SECURITIES LENDING MARKET GUIDE 2008

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2008INVESTORSERVICES

JOURNAL

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Welcome to the 2008 edition of ISJs annual

Securities Lending Market Guide. It has been a

busy year for securities lending and borrowing, and

there has been no shortage of press coverage sur-

rounding the market and its potential in the future.

This guide aims to bring you up to speed with the

latest market developments and act as a reference

handbook to the particularities of this rapidly evolv-ing business.

Our special feature examines the last 12 months in

the market and what we can expect from the next

year in terms of progress. The impact of hedge

funds and 130/30 funds is of particular interest, asthey are the underlying cause of a large part of the

growth that is happening in the securities lending

market at the moment. Securities financing is the

bridge between hedge funds, one of the main bor-

rowers of stocks, and institutional investors such as

insurance companies, mutual funds and pensionfunds, the dominant lenders of securities.

Furthermore, if you believe the hype, the growth of

traditional long only funds investment in 130/30

strategies could overtake the growth of hedge funds

and become the largest single driver of securitieslending over the next five years.

The growth of the market is set to continue,

according to reports by a number of financial serv-

ices analyst firms. For example, Celent expects

growth in the US securities lending market alone toincrease at a rate of 5% per year.

However, it has not been smooth sailing for the

market over the last year, as industry practices sur-

rounding proxy votings relationship to securitieslending and the potentially negative influence of

hedge funds have gained notoriety in the press.

Hedge funds in particular, have faced increased

scrutiny for allegedly borrowing to buy votes.

The International Corporate Governance Network

(ICGN), whose members include some of the

worlds largest pension funds, has publicly urgedregulators to force funds to make detailed disclo-

sures of sale and repurchase agreements. The

ICGN has accordingly drawn up a code of best

practice on stock lending in all jurisdictions and is

campaigning for the authorities to support it. DrAndrew Clearfield, member of the ICGN board of

governors, spoke to ISJ about his perspective on

the matter for our special feature.

The Markets in Financial Instruments Directive

(MiFID), due to be implemented on 1 November this

year, could also mean more scrutiny of lending pro-grammes. It could potentially result in loans being

made based on price and best execution, rather than

relationships, thus increasing the transparency of the

market as a whole.

With these opportunitiesand challenges in mind, we

have gathered together the

leading lights of the securities

lending industry to provide

you with a comprehensiveinsight into the market as it

stands today.Virginie OShea

Group Editor

INTRODUCTION

Fast times

SECURITIES LENDING

MARKET GUIDE

2008

It has been a year of great change forthe securities lending market


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Foreword Pan Asia Securities Lending Association

2 INVESTORSERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2008

Securities borrowing and lending activity contin-ues to expand in Asia and spans a range of levelsof maturity, from Japan, which represents the sec-ond largest securities borrowing and lending mar-ket globally, through to Vietnam and Pakistan, inwhich it is still not permitted.

Testament to the degree to which lending vol-umes have increased in Asia (ex Japan) is that fiveto seven years ago, securities borrowing and lend-ing flows through Japan accounted for, on average,

about 90% of participants' securities borrowingand lending activity throughout the region. As

these flows in other markets have grown relative toJapan, this figure has now fallen to roughly 50%.

To reflect this, a growing number of hedgefunds have established offices in Asia - particular-ly in Hong Kong, Singapore and Australia - and

leading global prime brokers have extended theirpresence in the region to support this activity.Three years ago, the hedge fund market in Asiarepresented approximately USD250 billion out ofa total USD1 trillion hedge fund market globally.These ratios have remained broadly consistentduring the subsequent period, with total hedgefund assets in Asia doubling to approximatelyUSD500 billion, balanced against total globalhedge fund assets of USD2 trillion.

Looking at the development of Asia's securities

borrowing and lending markets more closely,Japan was one of the first to establish a market inthe region and this remains substantially thelargest market in terms of transaction flow.

Australia and Hong Kong have both seen lendingflows expand dramatically over the last 12months; and the South Korean market has grownrapidly during the five years in which securitiesborrowing and lending has been permitted.

Several other markets have made big strides for-wards during the last 12 months in setting inplace an efficient regulatory and infrastructureframework to support securities borrowing andlending activity. The Philippines has made impor-

tant advances in this area - and the PhilippinesStock Exchange recently invited comment from

PASLA members on its proposed regulations onshort selling, upon which it soft launched a securi-ties borrowing and lending model in February ofthis year. Malaysia has set securities borrowingand lending arrangements in place and is progres-

sively refining its operational procedures in closeconsultation with market participants. In India,the Securities and Exchange Board of India hasput out discussion papers and it is hoped that itwill bring proposed laws on short selling and secu-rities borrowing and lending into line with interna-tional standards.

