirror Group pension fund revelations in the early 1990s, Chris Hitchen has a surprisingly warm attitude towards the borrowing and lending of stock by pension funds.

But Hitchen is exceptionally qualified to talk about the subject. As chief executive of pensions administrator rpmi and the Railways Pensions Trustee Company, which runs the industry-wide pension arrangement for the UK’s railways, Hitchen is at the forefront of the UK pensions sector.

There was also the small task of being chairman of the National Association of Pension Funds (a role he no longer fills) during the financial crisis. Despite the negative press that securities lending received, he told the OPDU Annual Conference in January 2009: “Don’t abandon your securities lending programmes. Having stock to lend and borrow is crucial for efficient markets.”

Does he still stand by this statement? “Yes,” he answers. “I have always been of the view that securities lending is highly beneficial to institutions because what we want is liquid markets, which cannot happen without the lending of stock. We probably have more to fear from illiquid markets and inadequate price discovery

than we have from short sellers.”The Railways Pension did not stop its

securities lending programme during the recent turmoil. Hitchen puts this down to good management. “At this fund, we were always very particular about the way we treated collateral and very particular about the indemnities we received, but that was probably not true more generally across the industry.

“We have thought quite carefully about relating collateral to the assets. If we were accepting a type of collateral that would not function in line with what we had lent out then we would ask for a higher haircut. That has meant that we have lent a lot less stock than we could have done, but we felt that was fine because it was the risk that was most important to us.”

Pension thoughtsIn his role as NAPF chairman Hitchen

was able to hear the concerns and thoughts of the UK pensions industry. So how has its view on securities lending changed given recent events?

“Securities lending has always been taken seriously. It has never been a big money spinner, but it was a nice source of income and if nothing else it helped offset some of the custody and other costs,” he says.

“It would be wrong to say that people are thinking about securities lending more than they are about the level of markets because we have had such a rollercoaster ride in that arena. But people are much more tuned in generally now to the fact that you can lose money – it is not just about the return on the money, it is about the return of the money sometimes.

“There has been a flight to quality in every respect and I think that has resulted in people dusting off their securities lending agreements and looking at what their

Pension Funds: Owning the Benefits

7


Owning the Benefits

safeguards are, in a way that they might not previously have worried about.”

Hitchen thinks that some of the funds that ceased lending did so “on ideological grounds”. He explains: “They worried that they were lending to hedge funds, for example, who were just going to sell the stock short and force prices down. We found little evidence that that was really happening inside the market.”

In addition, he says that pension funds have a long view and any short term affect on a price “should not bother us too much” and if a premium can be obtained for lending the stock then “that fits with our longer term horizon”.

Two cheers for hedge fundsHitchen also reveals that not standing

by his statement at the OPDU conference would be “hypocritical” – given that “we do invest with hedge funds as part of our wider portfolio”. Hitchen explains that the fund chose hedge fund investment because it “delivered higher returns than cash generally but had much lower volatility than equities”.

A report from US consultancy firm Agecroft Partners released at the start of 2010 suggested that pension funds will increase the allocation of their asset base to hedge funds from 2.5% to 15% over the next decade – does Hitchen see this as a possibility?

“We are increasingly using hedge funds in a more targeted way, treating them not just as an asset class. We are using them within our main equity portfolio as a way of managing the assets. When we are looking for alpha generation we won’t necessarily only appoint long-only managers - we might appoint hedge fund managers and then use a future to complete the market exposure.”

However, this diversification of investment strategy has potential pitfalls for the pension fund’s lending programme, Hitchen suggests.

“It makes securities lending harder to do.

Portfolios are increasingly not filled with real stocks, or are seen through the lens of some vehicle such as the hedge fund, making it harder to lend the stock because you do not have the direct line of ownership. We are getting increasingly complicated fund management arrangements and that makes lending harder to organise.

“Even in the long-only space we now have more specialist equity managers and fewer large, low-transactional portfolios, and that means that there are more parts moving and it is harder to be sure that a particular stock is going to be in one place and that it is going to stay there over the timeframe that makes it possible for someone to borrow it.

On a more positive note, Hitchen sees opportunity for lenders in a new trend developing in the pension fund space. “Over the next few years interest-rate and inflation swaps will increasingly be used by pension funds to try to match out their liabilities and there must be some scope for lenders to get involved in actually helping those swaps to be packaged. I think that is going to be a growing area.”

However, he warns: “Trends take a long time in pension funds – things do not happen overnight. We could be talking about these issues in much the same way in three years time, I expect.” n

Cash collateral reinvestment has been one of the major talking points in securities lending since the financial crisis.

What are the experts’ views?

Virgilio ‘Bo’ Abesamis III, senior vice president and manager of the Master Trust, Global Custody, and Securities Lending Group

Sonja Spinner, senior associate at Mercer Investment Consulting

Brian Staunton, managing director, Securities Finance, EMEA, at Citi

Experts’ Panel: The Dash for Cash

For some agent lenders, there has been an increased focus on profits derived from the intrinsic value of the loan itself, rather than returns from cash collateral reinvestment. How significant is this shift?

VIRGILIO ‘BO’ ABESAMIS: The focus on intrinsic value vs. reinvestment of cash collateral would definitely have an impact.

We believe this shift away from cash collateral reinvestment could mean a 40% to 60% reduction in revenues. However, we also believe that those clients with real inventory of intrinsic value securities would be paid commensurately and should achieve better demand spreads of at least 10% to 20%.

SONJA SPINNER: The intrinsic value of loans should be the driver of lending activity as opposed to cash yields.

Many of the issues which have impacted beneficial owners in agent lending programmes arose because the focus was on an aggressive cash reinvestment programme as opposed to prudently managing securities lending programme risks.

Whilst money market yields remain low it is difficult to make a case for accepting cash collateral as the incremental spreads over a non-cash programme are not outweighed by the additional reinvestment risks.

Recent market events have also highlighted the issues associated when collateral pools are shared by multiple lenders. I always steer clients with the risk appetite to accept cash collateral to a segregated cash fund.

At the height of the financial crisis, many beneficial owners did not seek to liquidate their cash reinvestments due to the loss they would incur. Should the status of these reinvestments be marked

8

The Dash for Cash


9


The Dash for Cash

to market?

ABESAMIS: Before any talk of liquidation or exit strategy, we believe that the prudent approach is to have those reinvestments be marked to market to determine ‘real’ valuation levels and the potential market impact of a forced sale.

SPINNER: The use of a constant dollar net asset valuation (NAV) is common industry practice for cash collateral reinvestment pools. I don’t think that there is a requirement to amend this when computing revenues and fee splits. Beneficial owners would, however, gain additional transparency if mark to market valuations were also published. Many beneficial owners had no transparency regarding the performance of commingled cash reinvestment pools until agent lenders informed them the fund could no longer support a constant dollar NAV and funds were trading at a considerable discount.

This is clearly inappropriate as mark to market valuations gradually decreased over the later part of 2007 and 2008 and then decreased substantially following the collapse of Lehman Brothers.

Sharing mark to market valuations with beneficial owners would have alerted them to the issues facing some cash reinvestment funds and enabled them to make the decision whether to fund losses and suspend lending earlier and at less cost.

BRIAN STAUNTON: Some lenders in the industry faced a situation where they wanted to suspend lending because of market volatility, but to do so would have incurred a loss on the cash collateral re-investments. So the question they ask is: ‘do I liquidate and take a loss or maintain the positions until final maturity in the hope they’d maintain their value?’ I don’t know if the investments should be marked to market.

If they were – perhaps if there was a shortfall in collateral value – who’s going to

post the additional margin? In a classic mark to market process you’re marking the loan and collateral whereby you’re taking more collateral if need be. But marking the cash re-investment isn’t a classic mark to market, as you’re marking an investment that’s possibly lower than the value you bought it for. So whose responsibility is it to top up the value? Under the current legal arrangements it is the lenders’ responsibility.

Some call reinvestment a front office activity or an ‘investment management overlay’. Will this evolution of cash reinvestment aid understanding of risk, liquidity and returns?

ABESAMIS: This is a very good question. We believe that a client should assess securities lending from both direct lending (i.e. custody, a third-party agent or principal) and indirect lending (i.e. mutual funds, commingled funds, index funds, etc.) viewpoint.

Those that participate via indirect lending should take into consideration that seclending is already embedded in the asset allocation, especially those using index funds as the core exposure to asset classes.

In the area of direct lending, the issue is not that simple. Two factors have to be given proper consideration- wherein (a) securities lending is utilised as a fee/cost offset or (b) securities lending is employed as an alpha generator. As a fee/cost offset, the client has to weigh the merit of securities lending as a front-office or investment management overlay activity. This could be problematic for those clients because a fee/cost offset approach does not align well with risk taking.

On the other hand, if a client believes that this is an alpha generator, then this needs to be factored in the risk budgeting exercise and in what context of the asset allocation should it be carved out.

SPINNER: Cash reinvestment absolutely


The Dash for Cash

is a front office activity. Beneficial owners choosing securities lending programmes with cash reinvestment need to apply the same due diligence process and monitoring of managers to cash reinvestment funds that they apply to other manager mandates. I would encourage all owners lending securities against cash to view their lending programme as a cash fund investment, with all the same risk and return considerations as any other money market fund investment. I would also encourage all beneficial owners lending against cash to reflect whether they really consider that the additional revenues they may receive if they lend against cash really are sufficient to compensate for the additional risks.

STAUNTON: That’s a good question, and it is one of education. If you’ve appointed an agent lender for a specific role, that lender should have the capability to manage, calculate and record risk and provide a very good and professional level of cash reinvestment as good as any money manager. I think there are players who can do that very well. As a firm we have that capability so we agree with the statement – it is a front office function.