PASLA has been working closely with regulatorsand with market participants in highlighting thebenefits of an active securities borrowing andlending market that is compliant with international

best practice. This can serve as an important routeto international investment: foreign institutionalinvestors may be willing to allocate a larger per-centage of assets to more liquid markets that offer

Asian perspectiveThe Pan Asia Securities Lending Association(PASLA) has witnessed a year of great changein the Asian markets, says Sunil Daswani

Japan was one of the first to establish a market in the region and this remainssubstantially the largest market in terms of transaction flow


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efficient price discovery mechanisms - and securi-ties borrowing and lending facilities can be key todelivering this liquidity.

To facilitate the extension of a seamless andtransparent market, PASLA has been working withregulators and market participants to identify and

address areas where a market's securities borrow-ing and lending procedures differ from internation-al best practice. We recognise that these changes

will not be achieved overnight - but our goal is tomake securities borrowing and lending functions

more streamlined and convenient for participantsto use, thereby meeting the preconditions for lend-ing volumes to increase.

As a culture of securities borrowing and lendingevolves in Asia, we note a tangible shift in levelsof educational awareness on both sides of therelationship. In the past, lender clients would beasking us to explain why it would make sense tolend in a new market and to confirm that thiswould generate acceptable revenues to cover therisks involved. Now the tables have been

reversed, with lenders asking why they cannotlend securities in certain markets - and to inquirewhen necessary regulatory amendments will bepassed to make this possible.

Sunil Daswani is a director and the regionalmanager for Securities Lending, Asia, at NorthernTrust Global Investments. His primaryresponsibility revolves around addressing andevaluating securities lending initiatives for lendersand borrowers where Northern Trust acts as an

agent lender. Additionally he focuses on buildingthe supply of Asian assets for Northern Trust globalsecurities lending programme, ensuring that the

due diligence is carried out when lending its clientsassets in each jurisdiction.

Daswani is responsible for maintaining updated

market information and knowledge through relation-ships with regional contacts that may influence orshape the markets in which Northern Trust lendsecurities. He has 14 years of experience in thesecurities industry, of which the last five have beenat Northern Trust.

In May 2005, Daswani accepted the position ofchairman for PASLA for one year. He wasre-elected in 2006 and 2007. In this role heensures that the fellow members are kept updatedon key industry events, coordinating as anindustry where necessary responses to various

international regulatory bodies on topical issues,discussion papers and general market issuesthat feedback may be required or furtherclarification is sought.

PASLA has been working closely with regulators and with market participants inhighlighting the benefits of an active securities borrowing and lending market that iscompliant with international best practice

SECURITIES LENDING MARKET GUIDE 2008 INVESTORSERVICES JOURNAL 3


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Since the admission of borrowers to the association

in 2004, membership has almost doubled and it willnot be long before the numbers reach 100. It wasbecoming increasingly obvious that we could nolonger rely solely on the goodwill of individuals, eachwith primary responsibility to their firms, to carry outthe ever increasing workload.

I am delighted therefore that the AGM unanimous-ly approved the board's proposals to expand the asso-ciation's activities to provide full time support to themembership. We have been very fortunate to recruit

David Rule from the Bank of England as our firstchief executive officer. His first priority will be torecruit support staff and secure office premises inthe City. We expect the new infrastructure to be inplace by autumn.

Our new constitution will allow us to take a muchmore proactive role in representing our industry, notonly in Europe and the Middle East, but globally.

Our major initiatives to date have included creat-ing a new class of membership, associates, to caterfor those who support our industry, for examplelawyers, accountants and software houses. I ampleased therefore to report that we are receiving asteady flow of applications. We are working moreclosely with our equivalents in Asia (PASLA) and theUnited States (RMA) and we are conducting a reviewof the market standard legal agreement (the GMSLA).

We will continue to rely heavily on our specialistsub-groups for which the contribution of time andexpertise by our members remains invaluable. Ourregulatory group has been spending a considerableamount of time focusing on the large number of new

directives, which will culminate with the implementa-tion of MiFID in November. Our governance group isdetermined to achieve a universally accepted code ofpractice for voting, a topic which has produced much

controversy over the last year. Our operational group

is producing a steady stream of best practice papers,covering all aspects of the back office.In response to members demands, we have creat-

ed a New Markets group to help open up new mar-kets and work with local exchanges and regulators toestablish best practice from the outset. We will alsobe establishing closer contact and dialogue with theregulators in established markets, as well as theEuropean Commission and CESR.

I would encourage all firms who are involved in the

industry to join ISLA, whether as full members orassociates. Full details of our aims and objectives, aswell as application forms, can be found atwww.isla.co.uk.

Laurence Marshall is a managing director in PrimeBrokerage Services with UBS Investment Bank,London. He joined UBS in 1993 where heestablished and managed the Securities Borrowing

and Lending desk.Marshalls current area of responsibility is themanagement of the international supply business,and is responsible for managing client relation-ships. He has represented UBS on various industrybodies and is currently chairman of the EuropeanEquilend Board.

Marshall was appointed ISLA chairman in May2007.

The views and opinions expressed in this materi-al are those of the author and are not those of UBSAG, its subsidiaries or affiliate companies.

Accordingly, UBS does not accept any liabilityover the content of this material or any claims,losses or damages arising from the use or relianceof all or any part thereof.

Foreword International Securities Lending Association

Broadening horizonsLaurence Marshall of the InternationalSecurities Lending Association (ISLA)highlights the growth the association hasseen over the last 12 months

Our new constitution will allow us to take a much more proactive role in representing

our industry, not only in Europe and the Middle East, but globally


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From a volume perspective, in the first half of thisyear, weve seen broad based growth in on-loan bal-ances, with some lenders balances up more than40% versus the year earlier period. I think thisreflects continued growth in demand from hedge

funds as well as 130/30 and other alternative invest-ment structures. Some industry watchers speculatethat 130/30 could grow to be a USD1 trillion assetclass over the next five years, from its currentUSD60-70 billion. That may be a bit optimistic;however, there is no doubt that this is an area thatwill experience significant growth.

Away from the equity markets, some short demandfor corporate bonds previously covered through a tra-ditional securities lending structure is now being sat-isfied through the use of credit default swaps. Inaddition, we continue to see the use of equity swap

structures in markets that have not yet developed atraditional stock loan structure.There is also a growing list of new markets in

which the borrowing and lending of stocks is begin-ning to take hold. Weve seen interest in Taiwan,Malaysia, the Czech Republic, Hungary, Turkey,Greece and Israel, all at different stages of develop-ment. I believe well see revenue growth in thesemarkets, where the spreads are wider and wherehedge funds are looking for exposure. Were also see-ing a contraction in the development cycle for thesemarkets, as countries work diligently and quickly toput in place the necessary tax, legal and regulatory

frameworks for securities lending.Another important theme in the lending markets

has been the ongoing move toward greater trans-parency, although certain market participants havenot embraced products such as Lending Pit andPerformance Explorer. These products have improvedthe price discovery process and provided objectivebenchmarking information to beneficial owners. Inaddition, with the implementation of the AgencyLending Disclosure initiative, borrowers creditdepartments have gained daily visibility into their bal-ance with lenders.

The application of technology also continues toplay a role in the development of the securitiesfinance market. With continued margin compression,industry participants are looking to apply technologyto streamline processes. Applications such as auto-

borrow, EquiLend Dividend Compare and ARMS aretools that allow participants to increase volumes andreduce spreads.

The industry is not without its challenges, however.I believe one of the major challenges we face is the

ongoing discussion surrounding corporate gover-nance, proxy voting and securities lending. RMA, theInternational Securities Lending Association (ISLA)and the Securities Industry and Financial MarketsAssociation (SIFMA) have been vocal in respondingto misinformation in the press and taking steps to setthe record straight. A number of industry representa-tives have spoken at RMA conferences and havedirectly engaged those who have criticised the indus-try. I believe the RMA Committee on SecuritiesLending has done an excellent job of disseminatinginformation about existing regulations and safeguards

that protect securities lending clients. However, thereis still more that needs to be done and we are pursu-ing several agenda items. For one, RMA and SIFMAare providing seed money for a planned academicstudy of ASTEC Consulting lending data. We hopethe results of this study will serve to substantiate ourcontention that securities lending has had no dis-cernible impact on the outcome of important proxyvote situations.