I would go a step further too: because it’s defined as front office it needn’t go to a traditional fund management firm – if you have the capability in-house it’s a good situation. n

On loan versus cash collateral ($m)

cash collateral as % of total on loan

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

$1,000,000

Equities Bonds Totals

2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

As % of total on loanSecurities on loan ($m)On loan versus cash collateral ($m)


$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

$1,000,000


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash



$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

$1,000,000


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash



$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

$1,000,000


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


2009 Cash

2009 Non-cash

2010 Cash

2010 Non-cash

The graphs below show the slight decline in the use of cash collateral over the past year. Figures are for Q209 and Q210 and come courtesy of the Risk Management Association.

Key figures: 2009 Total securities on loan ($m) Equities: $518,070 Bonds: $705,533 Total: $1,223,603 2010 Total securities on loan ($m) Equities: $485,647 Bonds: $665,930 Total: $1,151,578

10

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12


Short of Demand?

Short selling, a key source of demand for securities lending, has come under scrutiny from regulators across the globe - here we look at the actions taken by the US Securities and Exchange Commission

Short of Demand?

It is probably not essential for beneficial owners to understand the details of short-selling. But it could well help them in making a decision on whether to facilitate the practice by lending the stock that enables short-sellers to go about their business. And to understand just why this often controversial practice attracts such attention in difficult markets.

The Securities and Exchange Commission (SEC) has been under pressure to introduce new rules on short-selling for some time. Approximately 4,400 companies have petitioned the SEC to clamp down, with industry heavyweights such as John Mack, chairman of Morgan Stanley, blaming short-sellers for perilously driving down company share prices in 2008. The new rules have finally emerged. What impact are they likely to have?

The SEC’s new rules aim to ‘promote market stability and preserve investor confidence’ by placing restrictions on selling stock short if a company is experiencing significant downward price pressure on their share price. The ‘alternative uptick rule’ will restrict short-sellers from driving down the price of a stock that has dropped more than 10% in one day. Once this ‘circuit breaker’ is triggered, holders of the stock will be first in line and can sell their shares before any short sellers.

Once the circuit breaker has been triggered, the rule applies to short sale orders for the remainder of the day’s trading, plus that of the following day. It applies to all equities listed on a national securities exchange, whether they are traded on an exchange or over-the-counter.

Importantly, it offers no exemption for market-makers. Also, companies will be required to have written procedures in place to prevent the execution or display of prohibited short-selling transactions.

Not a complete prohibitionRobert Colby, deputy director of trading

and markets division at law firm Davis Polk and Wardwell says: “It is not a complete prohibition. It means that a short-seller can’t execute at the bid price. This means they can’t chip away at the price people are willing to buy. If, for example, a stock is trading at 105-110 and a trader was trying to short-sell and it triggered the circuit breaker, they could no longer sell at 105. They could only say that they were willing to sell at 106 up to 110 and wait for people to come to them.”

The SEC is clear in its intent. SEC chairman Mary L Schapiro says that the ruling recognises that short-selling can have both a beneficial and a harmful impact on the market. She continues: “It is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility.”

There has been considerable debate as to whether the new rule will achieve its goal of greater stability. The Securities Traders’ Association issued a lengthy response to the SEC’s regulations, suggesting that they were based on “inadequate analysis, a lack of empirical data, and questionable rationale by the SEC”.

It also accuses the SEC of not being consistent. It says in its letter to the SEC: “This inadequacy was noted by SEC Commissioner Paredes in his opening

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Short of Demand?

statement... there is an insubstantial empirical basis to support the commission in adopting the rule, especially in light of the rigorous economic analysis that led the SEC to repeal the ‘original’ uptick rule in 2007 after years of study. The commission bears the burden to justify its rules. It has not done so in this instance.” The regulations were voted through the SEC on a paper-thin 3-2 majority.

The STA suggests that the new regulation will not resolve the issue of manipulative short-selling that it was designed to address. As such, it cannot bring about the ‘investor trust’ as intended. It will also have significant implementation costs. Many broker dealers, for example, will need to upgrade their computer systems to ensure that they can distinguish between short-sellers and those investors who hold stock and wish to sell.

Exemption soughtIn particular, the STA requested that the

regulator make an exemption for options market makers, saying: “The nature of the derivatives market is such that market makers must be able to hedge their positions easily and cheaply to reduce trading costs. Failure to do so would cause a decoupling of prices in the options markets from the prices of the underlying instruments. This would result in reduced liquidity and wider spreads to the detriment of individual investors.”

The group believes that the regulations may be counter-productive, resulting in less liquidity, greater volatility, and wider bid-ask spreads, none of which is conducive to boosting investor confidence. Furthermore, a short sale restriction that makes it more costly for investors to manage their risk by hedging can hinder the ability of companies to raise capital.

With the two sides clearly delineated, what do industry participants believe will be the likely outcome of the regulations? Jerome Lussan, managing director of hedge fund consultancy Laven Partners, says:

“This will impact all international hedgers operating in US markets. It will limit their ability to make profits in falling stocks. That said, it doesn’t kick in until there has been a 10% drop, which is relatively rare, but if you sell stock with small volumes it could happen a lot faster. Therefore mid and small cap managers may find themselves disproportionately affected.”

It is difficult to see how the new regulations will act to stop additional market abuse. The SEC had already introduced changes to tackle manipulative and naked short selling. In normal circumstances, if RBS looks over-valued, the short-sellers move in and create a temporary fall in the share price, but then the shorts go too far and the long investors come in and scoop up value. Black suggests that much of the

criticism of short selling should properly be directed at market abuse; for example the spreading of negative rumours to artificially depress prices accompanied by short selling.

The goal of ‘strengthening public confidence’ is sufficiently nebulous to make any real judgement on the success of the rules difficult. With a relatively small majority in favour of the new regulations at the SEC, there may be room for a re-examination of the rules on market-makers and possibly for a full change of heart if the rules are found to create additional volatility. Lussan sums up the view of many when he concludes: “This is the least bad alternative. The market was expecting something and was afraid it could be worse.” n

“It is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility”

Mary L Schapiro, SEC chairman

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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 pooled 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 agency exclusive lending 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 enables best execution and also provides clients with greater control over their programs, allowing them to more effectively monitor and mitigate risks and counterparty relationships.

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.

CELEBRATING

10 YEARS

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16


Exchange-traded funds

Exchange-traded funds, now more than 10 years old, are beginning to offer a new source of supply for the securities lending and borrowing industry


Exchange-Traded Funds, better known as ETFs, celebrate their 10th anniversary in Europe this year. The product has found its way from the U.S. into Europe and has seen impressive growth in virtually every category: assets managed, funds offered, traded volumes as well as the number of issuers, exchanges and user groups involved.

Exchange traded funds are low-cost, tax-efficient investment vehicles that passively track indexes and can be traded like shares. The fund, which may contain assets such as stocks or bonds, trade at approximately the same price as the net asset value of its underlying assets.

They are similar to traditional mutual funds in giving investors an undivided

interest in a pool of securities. However, ETFs do not sell or redeem individual shares at net asset value. Instead, financial institutions purchase and redeem ETF shares directly from the ETF in the form of units.

An in-specie ETF will buy up the underlying securities in an index. A company writing an ETF on the FTSE will go into the market and buy all the underlying components of the FTSE shares. These shares are ring-fenced into separate accounts, meaning that there is no risk of default from a counterparty. Further, there is full disclosure of the fund’s holdings.

Within the securities lending world, the basic premise is that you have to buy the underlying securities and lend them out. There is some difficulty in buying

the underlying, because when you go in the market and buy and sell underlying securities, you’ve got tracking error, execution risk - many problems from buying those underlying securities.

These ETFs seek to replicate market performance by holding a basket of securities along with a swap agreement with a third party – often a brokerage – which will agree to pay the performance of the index. It is the that ETF holds an exposure to the market: if the market goes up under the swap contract, the swap company pays the ETF company the performance; if it goes down, the ETF pays the swap company. They still have total market exposure, but one had the underlying securities as

assets and one has the swap as the asset.Given the chance of default of the third

party, there is a greater concern around counterparty risk for swap-backed ETFs, although UCITS ruling limits this loss to 10% of the value of the ETF. The advantage of doing a swap back is you get the absolute performance of the underlying market. The investment bank, which has provided a swap has to hedge itself, has written out the performance of the FTSE, for example. To hedge itself, the bank would go and buy all the underlying components of that market in the same way that a bank has bought the underlying securities.

Further, investors can actually buy an ETF that gives you the short exposure to an underlying index. So in the case

Within the securities lending world, the basic premise is that you have to buy the underlying securities and lend them out.

17



of a FTSE ETF short, if the FTSE goes down, the ETF increases in value. So to do that, the investment bank has to right short performance swap to the ETF. It’s already got the stock, because it’s already written a long exposure because it’s already holding the inventory.

So, within the swap it can charge a stock loan fee, and charge 100% of the dividend.

It’s like shorting itself but is instead ‘netting off ’. If you are writing the exposure of a 150 million long position and $100 million short position, to hedge that position all you have to do is buy $50 million worth of securities - that’s the difference between the two. But in the swap, you are charging one dividend rate on the whole $150 million long, and on the short you are charging a different rate on the whole $100 million short.

There are two ways to lend with ETFs: the underlying shares themselves, or the units. Owners of a unit may lend it themselves, giving direct potential profit to the owner.

In Europe, currently over $200bn is invested in ETFs, and an increasing number of issuers and investors are asking for options on those underlyings, adds Ralf Huesmann, who works in the Product Development Department of Eurex in London, focussing on index products. To meet market needs, Eurex Exchange,one of the world’s leading derivatives exchanges, has extended its ETF segment by launching new options. In May 2010, three options on ETFs by Deutsche Bank were launched, more precisely on the db x-trackers MSCI Emerging Markets, MSCI Europe and MSCI World.

Only a few weeks later, Eurex added

18



It is interesting to see that the growing use of ETF options has no negative influence on the corresponding cash-settled options on the same underlying. In fact, the opposite is the case

options on seven ETFs listed by Source, focussing on their STOXX Europe 600 Optimised sector ETFs. It is very likely that further options on ETFs will follow soon, also on other issuers.