In addition to the proxy voting and corporate gover-nance issue, the committee is also tackling someother issues affecting the securities lending industry.Among other initiatives planned is a salary survey for

member organisations, which we believe will be par-ticularly useful as a benchmarking tool. We are alsoin the very early planning stages of a Latin Americanlending conference to be jointly sponsored withSIFMA. Were excited about the prospects for thisconference, as we believe there are many beneficialowners in these markets who may be interested inlearning more about lending.

William Tredick McIntire is president, BostonGlobal Advisors, and chairman of the RMACommittee on Securities Lending. He oversees the

agent securities lending business of GoldmanSachs in the US and Europe. He joined the busi-ness in 1998, after spending the previous two

years as chief financial officer of the EquitiesDivision of Goldman Sachs.


Foreword Risk Management Association

Right here, right nowThere seems no better place to be right now

than the securities lending industry, saysWilliam Tredick McIntire of the RiskManagement Association (RMA)


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Contents

1 Introduction Securities Lending Market Guide 2008

2 PASLA Foreword The Asian perspective

4 ISLA Foreword Broadening horizons

6 RMA Foreword Right here, right now10 Main Attraction Securities lending in the limelight

16 Statistics RMA data dissected

20 Panel Debate A panel of industry experts debate the issues

28 Ask the experts Practitioner perspectives

34 JPMorgan Now and the future

36 eSecLending An investment decision

38 SGSS If the shoe fits

40 BBH MiFID and the market

42 RBC Dexia A new era beckons

44 COMIT Deep impact

46 Technology Panel How has the securities lending market beenaffected by the advances in technology?

50 Guide A guide to the sec. lending of the market

66 FAQs Your questions answered

68 Fintuition Learning about securities lending

70 A-Z Those key terms in full

72 Profiles The details of securities lending service providers


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It has been another year of flux for the securitieslending market. Increased activity by hedgefunds and the search for alpha by the more tra-ditional players in the market has caused securi-ties lending volumes to rise at a significant rate.The high level of mergers and acquisitions hasalso acted as a catalyst to this growth. Whenthere is a lot of M&A activity, there is generally ahigh level of borrowing for arbitrage going on

behind the scenes.Since the end of 2003, the value of securitiesavailable for loan in the global market hasgrown at an estimated compound annual rate

of 15-20% to USD13.2 trillion. This years figuresby Data Explorers indicate that the value onloan in the spring was USD3.5 million. Analystfirm Aite Group has estimated that the globallendable asset market is USD16 trillion and theactual lending market is nearly USD4 trillion.

On an institutional level, the California PublicEmployees Retirement System (Calpers), forexample, indicated that it made USD150 millionfrom securities lending for the year ended 31March 2007, an increase of 16%, from the year

before. Moreover, according to figures by rivalanalyst firm Celent, the market as a whole isexpected to increase annually at a rate of 5% inthe US and 10% in Europe over the next twoyears. Good news, it seems, for all thoseinvolved in the market.

Rob Coxon, head of International SecuritiesLending at ABN AMRO Mellon GlobalSecurities Services, adds: The bottom line isthe business has become much more com-moditised, there is spread compression but a

lot more volume is being done. Coxon believesthat demand for exclusive supply shows no signof slowing down, although borrowers are beingselective in how they bid. Emerging market


Securities lending is no longerloitering in the back office,spurred on by an active hedgefund community, it has nowstepped into the custodiallimelight. Virginie OSheareflects on the last 12 months

in the market

YEAR IN REVIEW

Main Attraction


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lending is on increase, he adds, with thedemand for assets in esoteric markets such asRussia and India growing. There is also an

increased appetite by traditional long sideinvestors for short exposure, as demonstrated bythe deployment of 130/30 strategies and shortextension funds.

Andy Clayton, head of securities lending forEurope Middle East, Africa and Asia Pacific,Northern Trust Global Investment, has also wit-nessed an increase in new market activity.There is huge interest from clients who now

have more exposure to emerging market man-dates and from borrowers who see more hedgefund activity in these markets. Also, active exten-sion is the new buzzword in the industry aslong/short strategies take hold, this has led to allplayers analysing how they can leverage thistrend to best effect.

There has been some very successful liaisonwith market infrastructure providers and regula-

tors in Asia in respect of opening markets forsecurities lending, says Clayton. He expects thatthe market will see the benefits of this period ofconsultation over the next few months. Also, headds, the industry associations have led the waywith discussions with regulators regarding forth-coming regulatory changes such as Basel II andMiFID. At this moment, it looks like the indus-try will reach a position where it can successfullywork within the new regulations without incur-ring huge additional cost to support wholesale

changes to practice, he says.Despite the recent decision by some invest-ment banks to impose tougher lending terms onhedge funds, their investment strategies are con-tinuing to drive forward the growth of securitieslending. The decision to raise margin require-ments is a response to rising credit concernsabout the impact of the funds on the widerfinancial market. Prime brokerage departmentsat several investment banks are thus attemptingto insure themselves against the possibility of

new hedge fund collapses in the vein of the BearStearns funds last month. However, regardlessof these restrictions, the hedge funds activetrading styles, including the use of shorting and

the pursuit of more complex investment strate-gies, have increased the demand for securitieslending.

Hedge funds and their appetite for securitiesdriven through their prime brokers represent thebiggest single source of demand in the market,says Coxon. This has been positive for thegrowth of securities lending, but the secrecy sur-rounding the activities of these firms has led tosome observers questioning their motivations.They are perceived to be driven by short termopportunism, and this has been particularly evi-

dent in the sphere of corporate governance, headds.

Although there has been a lot of growth, therehas also been a number of firms that have decid-ed to exit the securities lending market. AndrewClearfield, president, Investment Initiatives andchairman of the International CorporateGovernance Network (ICGN) Securities LendingCommittee, explains: It seems like the market is

expanding strongly; my impression is that it hascontinued to grow. There have been a few majorexceptions to that in that there have been a cou-ple of public pension funds in the last 12months, most notably Ontario Teachers, thathave decided that lending wasnt worth itbecause they were having such problems recall-ing in order to vote. They decided that as aresult of this, that the income they were gettingfrom the lending wasnt worth it. It wasannounced loudly and publicly all over Canada.

Clearfield continues: I have had conversa-tions with some consultants and fund managersin the industry that have said that unlessinvestors get a larger cut of lending, they will exitthe market. The brokers currently get the lionsshare of the fees and the custodians and inter-mediaries get another significant share, althoughit is much smaller than that of the brokers. Theshare that goes to the funds is so laughable thatit is hardly worth it for what they get. They areessentially selling their votes for a few basis

points.It is not just the hedge funds that are provingto be influential in this area. A large number oftraditional fund managers are engaged in devel-


The hedge funds active trading styles have increased the demand

for securities lending


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oping absolute return strategies that requirethem to go short and this is having a significantimpact on the growth of the securities lendingmarket. The recent popularity of 130/30 funds,which effectively involve borrowing for short sell-

ing purposes, is testament to this trend. As partof a 130/30 fund strategy, fund managers runshort positions but remain 100% net invested bybeing 130% long of the over-performing stocksand 30% short of the underperforming stocks.

These funds need stock loan accounts toreceive the proceeds of the short sales and thenaugment the long positions without the need toborrow cash. In order to go short, these marketparticipants must borrow securities. The 130/30funds are seen as an attractive alternative to

going long only as you are no longer so tied tothe ups and downs of the market and they thusprovide the ability to more consistently beat themarket. In fact, the funds are so popular at themoment that market commentators have specu-lated that their growth may supersede thegrowth in hedge funds over the next few years.This could, in turn, become one of the largestdrivers of securities lending over the next five to10 years.

There is a slight difference between the

American and European model of borrowing for130/30 funds. The US model involves borrowingand shorting in order to execute leverage, where-as in Europe, the leverage is obtained throughderivatives. This divergence in practice has comeabout due to the fact that European regulatorsdo not support the shorting of physical securi-ties to obtain leverage. Despite the discrepancy

between the markets, both are experiencing ahigh level of growth in securities lending. DeniseValentine, senior analyst at rival analyst firm AiteGroup, explains: The US market is a verymature market with a vast inventory of securi-

ties, and is growing at about 5%. However theEuropean market is growing at double this rate.

The 130/30 funds are not just driving forwardthe growth of the securities lending market; theyare also altering the participants service require-ments. Fund managers that invest in thesefunds require fully integrated securities lending,borrowing and collateral management, as well asthe execution services to affect the initial shortsale and subsequent buy back. Servicing there-fore goes way beyond custody and fund account-

ing. This requirement for execution services canprove an onerous task for those engaged in pro-viding securities lending and custodian banksare accordingly obliged to invest in systems tofurther integrate their processes.