ETFs provide investors with an opportunity to trade broader indexes in just one single trade, similar to trading shares. Before ETFs were made available to the market, indexes were tradable either via basket trades (with more transactions involved), index swaps and structured products (including counterparty risk) or futures (for which a margin account is necessary). Against this backdrop it becomes clear why the emergence of ETFs substantially facilitated index trading.

With the growing amount of money invested in ETFs and the increased trading

activity, institutional investors have started to look for a safe and sound way to trade optionality on those ETFs. Eurex’s options on ETFs cover expiries up to two years.

In the past, the only liquid, exchange-traded equity index products in Europe were cash-settled options on the relevant national benchmark indexes like DAX, SMI or FTSE 100 or the most important benchmark index for the Eurozone, the EURO STOXX 50.

For other underlying indexes like MSCI World or MSCI Emerging Markets, it is more difficult to find liquidity providers, as those indexes cover different time zones, currencies and exchanges. Options on ETFs could show a way out of this dilemma. As the ETF itself is already traded and quoted on Xetra, the leading ETF platform in Europe, by a number of market makers, it is easier to trade options on that particular ETF (and use the ETF as the hedge), than doing

it on the index itself and then struggle to get the hedging right. ETF options could therefore pave the way for exchanges to cover more markets with liquid options. In return, the ETF issuers, who often act as liquidity providers, can expect positive effects on the assets under management.

A look into the U.S. market reveals the potential of ETF options. For the first time, the number of ETF options being traded on eight different U.S. option exchanges exceeded one billion in 2008. It is interesting to see that the growing use of ETF options has no negative influence on the corresponding cash-settled options on the same underlying. In fact, the opposite is the case: cash-settled options have flourished after ETF options on the same underlyings had been listed in parallel.

The product can either be traded based on the permanently generated quotes shown on the Eurex screen, or by contacting the Market Makers directly: Deutsche Bank is the market maker for the options on db x-trackers ETFs, whereas the banks behind the Source consortium (Goldman Sachs, Morgan Stanley, BoA Merrill Lynch, Nomura and JP Morgan) are the liquidity providers for the options on Source ETFs, with Nomura acting as on-screen market maker.

Elsewhere, BNY Mellon Asset Servicing is laying claim to being the first service provider to support short positions in an ETF. The claim came after it was selected to provide ETF services, custody, fund accounting and fund administration for the Mars Hill Global Relative Value ETF, which it describes as the first actively managed ETF to pursue a long-short equity strategy. n

Flexible, customised securities lending solutions

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When challenging markets put pressure on investment returns, it’s important to

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Advertorial - Collateral Management

How technology can play a role in ensuring efficient and optimised collateral management, with SunGard

Collateral Management Efficiency and Optimisation

Over the past few years, there has been heightened interest in collateral management, due in part to internal risk management sensitivities and impending external regulatory pressures. It has been widely recognized that the bi-lateral collateral and margin management associated with OTC transactions can be fraught with issues and challenges. This is compounded by the fact that there may be multiple business areas within a firm that carry out this processing independently, making it nearly impossible to see a single exposure with a counterparty, or benefit from the cross-margining opportunities that exist. The recent Bank of International Settlements (BIS) report on “The role of margin requirements and haircuts in “procyclicality” made a number of observations regarding the management of collateral for both securities financing and OTC derivate transactions. The report recommends enhancements to haircut-setting and margining practices to dampen the build-up of leverage in good times and soften the system-wide effects during a market downturn.”

Collateral management is a core capability of all SunGard’s securities finance solutions, including functionality within each that addresses the challenges associated with daily collateral and margin management for stock borrow loan and repo transactions. Although already flexible, this functionality continues to be expanded in response to new customer needs, and made available through standard releases. In the US stock loan market, where cash is currently the primary form of collateral, there is an enviable degree of automation provided by Loanet’s automated mark service. Loanet instigates marks based on agreed independent pricing, and acts as a communication hub for the generation of the mark transactions and the cash charge to DTCC. There is no equivalent service available for international business, and still requiring considerable manual

effort to process cash mark agreement and collection. Adding to this are the increasing complexities of non-cash collateral management, so it is no surprise that processes are typically highly manual and people dependent. As a result, firms are constantly looking to increase operational efficiency, streamlined processing and risk control.

In addition to the collateral management aspect of our securities finance solutions, SunGard also offers a sophisticated solution for OTC derivatives collateral management, featuring automated, exception based, end-to-end workflow. This solution is used by one of the major custodian banks as its derivatives collateral management offering, and is recognized as a leading solution to handle the more specific and complex ISDA/CSA requirements. With SunGard’s strong history in collateral management and the increasing demand for a more holistic solution across different product types, we have been exploring new ways to address the requirement for a cross-asset collateral management solution. One thing is clear: collateral management requirements vary, depending on the firm type and structure.

From the treasurer’s point of view, the firm’s inventory must be most effectively used. Collateral management groups already have basic collateral management functions, and they now want to further optimize their operations and drive out even more efficiencies, particularly around inter-market-participant communications. Hedge funds or institutional investors want to independently compute and compare margin requirements against their broker’s records. At SunGard, we are pulling together the relative strengths of the different solutions to enable us to offer a solution that not only addresses the nuances of the SBL, repo and OTC derivatives markets, but also optimizes the use of collateral assets and improves workflow efficiencies with maximum STP and exception processing. n

Pirum provides highly functional and reliable electronic servicesfor global equity and fixed income products.

Focused on automating post-trade processes in the securitieslending and repo markets, we deliver innovative and flexibleservices which are tailored to fully support the complexities ofthe industry’s evolving business processes.

Our clients benefit from increased processing efficiency,greater STP, reduced operational risk and improvedprofitability.

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22


The Securities Lending Industry Awards

This year saw the inaugural Securities Lending Industry Awards take place.

The Awards differ from the usual format by inviting those who work within the industry to vote for the winners, ensuring the Awards are “for the industry, by the industry”.

Deutsche Bank was the big winner on the night, scooping three awards, including Best Equity Trading Capability – Multi-location Borrower.

Other success stories included eSecLending, UBS, Barclays Capital and Nomura, which each picked up two awards.

The remaining prizes were shared between 11 firms with one a piece, including SunGard which was named Technology Provider of the

Year. Several other firms also received “highly commended” certificates.

The culmination of the Awards was the Ceremonial Dinner, held on 1st July at the Dorchester London.The event was held in support of Wooden

Spoon, the Children's Charity of Rugby, and featured an auction hosted by BBC Sport's Ian Robertson (pictured below), who entertained the audience with his showbiz anecdotes.

A full list of winners can be found on the next page.

For full listings, including highly commended firms in each category, please visit www.GSL.tv/Awards

TheSecurities Lending IndustryAwards

GSL2010

23


The Securities Lending Industry Awards

Award Winner

Overall Awards

Multi Location Lender eSecLending

Single Location Lender UBS

Multi Location Borrower Barclays Capital

Single Location Borrower Nomura

Technology Provider of Year SunGard

Equity Trading

Multi-location Lender eSecLending

Single Location Lender CIBC Mellon

Multi Location Borrower Deutsche Bank Global Prime Finance

Single Location Borrower Goldman Sachs

Fixed Income Trading

Multi-location Lender State Street

Single Location Lender Deutsche Bank Agency Lending

Multi Location Borrower Morgan Stanley

Single Location Borrower UniCredit

Global Market Knowledge

Lender Citibank

Borrower HSBC

Operations

Multi-location Lender Northern Trust

Single Location Lender UBS

Multi Location Borrower ING

Single Location Borrower Barclays Capital

Up & Coming Firms

Lender Deutsche Bank Agency Lending

Borrower Nomura

Technology Pirum Systems

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Securities Lending Summits

GSL Summit Global SecuritiesLending|

Upcoming Summits Location Date

GSL Asia Pacific Securities Lending Summit Hong Kong, China 16th September 2010

GSL Dutch Securities Lending Summit Amsterdam, Netherlands 7th October 2010

GSL Swiss Securities Lending Summit Zurich, Switzerland 21st October 2010

GSL London Securities Lending Summit London, UK 28th October 2010

GSL Boston Securities Lending Summit Boston, USA 4th November 2010

GSL Middle East Securities Lending Summit Doha, Qatar 10th November 2010

GSL Luxembourg Securities Lending Summit Luxembourg 2nd December 2010

For more details please contact [email protected]

The Global Securities Lending Summits have continued apace in 2010, following on from their successful introduction in 2009.

Unlike many of the beneficial owner-focused events on the securities lending calendar, GSL Summits last for just one afternoon, with the focus on relevant, concise content, followed by networking sessions.

So far in 2010, GSL has visited Stockholm, London, Frankfurt, Paris, New York, Tokyo and Toronto. There are seven more events planned for the rest of the year (see below).

Topics and discussion points have varied dramatically over the course of the sessions, but recurring themes have included, of course, regulation, but also a significant strand has been that benefical owners have returned to their securities lending programmes, albeit wiser and more educated - something that the Summits help to enhance.

Full coverage of all of the summits is available online at www.GSL.tv/Videos n

http://gsl.tv/events

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mailto:[email protected]

For more information: www.db.com. This advertisement has been approved and/or communicated by Deutsche Bank Group and appears as a matter of record only. The services described in this advertisement are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation. Deutsche Bank operations in Dubai are regulated by the Dubai Financial Services Authority from the Dubai International Financial Centre. Any financial services or products offered by Deutsche Bank from the centre are only available to clients who satisfy the regulatory criteria to be a professional client, set out in the Authority‘s rules and this communication is directed only at such persons. Copyright © 2010 Deutsche Bank AG.

Where do I find a financial institution with a global presence and expertise in agency securities lending?

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We provide an extensive range of agency securities lending, securities custody, clearing and fund services from a network spanning over 30 securities markets.