Valentine highlights the recent trends that shebelieves have influenced the securities lendingmarket: The last 12 months have been aboutincreased participation on electronic platformsto some degree, the increasing use of securitieslending as the capital markets continue to glob-

alise, and, finally, hedge funds and large institu-tional money managers engaging in short sell-ing. In the case of the latter, 130/30 funds, whichshort securities, have been increasing signifi-cantly as traditional money managers seek high-er investment returns and compete with hedgefunds for institutional money.

Rather than a purely operational activity, secu-rities lending is now considered to be an invest-ment management discipline in its own right.Furthermore, rather than automatically opting topass the activity to an institutions custodian,these traditionally dominant players are havingto compete for business with third party lendersand electronic auction platforms. Institutions arealso increasingly using multiple providers acrossdifferent parts of their asset base, as beneficialowners have unbundled the securities lendingfunction from the custody business.

Valentine adds: Theres no shortage of partic-ipants, including principal owners, custodianbanks, third party agents, broker-dealers, primebrokers, investment banks, and hedge funds. Big

banks use securities lending for market making,hedge funds often short the security for a strate-gy play. Owners and lenders participate for prof-its on the loan.


YEAR IN REVIEW


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In the rush to gain market share, borrowershave sought alternative sources of supply,lenders have developed new routes to marketand exchanges and brokers have developed elec-tronic trading platforms. These trends have put

downward pressure on pricing and have forcedcustodians to seriously rethink their businessmodels.

The rise of short selling has also raised theprofile of issues around fee transparency. The feepaid by investors to borrow shares they want tosell short has been notoriously difficult to fore-cast. Borrow supply is a key determinant to thelevel of fee paid but the exact calculation is moreoften than not opaque. Fees for a 130/30 strategy

are higher than long only mandate fees in partbecause the manager must go to a prime brokerto borrow securities to short. Hedge funds maybe naturally more lenient with regards to trans-parency, but the traditional asset managers nowengaged in 130/30 funds are likely to demandincreased fee transparency, which will then putpressure on managers to reduce their fees.

Valentine explains: Improving transparencyhas been one of the drivers of changes in recentmonths and that is an ongoing process. Giventhe level of entrenched interests in this market, itwill not be an easy process to continue to buildon some of the automation and transparency ini-tiatives.

ABN AMRO Mellons Coxon adds:Accountability and automation are big themes there is much greater transparency today due to

the rise of industry consultants and independentbenchmarking services like Astec and DataExplorers. The market has traditionally been fairlyopaque, with a strong emphasis on relation-ships. While this still holds true, it is also thecase that price and efficiency are becomingdetermining factors on where business is trans-acted.

Transparency brings challenges, as beneficialowners today are much more engaged and thedegree of scrutiny has increased significantly,

and that additional scrutiny leads to greater com-petition, adds Coxon. Only those firms that runaccountable programmes can hope to survive inthe new environment. The same holds true on

the borrower side of the business, as hedgefunds demand more information on where theirtrue borrowing costs reside, he explains.

Northern Trusts Clayton agrees:Transparency will not go away so we need to get

used to living in the new environment. Marketparticipants will develop their game to play bet-ter under the new rules and increased competi-tion will result. It is critical that people consider-ing the data create a level playing field though with more information available there isincreased responsibility on the users to ensurethey know what they are doing with the data oth-erwise they may make erroneous assumptionsand decisions.

Transparency has obviously had a directimpact on technology spend, as has the increas-ing complexity of customer requirements. Firmshave to spend more on their systems in order tokeep up with demand. The focus of securitieslending technology has shifted from the back

office to the front office, says Valentine.Technology has advanced with electronic plat-forms. By 2008, about 15-18% of securities lend-ing will be done over an electronic platform.Examples of trading platforms include EquiLend,eSecLending and SecFinex. Bloomberg instantmessaging continues to be a key method ofcommunication for securities lending, and cer-tainly old manual methods of phone and fax arewell entrenched, at least for initial order place-ment, she elaborates.

Overall, Valentine believes that the market is

fragmented in its use of technology: Generalcollateral and highly liquid security securitieslending is as old as the hills and these types ofsecurities lending are well suited for automation.This has prompted more technology firms toenter the market, around 2000. Specials, or hardto borrow securities lending, are complex: theyremore profitable and still negotiated by phone.

The influence of technology has largely beennegative, says ICGNs Clearfield. For example,commingled accounts from the point of the view

of the custodian save a lot of money, but theyhave made it difficult to track any kind ofaccountability with respect to individual posi-tions. It is hard to tell if you have had a problem


The 130/30 funds are not just driving forward the growth of thesecurities lending market; they are also altering the participantsservice requirements


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with over-voting if you dont know whose shareswent where which shares in an omnibusaccount were actually lent out. That is a practice

that I predict is going to have to end.Technology can have a strongly positive effect ofcourse, but so far, it hasnt been used that way;instead its all been about lowering costs andgetting more paper out there, he adds.

Coxon is much more positive about theimpact of technology on the market: Auctions,and by extension auction platforms, have cer-tainly enjoyed a high profile recently. The emer-gence of players such as eSecLending has creat-ed more competition, particularly in respect ofagency lending. That has shaken any compla-cency there may have been out of the industry.Certainly it is a great time to be a beneficialowner there is a good choice of suppliers,they enjoy pricing leverage and also have moreoptions in terms of selecting the most appropri-

ate route to market for any given portfolio. It iscritical in this environment that agent lenders

be able to offer a flexible platform that can offera variety of entry points that reflect the multi-faceted nature of securities lending.

Clayton believes that because the whole mar-ket has seen a big increase in volumes over thelast 12 months, it is important that all partici-pants embrace technological solutions to insu-late themselves from the impact of thisincrease. SecFinex, EquiLend, ICap and Eurexare all illustrative of the demand in the marketto capitalise on inherent operational weakness

and service a growing need to automate anddrive down costs as volume explodes, Coxoncontinues. However, with the exception ofEquilend, all of these platforms have enjoyedeither limited success or remain in their infancy,he adds.

Regulation and industry best practices (orrather the lack of either) have also been impor-tant discussion topics in the securities lendingindustry over the last 12 months. The issue ofsecurities lending and proxy voting has recently

garnered headlines, most notably the Securitiesand Exchange Commission (SEC) has indicatedan interest in the area and suggested furtherresearch be carried out.

Securities lending and its impact on proxyvoting policies and practices has long been theconcern of the corporate governance industry,

since, potentially, market participants canacquire voting rights in a company without anaccompanying financial stake. This separationof economic from voting interest in a companybends one of the basic assumptions behind theone share, one vote principle, and placesinvestors who retain the economic interest in achallenging position. However, it seems thatshare lending has become a lucrative practicefor many institutions.

This years International Securities LendingAssociation (ISLA) and Pan Asia SecuritiesLending Association (PASLA) annual confer-ences both covered the subject of proxy votingand share lending. Speakers stressed thatrecent press coverage about the practice ofhedge funds obtaining more votes than their

holdings in order to influence voting was vastlyexaggerated. Earlier in the year and in response

to such an article in the Wall Street Journal,ISLA issued a statement that declared:Securities are rarely borrowed for the purposeof influencing votes, and the cases in which bor-rowed shares can be shown to have influenceda shareholder vote are rarer still.

In the UK, borrowing shares solely for thepurpose of voting is contrary to the SecuritiesLending and Borrowing Code of Guidance,which was drawn up by ISLA to highlight goodpractices for lenders and their agents. The secu-

rities lending contract has been designed toallow lenders to continue to exercise their vot-ing rights if they wish by giving them the rightto recall equivalent securities from the borrowerat any time, says ISLA.

Conversely, ICGNs Clearfield feels that theissue of vote selling is something that shouldbe dealt with immediately. One of the issuesthat the ICGN is focusing on is making trusteesaware of the fact that they are selling their votescheaply, he explains. The point of the 2005

code is insisting that trustees have guidelinesdown to make it clear to all their beneficiariesthat they are sacrificing voting under certain cir-cumstances, and what those circumstances are,


YEAR IN REVIEW

Auction platforms have enjoyed a high profile recently


17/84

as well as when they will not sacrifice their votesfor this reason, he says.

This is an ongoing engagement and we are

also talking to the issuers, who are also veryconcerned about the discrepancies in voting(usually manifested by over-votes) and the factthat a few funds have visibly shown up withempty votes and tried to influence meetings.This is enough of a problem for these issuers toget concerned. I am told that it has also cometo the attention of the SEC. I know that it is aconcern of the World Federation of Exchanges,

as well as of the European Commission. Theyare all looking at the copies of our code and, inparticular, two aspects that call upon issuers toseparate the record dates for voting from therecord dates for entitlement to dividends,essentially eliminating the tax arbitrage, andalso to make sure that the agenda is madeknown before any kind of deadline for recall.These are two things that issuers can do them-

selves that will possibly reduce the amount ofshares out on loan before a crucial vote, heelaborates.