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Best Fixed Income Trading Capability, Single Location Lender category

Looking to the Future – Up and Coming Firms, Lender category

Commended: Best Equity Trading Capability, Single Location Lender category

Global Securities Lending, Securities Lending Awards 2010

Highest scoring regional provider in Europe

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34 Best in Class Awards

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Part One What is securities lending? Securities lending is a long-established practice that plays an important role in today’s capital markets by providing liquidity that reduces the cost of trading and promotes price discovery in rising as well as falling markets. The resultant increase in efficiency benefits the market as a whole - from the securities dealers and end investors through to the corporate issuers that depend on efficient, liquid markets to raise additional capital. The Legal Framework

Definitions In some ways, the term “securities lending” is misleading and factually incorrect. From a legal perspective in many jurisdictions, the transaction commonly referred to as “securities lending” is, in fact... “a transfer of title of securities linked to the subsequent reacquisition of equivalent securities by means of an agreement.” Such transactions are collateralized and the “rental fee” charged, along with all other aspects of the transaction, are dealt with under the terms agreed between the parties. It is entirely possible and very

commonplace that securities are borrowed and then sold or on-lent. There are some consequences arising from this clarification: 1.Absolute title over both the securities on loan and the collateral received passes between the parties.2.The economic benefits associated with ownership – e.g. dividends, coupons etc. – are “manufactured” back to the lender, meaning that the borrower is entitled to these benefits as owner of the securities but is under a contractual obligation to make equivalent payments to the lender.3.A lender of equities surrenders its rights of ownership, e.g. voting. Should the lender wish to vote on securities on loan, it has the contractual right to recall equivalent securities from the borrower.4.Appropriate documentation of lending ensures that securities lending transactions do not incur taxes that would negate any financial benefit. Different types of securities loan transaction As a by-product of being “appropriately documented”, and as a result of prudent risk management, securities loans in today’s markets

are made against collateral in order to protect the lender against the possible default of the borrower. This collateral can be cash, or other securities or other assets (a) Transactions collateralised with other securities or assets Non-cash collateral would typically be drawn from the following collateral types: Government Bonds: OECD debt, or restricted to G7, G20, etcCorporate Bonds: Typically a minimum credit ratingConvertible Bonds: Usually matched to the securities being lentEquities: Of specified IndicesLetters of Credit: From banks of a specified credit qualityCertificates of Deposit: Drawn on institutions of a specified credit qualityWarrants: Atypical, but usually matchedOther money market instruments

The eligible collateral will be agreed between the parties, as will other key factors including: Notional limits: The absolute value of any asset to be accepted as

Beneficial Owners’ Guide to Securities Lending

in association with

http://dataexplorers.com/

27



collateralInitial margin: The margin required at the outset of a transactionMaintenance margin: The minimum margin level to be maintained throughout the transactionConcentration limits:The maximum percentage of any issue to be acceptable, e.g. less than 5% of daily traded volumeThe maximum percentage of collateral pool that can be taken against the same issuer, i.e. the cumulative effect where collateral in the form of letters of credit, CD, equity, bond and convertible may be issued by the same firmIn a large number of securities lending transactions, collateral is held by a Tri Party Agent. This specialist agent (typically a large custodian bank or International Central Securities Depository) will receive only eligible collateral from the borrower and hold it in a segregated account to the order of the lender. The Tri Party Agent will mark this collateral to market, with information distributed to both lender and borrower. Typically the borrower pays a fee to the Tri Party agent. There is debate within the industry as to whether lenders that are flexible in the range of non-cash collateral they are willing to receive are rewarded with correspondingly higher fees. Some argue that they are, others claim

that the fees remain largely static but that borrowers are more prepared to deal with a flexible lender and therefore balances and overall revenue rise. The agreement on a fee is reached between the parties and would typically take into account the following factors: - Demand and supply: The less of a security available, other things being equal, the higher the fee a lender can obtainCollateral flexibility: See above – the cost to a borrower of giving different types of collateral varies significantly, so that they might be more willing to pay a higher fee if the lender is more flexibleDividend issues: The size of the manufactured dividend required to compensate the lender for the post-tax dividend payment that it would have received had it not lent the security: Different lenders have varying tax liabilities on income from securities; the lower the manufactured dividend required by the lender, the higher the fee it can negotiateThe term of a transaction: Securities lending transactions can be open to recalls or fixed for a specified term; there is much debate about whether there should be a premium paid or a discount for certainty. If a lender can guarantee a recall-free loan then a premium will be forthcoming. One of

the attractions of repo and swaps is the transactional certainty on offer from a counterpartCertainty: There are trading and arbitrage opportunities, the profitability of which revolves around the making of specific decisions. If a lender can guarantee a certain course of action, this may mean it can negotiate a higher fee Fees vary from security to security and over time. (b) Transactions collateralised with cash Cash collateral is, and has been for many years, an integral part of the securities lending business, particularly in the United States. The lines between two distinct activities - Securities lending and Cash reinvestment - have become blurred; and to many US investment institutions securities lending is virtually synonymous with cash reinvestment. This is much less the case outside the United States but consolidation of the custody business and the important role of US custodian banks in the market means that this practice is becoming more prevalent internationally. The importance of this point lies in the very different risk profiles of these increasingly intertwined activities. Crucially, cash

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reinvestment is not usually covered by an indemnity – insurance from the lending agent that provides some protection in the event of a counterpart default. It can be argued that this creates a conflict of interest for the cash manager – they earn fees but do not share the direct financial risk of this activity. They do, however, run considerable reputational and commercial risk if they do not manage this potential conflict. Cash reinvestment was traditionally dominated by unitized funds that pooled the collateral for ease of management and to achieve the various economies of scale available in money market investment. However, segregated accounts with client specific risk profiles are now becoming much more common. Note that the securities lending loan term (i.e. time to maturity) will determine the benchmark rate that is to be paid on the cash. Most loans can be recalled at any time, so the cash will generally have an overnight rate benchmark. It is common for the interest to be physically settled monthly. Below we provide an example of relative importance of cash and non-cash to different fiscal locations and as you can see the US domiciled

lenders are overwhelmingly taking cash as collateral whilst other jurisdictions have a predilection for non-cash collateral. The relative scale and importance of the US lending community brings the overall percentage of collateral taken as cash up to 59.5%. These statistics owe a great deal to historic tax legislation and inertia but have served the non US lenders well in during the credit crunch when some money market funds lost money. Table 1.1 Use of Cash as Collateral (02 April 2010)

Domicile of lender

% of collateral taken as cash

US 96.7

Canada 13.24

Luxembourg 16.24

UK 15.44

All Lenders 58.13 Source: Data Explorers The revenue generated from cash-collateralised securities lending transactions is derived in a different manner from that in a non-cash transaction. It is made from the difference or “spread” between interest rates that are paid and received by the lender. Reinvestment guidelines are typically documented in the appendix of the

underlying securities lending agreement. Unfortunately it is still typical for these guidelines to be bespoke and lack any specific risk language. This situation is changing in light of client and provider experiences related to the liquidity crisis prompted by the Credit Crunch. The adoption of a more risk management orientated approach is to be welcomed and encouraged. Some typical guidelines might be as follows: Conservative

Overnight G7 Government Bond repo fund Maximum effective duration of 1 day, or any term agreements are a small proportionFloating-rate notes and derivatives are not permissible Restricted to overnight repo agreements

Quite Conservative

AAA rated Government Bond repo fundMaximum average maturity of 90 days Maximum remaining maturity of any instrument is 13 months

Quite FlexibleMaximum effective duration of 90 days Maximum remaining effective maturity of 2 - 3 years Floating-rate notes and eligible derivatives are permissible

29



Credit quality: Short-term ratings: A1/P1, long-term ratings: A-/A3 or better

Flexible

Maximum effective duration of 90 days Maximum remaining effective maturity of 5 years Floating-rate notes and eligible derivatives are permissibleCredit quality: Short-term ratings: A1/P1, long-term ratings: A-/A3 or better

Some securities lending agents offer bespoke reinvestment guidelines whilst others offer reinvestment pools. Other transaction types Securities lending is part of a larger set of interlinked securities financing markets. These transactions are often used as alternative ways of achieving similar economic outcomes, although the legal form and accounting and tax treatments can differ. The other transactions include: Sale and repurchase agreements (“Repos”)

SwapsBuy/sell backs

ConclusionThe scale and significance of the securities lending industry should now be apparent to the reader. It is important to note that this is not purely a business that drives short selling – there are many reasons

to borrow securities and securities lending is an important tool in a variety of capital market functions. In the next chapter we will focus in more depth on the structure of the market and the different routes that supply can follow through it.

Part TwoLenders and intermediaries

The securities lending market involves various specialist intermediaries which take principal and/or agency roles. These intermediaries separate the underlying owners of securities – typically large pension or other funds, and insurance companies – from the eventual borrowers of securities, whose usual motivations are described later. Intermediaries1. Agent intermediariesSecurities lending is increasingly becoming a volume business and the economies of scale offered by agents that pool together the securities of different clients enable smaller owners of assets to participate in the market. The costs associated with running an efficient securities lending operation are beyond many smaller funds for which this is a peripheral activity. Asset managers and custodian banks have added securities lending to the other services

they offer to owners of securities portfolios, while third-party lenders specialise in providing securities lending services. Owners and agents “split” revenues from securities lending at commercial rates. The split will be determined by many factors including the service level and provision by the agent of any risk mitigation, such as an indemnity. Securities lending is often part of a much bigger relationship and therefore the split negotiation can become part of a bundled approach to the pricing of a wide range of services. (a) Asset managersIt can be argued that securities lending is an asset management activity – a point that is easily understood considering the reinvestment of cash collateral. Particularly in Europe, where custodian banks were perhaps slower to take up the opportunity to lend than in the United States, many asset managers run significant securities lending operations. What was once a low-profile, back-office activity is now a front-office growth area for many asset managers. The relationship that the asset managers have with their underlying clients puts them in a strong position to participate.

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(b) Custodian banksThe history of securities lending is inextricably linked with the custodian banks. Once they recognised the potential to act as agent intermediaries and began marketing the service to their customers, they were able to mobilise large pools of securities that were available for lending. This in turn spurred the growth of the market. Most large custodians have added securities lending to their core custody businesses. Their advantages include: the existing banking relationship with their customers; their investment in technology and global coverage of markets, arising from their custody businesses; the ability to pool assets from many smaller underlying funds, insulating borrowers from the administrative inconvenience of dealing with many small funds and providing borrowers with protection from recalls; and experience in developing as well as developed markets. Being banks, they also have the capability to provide indemnities and manage cash collateral efficiently – two critical factors for many underlying clients. Custody is so competitive a business that for many

providers it is a loss-making activity. However, it enables the custodians to provide a range of additional services to their client base. These include foreign exchange, trade execution, securities lending and fund accounting. (c) Third-party agentsAdvances in technology and operational efficiency have made it possible to separate the administration of securities lending from the provision of basic custody services, and a number of specialist third-party agency lenders have established themselves as an alternative to custodian banks. Their market share is currently growing from a relatively small base. Their focus on securities lending and their ability to deploy new technology without reference to legacy systems can give them flexibility. 2. Principal intermediaries There are three broad categories of principal intermediary:

Broker DealersSpecialist intermediariesPrime brokers

In contrast to the agent intermediaries, they can assume principal risk, offer credit intermediation and take positions in the securities that they borrow. Distinctions between

the three categories are blurred. Many firms would be in all three. In recent years securities lending markets have been liberalised to a significant extent so that there is little general restriction on who can borrow and who can lend securities. Lending can, in principle, take place directly between beneficial owners and the eventual borrowers. But typically a number of layers of intermediary are involved. What value do the intermediaries add? A beneficial owner may well be an insurance company or a pension scheme while the ultimate borrower could be a hedge fund. Institutions will often be reluctant to take on credit exposures to borrowers that are not well recognised, regulated or who do not have a good credit rating. This would exclude most hedge funds. In these circumstances, the principal intermediary (often acting as prime broker) performs a credit intermediation service in taking a principal position between the lending institution and the hedge fund. A further role of the intermediaries is to take on liquidity risk. Typically they will borrow from institutions on an open basis – giving them the option to recall the

31



underlying securities if they want to sell them or for other reasons – whilst lending to clients on a term basis, giving them certainty that they will be able to cover their short positions. In many cases, as well as serving the needs of their own propriety traders, principal intermediaries provide a service to the market in matching the supply of beneficial owners that have large stable portfolios with those that have a high borrowing requirement. They also distribute securities to a wider range of borrowers than underlying lenders, which may not have the resources to deal with a large number of counterparts. These activities leave principal intermediaries exposed to liquidity risk if lenders recall securities that have been on lent to borrowers on a term basis. One way to mitigate this risk is to use in-house inventory where available. For example, proprietary trading positions can be a stable source of lending supply if the long position is associated with a long-term derivatives transaction. Efficient inventory management is seen as critical and many securities lending desks act as central clearers of inventory within their organisations, only borrowing externally when netting of in-house

positions is complete. This can require a significant technological investment. Other ways of mitigating ‘recall risk’ include arrangements to borrow securities from affiliated investment management firms, where regulations permit, and bidding for exclusive (and certain) access to securities from other lenders. On the demand side, intermediaries have historically been dependent upon hedge funds or proprietary traders that make trading decisions. But a growing number of securities lending businesses within investment banks have either developed “trading” capabilities within their lending or financing departments, or entered into joint ventures with other departments or even in some cases their hedge fund customers. The rationale behind this trend is that the financing component of certain trading strategies is so significant that without the loan there is no trade. (a) Broker dealersBroker dealers borrow securities for a wide range of reasons:

Market makingTo support proprietary tradingOn behalf of clients

Many broker dealers combine their securities lending activities with their

prime brokerage operation (the business of servicing the broad requirements of hedge funds and other alternative investment managers). This can bring significant efficiency and cost benefits. Typically within broker dealers the fixed income and equity divisions duplicate their lending and financing activities. (b) Specialist intermediariesHistorically, regulatory controls on participation in stock lending markets meant that globally there were many intermediaries. Some specialised in intermediating between stock lenders and market makers in particular, e.g. UK Stock Exchange Money Brokers (“SEMB”). With the deregulation of stock lending markets, these niches have almost all disappeared. Some of the specialists are now part of larger financial organisations. Others have moved to parent companies that have allowed them to expand the range of their activities into proprietary trading. (c) Prime brokersPrime brokers serve the needs of hedge funds and other ‘alternative’ investment managers. The business was once viewed simply as the provision of six distinct services, although many others such as capital introduction, risk management, fund

32



accounting and start up assistance have now been added: Services provided by prime brokers • Profitable activities• Part of the cost of

being in business• Securities lending• Clearance• Leverage of financing

provision• Custody• Trade execution• Reporting

Securities lending is one of the central components of a successful prime brokerage operation, with its scale depending on the strategies of the hedge funds for which the prime broker acts. Two strategies that are heavily reliant on securities borrowing are long/short equity and convertible bond arbitrage. The cost associated with the establishment of a full service prime broker is steep and recognised providers have a significant advantage. Some of the newer entrants have been using total return swaps, contracts for difference and other derivative transaction types to offer what has become known as “synthetic prime brokerage”. Again securities lending remains a key component of the service as the prime broker will still need to borrow securities in order to hedge the derivatives positions it

has entered into with the hedge funds, for example, to cover short positions. But it is internalised within the prime broker and less obvious to the client. Beneficial owners Those beneficial owners with securities portfolios of sufficient size to make securities lending worthwhile include:

• Pension funds• Insurance and

assurance cos• Mutual funds/unit

trusts• Endowments

When considering whether and how to lend securities, beneficial owners need first to consider the characteristics of their organisations and portfolio. 1. Organisation characteristics (a) Management motivationSome owners lend securities solely to offset custody and administrative costs. Others are seeking more significant revenue. (b) Technology investmentLenders vary in their willingness to invest in technological infrastructure to support securities lending. (c) Credit risk appetiteThe securities lending market consists of organisations with a wide range of credit quality and collateral capabilities.

A cautious approach to counterpart selection (AAA only) and restrictive collateral guidelines (G7 Bonds) will limit lending volumes. 2. Portfolio characteristics (a) SizeOther things being equal, borrowers prefer large portfolios. (b) Holdings sizeLoan transactions generally exceed $250,000. Lesser holdings are of limited appeal to direct borrowers. Holdings of under $250,000 are probably best deployed through an agency programme, where they can be pooled with other inventories. (c) Investment strategyActive investment strategies increase the likelihood of recalls, making them less attractive than passive portfolios. (d) DiversificationBorrowers want portfolios where they need liquidity. A global portfolio offers the greatest chance of generating a fit. That said, there are markets that are particularly in demand from time to time and there are certain borrowers that have a geographic or asset class focus. (e) Tax jurisdiction and positionBorrowers are responsible for “making good” any benefits of share ownership (excluding

33


voting rights) as if the securities had not been lent. They must “manufacture” (i.e. pay) the economic value of dividends to the lender. An institution’s tax position compared to that of other possible lenders is therefore an important consideration. If the cost of manufacturing dividends or coupons to a lender is low then its assets will be in greater demand. (f) Inventory attractiveness“Hot” securities are those in high demand whilst general collateral or general collateral securities are those that are commonly available. Needless to say, the “hotter” the portfolio, the higher the returns from lending it. Having examined the organisation and portfolio characteristics of the beneficial owner, we must now consider the various possible routes to market. The possible routes to the securities lending market (a) Using an asset manager as agentA beneficial owner may find that the asset manager they have chosen, already operates a securities lending programme. This route poses few barriers to getting started quickly. (b) Using a custodian as agentThis is the least demanding

option for a beneficial owner, especially a new one. They will already have made a major decision in selecting an appropriate custodian. This route also poses few barriers to getting started quickly. (c) Appointing a third-party specialist as agentA beneficial owner who has decided to outsource may decide it does not want to use the supplier’s asset manager(s) or custodian(s), and instead appoint a third-party specialist. This route may mean getting to know and understand a new provider prior to getting started. The opportunity cost of any delay needs to be factored into the decision. (d) Auctioning a portfolio to borrowersBorrowers bid for a lender’s portfolio by offering guaranteed returns in exchange for gaining exclusive access. There are several different permutations of this auctioning route:

Do-it-yourself auctionsAssisted auctionsAgent assistanceConsultancy assistanceSpecialist “auctioneer” assistance

This is not a new phenomenon but one that has gained a higher profile in recent years. A key issue for the beneficial owner considering this option is the level of operational support that the auctioned

portfolio will require and who will provide it. (e) Selecting one principal borrowerMany borrowers effectively act as wholesale intermediaries and have developed global franchises using their expertise and capital to generate spreads between two principals that remain unknown to one another. These principal intermediaries are sometimes separately incorporated organisations, but, more frequently, are parts of larger banks, broker-dealers or investment banking groups. Acting as principal allows these intermediaries to deal with organisations that the typical beneficial owner may choose to avoid for credit reasons e.g. hedge funds. (f) Lending directly to proprietary principalsSometimes after a period of activity in the lending market using one of the above options, a beneficial owner that is large enough in its own right, may wish to explore the possibility of establishing a business “in house”, lending directly to a selection of principal borrowers that are the end-users of their securities. The proprietary borrowers include broker-dealers, market makers and hedge funds. Some have global borrowing needs while others are more regionally focused.


34



(g) Choosing some combination of the aboveJust as there is no single or correct lending method, so the options outlined above are not mutually exclusive. Deciding not to lend one portfolio does not preclude lending to another; similarly, lending in one country does not necessitate lending in all. Choosing a wholesale intermediary that happens to be a custodian in the United States and Canada does not mean that a lender cannot lend Asian assets through a third-party specialist and European assets directly to a panel of proprietary borrowers.

Part ThreeThe borrowing motivation

One of the central questions commonly asked by issuers and investors alike is “Why does the borrower borrow my securities?”. Before considering this point let us examine why issuers might care. Issuers If securities were not issued, they could not be lent. Behind this simple tautology lies an important point. When Initial Public Offerings are frequent and corporate merger and acquisition activity is high, the securities lending business benefits. In the early 2000s, the fall in the level of such activity

depressed the demand to borrow securities leading to:A depressed equity securities lending market meaning: Fewer trading opportunitiesLess demandFewer “specials”Issuer concern about the role of securities lending, such as Whether it is linked in any way to the decline in the value of a company’s shares?Whether securities lending should be discouraged?How many times does an issuer discussing a specific corporate event stop to consider the impact that the issuance of a convertible bond or the adoption of a dividend reinvestment plan might have upon lending of their shares? There is a significant amount of information available on the “long” side of the market and correspondingly little on the “short” side. Securities lending activity is not synonymous with short selling. But it is often, although not always, used to finance short sales (see below) and might be a reasonable and practical proxy for the scale of short selling activity in the absence of full short sale disclosure. It is therefore natural that issuers would want to understand how and why their securities are traded.

Reasons to borrow Borrowers, when acting as principals, have no obligation to tell lenders or their agents why they are borrowing securities. In fact they may well not know themselves as they may be on-lending the securities to proprietary traders or hedge funds that do not share their trading strategies openly. Some prime brokers are deliberately vague when borrowing securities as they wish to protect their underlying hedge fund customer’s trading strategy and motivation. This chapter explains some of the more common reasons behind the borrowing of securities. In general, these can be grouped into: (1) borrowing to cover a short position (settlement coverage, naked shorting, market making, arbitrage trading); (2) borrowing as part of a financing transaction motivated by the desire to lend cash; and (3) borrowing to transfer ownership temporarily to the advantage of both lender and borrower (tax arbitrage, dividend reinvestment plan arbitrage). Borrowing to cover short positions (a) Settlement coverageHistorically, settlement coverage has played a

35



significant part in the development of the securities lending market. Going back a decade or so, most securities lending businesses were located in the back offices of their organisations and were not properly recognised as businesses in their own right. Particularly for less liquid securities – such as corporate bonds and equities with a limit free float – settlement coverage remains a large part of the demand to borrow. The ability to borrow to avoid settlement failure is vital to ensure efficient settlement and has encouraged many securities depositories into the automated lending business. This means that they remunerate customers for making their securities available to be lent by the depository automatically in order to avert any settlement failures. (b) Naked shortingNaked shorting can be defined as borrowing securities in order to sell them in the expectation that they can be bought back at a lower price in order to return them to the lender. Naked shorting is a directional strategy, speculating that prices will fall, rather than a part of a wider trading strategy, usually involving a corresponding long position in a related security.

Naked shorting is a high-risk strategy. Although some funds specialise in taking short positions in the shares of companies they judge to be overvalued, the number of funds relying on naked shorting is relatively small and probably declining. (c) Market makingMarket makers play a central role in the provision of two-way price liquidity in many securities markets around the world. They need to be able to borrow securities in order to settle “buy orders” from customers and to make tight, two-way prices. The ability to make markets in illiquid small-capitalisation securities is sometimes hampered by a lack of access to borrowing and some of the specialists in these less liquid securities have put in place special arrangements to enable them to gain access to securities. These include guaranteed exclusive bids with securities lenders. The character of borrowing is typically short term for an unknown period of time. The need to know that a loan is available tends to mean that the level of communication between market makers and the securities lending business has to be highly automated. A market maker that goes short and then finds that there is no

loan available would have to buy that security back to flatten its book. (d) Arbitrage trading Securities are often borrowed to cover a short position in one security that has been taken to hedge a long position in another as part of an “arbitrage” strategy. Some of the more common arbitrage transactions that involve securities lending are described below. (i) Convertible bond arbitrageConvertible bond arbitrage involves buying a convertible bond and simultaneously selling the underlying equity short and borrowing the shares to cover the short position (see Box 3). Leverage can be deployed to increase the return in this type of transaction. Prime brokers are particularly keen on hedge funds that engage in convertible bond arbitrage as they offer scope for several revenue sources:

Securities lending revenuesProvision of leverageExecution of the convertible bondExecution of the equityWorked example of convertible bond arbitrage

Long side5% XYZ Limited convertible bondMaturing in one year at US$1,000Exchangeable into 100

36



non-dividend-paying sharesStock currently trading at US$10 per share Short sideA short position of 50 underlying shares at $10 per share Pricing inefficiencies between these two related securities can create arbitrage opportunities whether the underlying share price rises or falls. In general, however, the trade will be more profitable if the implied volatility of the share price rises, increasing the value of the call option embedded in the convertible bond. Unless the issuer defaults, convertible bonds can only fall in value as low as their “investment value” – what the same company bond would be worth if it were not convertible. In this case, the investment value is assumed to be US$920. Bondholders can purchase protection against issuer default using credit default swaps but this element of the transaction is not covered in this example. To keep the example simple, it is also assumed that the convertible trades with a “delta” of one to the stock (i.e. that the prices of the convertible bond and the share change at the same rate.)

A transaction such as the one above would have

these return dynamics:

No change in share price

Interest payments on $1,000 convertible bond (5%)

$50.00

Interest earned on $500 short sale proceeds (1.5%)

$7.50

Fees paid to lender of shares (0.25% per annum)

($1.50)

Net cash flow $56.00

Annual return 5.60%

25% rise in share price

Gain on convertible bond $250.00

Loss on shorted stock (50 shares @ $2.50/share)

($125.00)

Interest from convertible bond

$50.00

Interest earned on short sale proceeds

$7.50

Fees paid to lender of shares

($1.50)

Net trading gains and cash flow

$181.00

Annual return 18.10%

25% fall in share price

Loss on convertible bond (only falling as low as “investment value”)

($80.00)

Gain on shorted stock (50 shares @ $2.50/share)

$125.00

Interest from convertible bond

$50.00

Interest earned on short sale proceeds

$7.50

Fees paid to lender of shares

($1.50)

Net cash flow $101.00

Annual return 10.10%

Components of Return(ii) Pairs trading or relative value “arbitrage”This in an investment strategy that seeks to identify two companies with similar characteristics whose equity securities are currently trading at a price relationship that is out of line with their historical trading range. The strategy entails buying the apparently undervalued security while selling the apparently overvalued security short, borrowing the latter security to cover the short position. Focusing on securities in the same sector or industry should normally reduce the risks in this strategy. (iii) Index arbitrageIn this context, arbitrage refers to the simultaneous purchase and sale of the same commodity or stock in two different markets in order to profit from price discrepancies between the markets. In the stock market, an arbitrage opportunity arises when the same security trades at different prices in different markets. In such a situation, investors buy the security in one market at a lower price and sell it in another for more, capitalising on the difference. However,

37



such an opportunity vanishes quickly as investors rush in to take advantage of the price difference. The same principle can be applied to index futures. Being a derivative product, index futures derive their value from the securities that constitute the index. At the same time, the value of index futures is linked to the stock index value through the opportunity cost of funds (borrowing/lending cost) required to play the market. Stock index arbitrage involves buying or selling a basket of stocks and, conversely, selling or buying futures when mispricing appears to be taking place. (iv) When is an arbitrage possible?Where the current index futures price (FC) is not equal to the index value (IC) plus the difference between the risk free interest (RF) and dividends (D) obtainable over the life of the contract. Or whenever the following is not true FC = IC + (RF-D). Whenever the actual futures price moves away from the above calculated value, i.e. when FC > IC + (RF-D) or F < IC + (RF-D), arbitrage opportunities exist. The difference between the current

theoretical actual cost and the futures price is called the basis. It is this difference that creates an arbitrage opportunity. When FC > IC + (RF-D) a trader can profit by taking the following action:Buying a portfolio which is identical to the index valueSelling index futuresWhen FC < IC + (RF-D) a trader can profit by taking the following action:Going short (selling) a portfolio which is identical to the index valueBuying index futures It is here that securities lending plays its role. The ability of a borrower to source a complete portfolio of all the stocks in an index, properly weighted, that will accurately track the performance of the index is a big advantage. Incomplete indices or unbalanced indices open up the possibility of tracking errors occurring whereby the performance of the short cash portfolio deviates from that of the index. The ability to borrow securities that have a cheaper manufactured dividend obligation is an advantage too. One of the problem areas is when a component (or components) of the index is in high demand (“trading special”) and the cost of borrowing rises, thereby reducing the profitability of the transaction. The ability

to borrow for a fixed term is also an advantage. The best sources of securities to support this type of transaction are passive index tracking funds incorporated in countries that have high rates of withholding tax. Once established, the stock index arbitrage can generate profits should the price of the index and the underlying securities move up or down. The arbitrage opportunity is often short-lived as positions are taken and the price adjusts. As these transactions normally have thin margins, they are often executed in large sizes. (e) Financing As broker dealers build derivative prime brokerage and customer margin business, they hold an increasing inventory of securities that requires financing. This type of activity is high volume and takes place between two counterparts that have the following coincidence of wants:One has cash that they would like to invest on a secured basis and pick up yieldThe other has inventory that needs to be financed In the case of bonds, the typical financing transaction is a repo or buy/sell back. But

38



for equities, securities lending and equity repo transactions are used. Tri Party agents are often involved in this type of financing transaction as they can reduce operational costs for the cash lender and they have the settlement capabilities the cash borrower needs to substitute securities collateral as their inventory changes. (f) Temporary transfers of ownership (i) Tax arbitrageTax driven trading is an example of securities lending as a means of exchange. Markets that have historically provided the largest opportunities for tax arbitrage include those with significant tax credits that are not available to all investors – examples include Italy, Germany and France. The different tax positions of investors around the world have opened up opportunities for borrowers to use securities lending transactions, in effect, to exchange assets temporarily for the mutual benefit of purchaser, borrower and lender. The lender’s reward comes in one of two ways: either a higher fee for lending if they require a lower

manufactured dividend, or a higher manufactured dividend than the post-tax dividend they would normally receive (quoted as an “all-in rate”). For example, an offshore lender that would normally receive 75% of a German dividend and incur 25% withholding tax (with no possibility to reclaim) could lend the security to a borrower that, in turn, could sell it to a German investor who was able to obtain a tax credit rather than incur withholding tax. If the offshore lender claimed the 95% of the dividend that it would otherwise have received, it would be making a significant pick-up (20% of the dividend yield), whilst the borrower might make a spread of between 95% and whatever the German investor was bidding. The terms of these trades vary widely and rates are calculated accordingly. (ii) Dividend reinvestment plan arbitrage Many issuers of securities create an arbitrage opportunity when they offer shareholders the choice of taking a dividend or reinvesting in additional securities at a discounted level. Income or index tracking funds that cannot deviate from recognised securities

weightings may have to choose to take the cash option and forgo the opportunity to take the discounted reinvestment opportunity. One way that they can share in the potential profitability of this opportunity is to lend securities to borrowers that then take the following action:- Borrow as many guaranteed cash shares as possible, as cheaply as possible- Tender the borrowed securities to receive the new discounted shares- Sell the new shares to realise the “profit” between the discounted share price and the market price- Return the shares and manufacture the cash dividend to the lender. n

This section is an edited extract from ‘An Introduction to Securities Lending’ by Mark C Faulkner, Data Explorers. It has been prepared with permission. The original publication of ‘An Introduction to Securities Lending’ was commissioned by the International Securities Lending Association, the Association of Corporate Treasurers, the British Bankers Association, the London Investment Banking Association, the London Stock Exchange and the Securities Lending and Repo Committeee of the Bank of England.

Performance. Trust. Expertise.BBH Global Securities Lending

©2010 Brown Brothers Harriman & Co.This information is targeted at Professional Clients and Eligible Counterparties only.

Structuring securities lending

transactions that combine optimised

intrinsic value with conservative

collateral parameters has been

the foundation of our program

since inception.

With excellent client referenceability,

compelling economics, and no

collateral impairment, BBH has

proven that our philosophy delivers

both outstanding performance and

robust r isk management.

Custody

Accounting

Administration

Transfer Agency

Securities Lending

Foreign Exchange

Brokerage

Fund Distribution

Outsourcing

WWW.BBH.COM/SECURITIESLENDING

Contact us to learn more about what makes the BBH program unique:

Asia: Richard Meek +852 3756 1686 [email protected]

Europe: Keith Haberlin +44 (0) 207 614 2165 [email protected]

US: Andrew Pettit +1 617 772 6553 [email protected]

http://www.bbh.com/securitieslending

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Company Profile

A global leader with close to 200 years of experience, Brown Brothers Harriman is a privately-held financial services firm that helps many of the world’s most sophisticated institutional investors achieve their inter-national business objectives. BBH Global Securities Lending leverages our firm’s resources to achieve customized solutions and optimized performance for every client, providing third party and custodial lending services via traditional agency and agency exclusive arrangements.

PERFORMANCE: BBH works with our clients to achieve superior securities lending returns both in absolute financial and risk adjusted terms.• Customized trading solutions encompass-ing a broad range of inputs, including invest-ment strategy, performance goals and risk tolerance.• Continuous portfolio analysis designed to recommend the optimal trading strategy or route to market, based on market conditions and client goals. • Flexible and prudent collateral offerings which support an intrinsic value strategy.

TRUST: BBH has proven that our philoso-phy of partnership and client protection delivers both outstanding performance and robust risk management. • Independent, privately-held structure al-lows us to maintain an unwavering focus on

our clients’ long term best interests.• History of no losses, liquidity restrictions or collateral impairment.• 100% client referenceability.

EXPERTISE: BBH Global Securities Lending is run by a management team with over 20 years of diversified experience navigating a variety of market conditions. • Consistent management team has been structuring transactions that combine optimized intrinsic value with conservative collateral parameters since our program’s inception.• Dedicated traders in North America, Eu-rope, and Asia have diversified backgrounds, with experience in agency lending, broker/dealer financing and hedge fund trading.• Dedicated tax, regulatory, legal and risk management resources provide expertise across global markets, client domiciles and entity types.

Key Contacts:

Asia: Richard Meek, +852.3756.1686

EMEA: Keith Haberlin, +44(0)207.614.2165

US: Andrew Pettit, +1.617.772.6553

Brown Brothers Harriman

Christine Donovan is a managing director within BBH’s Investor Services Division. She founded BBH’s in-house Securities Lending Program in 1999 and continues to oversee the business globally today.

http://www.bbh.com/securitieslending

41


Company Profile

Clients around the world turn to Citi® Investor Services, for a range of securities finance capabilities that few organizations can match. Our solutions include agency and principal programs in either a custody or non-custody capacity as well as prime brokerage, collateral management, and liquidity management solutions. Through a coordinated global approach and securities lending trading capability strategically available in New York, London, Hong Kong Melbourne and Toronto, we provide 24-hour coverage to help our clients maximize their portfolios’ use.

We can fulfill the borrowing requirements of over 100 top banks, broker-dealers and other financial institutions worldwide. Our on-the-ground presence in the 38 markets where we lend securities is second to none and we can help you stay current with local market changes.

While maximizing yield is important, our priority is to preserve lender principal while maintaining liquidity, and you can rest assured that we will work with you to find the appropriate risk/reward balance.

In addition to securities finance, Citi® Investor Services includes local and global custody, mutual fund and alternative investment solutions as well as investment administration services for institutional,

high net worth and separately managed accounts.To learn how we can design a securities finance program that meets your needs, please contact:

Citi’s Securities Finance global product team

Americas, Laurie [email protected]

Asia, Lawrence [email protected]

EMEA, Brian [email protected]

Citi

Timothy Douglas, Managing Director, Global Head, Securities Finance,Global Transaction Services, Citi’s Institutional Clients Group

http://www.citigroup.com/transactionservices/home/securities_svcs/secfin.jsp

42


Company Profile

COMIT has been servicing the finance industry for more than 30 years with profes-sional IT services across the whole value chain. Key areas of expertise include strategic consulting, implementation of core bank-ing solutions, namely Avaloq and Finnova, application management and IT infrastruc-ture services. The design, development and integration of highly specialized solutions and products for the Securities Finance and Collateral & Risk Management market has also become a core competence. COMIT is an independent subsidiary of Swisscom IT Services, therefore a member of the Swiss-com group. COMIT currently employs 700 IT and business specialists at various locations in Europe and Asia/Pacific. Main offices are Zurich (headquarters), Geneva, Frankfurt, Munich, Vienna, Luxembourg and Singapore.

Product description:

FINACE currently is the only fully integrated solution which supports current and future business models within the area of Securities Lending, Repo, Synthetic Finance and OTC Derivatives Collateral Management. The ar-chitecture of FINACE is based on a scalable, leading edge technology platform, which was developed with performance and robustness as the focus of design. With flexibility at its core, customer-driven extensions and modi-fications can be quickly and easily applied to the standard component set.

Comit

http://www.comit.ch/web/en/competencies/investmentManagement/secLending.php

43


Company Profile

Deutsche Bank’s Global Transaction Banking division, offers its clients access to a grow-ing domestic custody and clearing network which currently covers more than 30 securi-ties markets globally. We are dedicated to providing cross-border custody services, fund administration, securities clearing and agency securities lending consistently in all markets to exceptional standards as part of our commitment to support our clients’ success.

Through offices in London, New York and Frankfurt, Deutsche Bank’s Agency Secu-rities Lending team operates one of the world’s largest non-custodial agency securi-ties lending programs offering institutional clients a comprehensive and efficient service for generating additional return on their fixed income and equity portfolios in a low risk environment.

Deutsche Bank has been recognized in Global Custodian’s Securities Lending Survey 2010 achieving “Top-rated” status in a number of categories. It was also the highest scoring regional provider in Europe, the highest scoring provider in the Multi-Provider category and obtained 34 Best in Class awards.

Contact:

Tim SmollenDeutsche BankManaging Director, Global Head of Agency Securities LendingTel: +1 212 250 4611Email: [email protected]

[email protected]

Deutsche Bank Direct Securities Services

http://www.tss.db.com

44


Company Profile

With 10 years of experience, eSecLending is a full-service global securities lending agent providing customized securities lending solutions for sophisticated institutional investors worldwide. The company’s approach has introduced investment management practices to the securities lending industry, offering beneficial owners an alternative to the custodial lending model. Their philosophy is focused on providing clients with complete program customization, optimal intrinsic returns, high touch client service and comprehensive risk management. Their differentiated process combines agency exclusives and discretionary routes to market to achieve best execution while providing clients with greater transparency and control, allowing them to more effectively monitor and mitigate risks.

Key Locations:Boston175 Federal Street, 11th FloorBoston, MA 02110United States of America+1 617 204 4500

London10 King William Street, 1st FloorLondon, EC4N 7TWUnited Kingdom+44 (0) 20 7469 6000 Sydney19-29 Martin Place, Level 56Sydney, NSW 2000Australia+61 (0) 2 9220 3610

Key Contacts:

Christopher JaynesCo-Chief Executive [email protected]+1 617 204 4500

Karen O’ConnorCo-Chief Executive [email protected]+1 617 204 4500

www.eseclending.com

eSecLending

http://www.eseclending.com/

45


Company Profile

Founded in 1997, the Global Securi-ties Finance Business (GSF) within ING Commercial Banking, has in recent years enjoyed exceptional growth in both securi-ties finance product offerings and in signing top tier institutional and hedge fund clients. GSF’s strong growth can be traced to ING Group’s: dominant credit position, large global footprint, and client-focused business philosophy.

ING Bank is a solid financial entity with an A+ credit rating and a proven abil-ity to manage risk while shepherding its clients through the most difficult of market conditions. In a similar fashion, ING’s GSF Business uses its robust balance sheet and market position to provide solid guidance and sound financial solutions to our clients when they need us most.

ING Group’s large global footprint (with offices in 50 countries) has enabled the GSF business to attain a position of market leadership in providing our clients with access to developed and emerging equity and fixed income markets around the world. With offices in New York, London, Amster-dam, Brussels, Moscow and Singapore, all linked together with a globally integrated trading system, GSF traders can provide real time access and pricing to global financing markets at all times.

When it comes to understanding client needs and providing innovative financing solu-tions, ING’s GSF group is second to none. GSF’s client-focused business philosophy has been, and will always be, the main driver in new product development and innovation. With specialized coverage in Equity Lend-ing and Repo, Fixed Income Repo, Synthetic Portfolio Solutions, Portfolio Enhancement Services, and Linear Equity Derivatives, GSF has the ability to create unique, multi-asset, financing structures for each and every cli-ent.

ING Financial Markets Global Securities Finance

http://www.ing.com/group/index.jsp

46


Company Profile

J.P. Morgan Worldwide Securities Services (WSS) is a premier securities servicing provider that helps institutional investors, alternative asset managers, broker dealers and equity issuers optimize efficiency, miti-gate risk and enhance revenue. A division of J.P. Morgan Chase Bank, N.A. (NYSE: JPM), WSS leverages the firm’s unparalleled scale, leading technology and deep industry exper-tise to service investments around the world. It has $15.3 trillion in assets under custody and $6.5 trillion in funds under adminis-tration. For more information, go to www.jpmorgan.com/visit/wss.

J.P. Morgan helps institutions enhance their portfolio performance, increase efficiency and mitigate risk through customized secu-rity lending programmes. J.P. Morgan offers clients separate managed cash collateral accounts, tailoring each account to a client’s unique risk profile, investment needs and collateral guidelines, and empowering clients with full account transparency and control. As a premier agent lender, we offer full-ser-vice capabilities: J.P. Morgan as agent, client directed, auctions and exclusives, designed to meet the risk and reward needs of our sophisticated client base.

The firm’s global banking and asset servic-ing franchise provides clients with one stop access to world markets, knowledgeable risk management and investment support, and best-in-class operations.

Key Locations & Contacts:

Americas:William Smithat [email protected] + 1 212 552 8075

Europe, Middle East and Africa:Paul Wilsonat [email protected] + 44 207 7420249

Asia:Andrew Chengat [email protected] + 852 2800 1809 x 21809

Australia and Japan:Stewart Cowanat [email protected] + 61-2 92504647

J.P. Morgan

http://www.jpmorgan.com/securitieslending

47


Company Profile

As one of the top 10 agent lenders in the world, RBC Dexia Investor Services of-fers proven expertise, responsiveness and a singular focus on the needs of our securities lending clients. RBC Dexia’s securities lend-ing program is structured and managed with one clear objective – to realise the securities lending potential in our clients’ portfolios while remaining within their risk tolerance framework. We offer the distribution capa-bility of our global infrastructure combined with a focused and flexible program de-signed to earn our clients additional returns.

RBC Dexia’s securities lending program is supported by one fully integrated trading platform, providing clients with access to a distribution network that covers 27 mar-kets worldwide. And our custodial lending program was ranked number one in Europe overall in Global Investor’s beneficial owners’ survey for 2010.

RBC Dexia offers a complete range of inves-tor services to institutions worldwide. Our unique offshore and onshore solutions, com-bined with the expertise of our 5,300 profes-sionals in 16 markets, help clients grow their business and sustain enhanced performance through efficiency improvements and robust risk management practices.

Equally owned by RBC and Dexia, the com-pany ranks among the world’s top 10 global custodians with USD 2.5 trillion in client assets under administration.

rbcdexia.com

For more information on our securities lending services, please contact:

Blair McPhersonDirector, Technical Sales, Global Products, Europe & Middle East44 (0) 20 7029 [email protected]

RBC Dexia Investor Services

http://www.rbcdexia.com/

48


Company Profile

Securities finance professionals in major financial institutions in Europe use SecFinex to electronically source and deliver value in the securities finance market. In 2007 NYSE Euronext became the majority shareholder of SecFinex. NYSE Euronext and SecFinex’s combined commitment is a proven testimony to its focus on innovation in electronic market places that will benefit the securities lending market.

Central counterparty service

In 2009, SecFinex was the first company to introduce centrally cleared services in the Securities Borrowing & Lending (SBL) industry.

The SecFinex central counterparty (“CCP”) service covering equity markets in Belgium, France, The Netherlands and Portugal, was introduced in Q2 2009, utilizing LCH.Clearnet, as the central clearer. In Q4 2009, centrally cleared equity markets was introduced in Austria, Denmark, Finland, Germany, Norway, Sweden and Switzerland, utilizing SIX x-clear as the central clearer. Similar services will be extended to additional markets in the near future, with the UK equity markets schedule for Q4 2010.

SecFinex offers three trading options:

• CCP & Bilateral Order Market (anonymous centrally cleared and pre-trade anonymous trading)

• Private Market (bilateral and negotiated execution) • Auction Market (lenders invite borrowers to participate on a ‘best bid’ basis).

Advantages received by trading via a CCP include:

• elimination of multi-entity counterparty risk • reduction of capital required to support stock loan transactions • reduction of administration costs associated with multiple credit agreements • the improvement of operational efficiencies.

SecFinex’s user friendly browser-based interface allows easy access to market information without costly and time consuming IT integration.

Reliable, resilient, and scalable – our system is designed to handle increased trade volumes, easily add markets, make enhancements and is fully redundant.

In the field of European equity finance, SecFinex strives to be a leading force for continuing market innovation.

For more information, visit www.secfinex.com or email [email protected]

To speak to a member of our team, please dial +44 (0) 20 7748 6146

SecFinex is Authorized and Regulated by the Financial Services Authority

SecFinex

http://www.secfinex.com/

49


Company Profile

Securities Finance

When challenging markets put pressure on investment returns, it’s important to work with a proven lending agent that understands your business. As one of the world’s most experienced lending agents providing both custodial and third-party lending, State Street offers the individualised service, client-facing technology and commitment to transparency you’re looking for.

Whatever the market conditions, our dedicated team can help you optimise opportunities without compromising our conservative approach to risk or your need for flexibility. By leveraging a consultative approach and our extensive local market expertise, we will work with you to develop a customised lending programme based on the parameters you specify.

This flexibility is underpinned by our investment in people, technology, product development and multiple distribution routes to market, including exclusives and auctions. Our team of more than 365 professionals serves close to 450 clients worldwide from 12 regional offices that include trading desks in London, Boston, Hong Kong, Sydney, Tokyo and Toronto, maintaining approximately $2.3 trillion in lendable assets and more than $400 billion in assets on loan.

For more information visit:www.statestreet.com/securitiesfinance

Or please contact:

Christopher HolzwarthSenior Managing DirectorState Street Securities Finance20 Churchill PlaceCanary WharfLondonE14 5HJ

+44 (0) 20 3395 [email protected]

The State Street AdvantageWith $19.0 trillion in assets under custody and administration, and $1.9 trillion in assets under management,* State Street is a leading financial services provider serving some of the world’s most sophisticated institutions. We offer a flexible suite of services that spans the investment spectrum, including investment management, research and trading, and investment servicing. With operations in 25 countries serving clients in more than 100 geographic markets, our global reach, expertise, and unique combination of consistency and innovation help clients manage uncertainty, act on growth opportunities and enhance the value of their services. *As of March 31, 2010

State Street

http://www.statestreet.com/

50


Company Profile

SunGard Securities Finance

SunGard provides a comprehensive suite of securities finance solutions: from trade initiation through to final return; including order routing, trading, position management, operations, accounting, settlement, transaction analytics and benchmarking and trade automation services. With over 20 years experience SunGard has a global linked community of securities finance users. 17 out of the world’s top 20 banks use one or more products from SunGard’s suite of solutions for Securities Finance. SunGard’s securities finance solution suite includes Apex, Astec Analytics, Global One, Loanet, and Martini.

For more information, please visit: www.sungard.com/securitiesfinance

Contact Details:

Americas: 001 646 445 1000 [email protected]

Europe, Middle East and Africa: 0044 20 8081 2000 [email protected]

Asia-Pacific: 0065 6227 [email protected]

www.sungard.com/securitiesfinance

About SunGard SunGard is one of the worlds leading software and IT services companies. SunGard serves more than 25,000 customers in more than 70 countries. SunGard provides software and processing solutions for financial services, higher education and the public sector. SunGard also provides disaster recovery services, managed IT services, information availability consulting services and business continuity management software. With annual revenue exceeding $5 billion, SunGard is ranked 435 on the Fortune 500 and is the largest privately held business software and services company on the Forbes list of private businesses. Based on information compiled by Datamonitor*, SunGard is the third largest provider of business applications software after Oracle and SAP. For more information, please visit www.sungard.com

*January 2009 Technology Vendors Financial Database Tracker http://www.datamonitor.com

SunGard

http://www.sungard.com/securitiesfinance

To more effectively manage your firm’s business in quickly evolving markets requires uncommon insight and on-the-ground expertise.

At Citi, we’ll partner with you to design solutions that deliver efficiencies, transparency and help mitigate risk — whether you’re entering new markets, launching new strategies or introducing new instruments. And our modular approach, robust operational support and unmatched global presence provide you with a rare combination of flexibility and scale.

That’s why firms worldwide partner with Citi. And that’s why Citi never sleeps.

Please contact Patrick Curtin at 212-816-3832 and [email protected] or visit us at www.transactionservices.citi.com.

Investor-driven solutions.Market-driven forces.

© 2010 Citibank, N.A. All rights reserved. Arc Design, Citi and Arc Design and Citi Never Sleeps are trademarks and service marks of Citigroup Inc., used and registered throughout the world.

Citi® Investor Servicessecurities finance

fund servicescustody

http://www.transactionservices.citi.com/


· Securities Lending· Repo· Synthetic Finance· OTC Derivatives Collateral Management

Finace is currently the only fully integrated solution which supports the future business models within the area of Securities Finance and Collateral Management. The architecture of Finace is based on a stable, leading edge technology platform which was developed with performance and robustness as the focus of design. With flexibility at its core, customer-driven extensions and modifications can be quickly and easily applied to the standard component set.



http://www.finacesolution.com/

Documents

Securities Lending Handbook 2011