Regardless of which party is right, the fact ofthe matter is that the profile of the issue hasbeen sufficiently raised for the regulators to takenotice. The UK Financial Services Authority andthe regulator in Hong Kong have indicated thatthey are looking into issues regarding disclosureand SEC chairman Christopher Cox has orderedan internal study on the practices surrounding

proxy voting in the US. Moreover, according to aglobal survey on securities lending byInstitutional Shareholder Services (ISS) earlierthis year, most institutions do not have explicitpolicies on securities lending relative to proxyvoting, leaving them wide open for the regulato-ry community to suggest appropriate legislativeaction.

Agent lender disclosure has also been a focusfor regulators over the last year. In the US thishas been driven directly by requirements issued

by the SEC and the New York Stock Exchange(NYSE), whereas in Europe, the driver has beenthe agency lending disclosure specificationsunder Basel II. The scale of the problem is far

greater in Europe due to the complexity of thecollateral that lenders exchange, the highernumber of disclosed lending programmes and

the decentralised infrastructure.ISLA has formed a working group to tacklethe issue of agent lending disclosure with thelong term objective of Europe achieving a levelof disclosure comparable to the US. The associ-ations proposals for disclosure include themonthly provision of details regarding theunderlying counterparty, loaned securities andcollateral. ISLA has indicated that it will be

working with the industry over the next year tofurther develop best practices in this area.

Regulation in general has been an issue forthe market over the last year. Clayton says: Ithink regulation is having more of an impactacross all of our businesses and securities lend-ing is no exception. All elements of securitieslending have been affected, whether it beincreased levels of information concerning our

business to allow counterparties to make theright risk decisions, or ensuring that we havecomprehensive policies and procedures toprove best execution. Finally, all businessesshould treat customers consistently, but thenew Treating Customers Fairly directive hasrequired a full examination of the business.

The focus on regulation is also likely to con-tinue for the next 12 months at least, Claytonadds. I think we will see increased focus on theuse of regulatory capital over the next few

months as the impact of Basel II will ensurethat participants pick the right products for theuse of their capital. The counterparties that areused, indemnification required and the collater-al provided will all come under the microscopein the next few months, he explains.

Despite these compliance concerns, thefuture of securities lending remains rosy.However, the key to maintaining and growingdemand is to be flexible in your business andlisten to what clients and borrowers want and

communicate well with both, says Clayton.This should ensure that you can continue tomatch supply to demand by developing compli-mentary capabilities, he concludes. SLMG


We will see increased focus on the use of regulatory capital

over the next few months


18/84

The Risk Management Associationssecurities lending data covers the firstquarter of 2007. Survey data is present-ed for primary lending markets world-wide, with cash collateral reinvestmentdata aggregated to reflect reinvestmentreturn, interest rate sensitivity, liquidity,

credit tiering and instrument types forboth US dollar and euro currency col-lateral.

The data has been collected by theRMA frominstitutions including AIG,Barclays Global Investors, BrownBrothers Harriman and JPMorgan.


STATISTICS

Data DissectedISJ examines the RMAs securitieslending market data for 2007

Instrument types on loan in the first quarter 2007As we can see from the chart, floating rateinstruments represented the largestpercentage of instrument types onloan in the first quarter of 2007.This is closely followed by fixedrate asset backed securities andcorporate collateral at invest-ment grade A or higher.

Also popular are US Treasuriesrepo agreements, althoughthese have declined since last

years survey. Floating rate assetbacked securities have also declinedto some extent.

According to RMA figures, the totalamount of assets on loan has

increased significantly over thelast six years. Moreover, thespread of instruments avail-able for borrowing and lend-ing indicates that the mar-ket is mature and stable.

All asset backed paper isincluded in the Asset Backed

Securities category and Other

Vehicles includes all otherinstruments that could not be

categorised.


19/84SECURITIES LENDING MARKET GUIDE 2008 INVESTORSERVICES JOURNAL 17

The Survey reflects dataprovided by thefollowing institutions:

AIG Global Investment CorpBarclays Global InvestorsBoston Global AdvisorsBrown Brothers Harriman & Co.

CitibankFrost National Bank

Investors Bank & Trust CompanyJP Morgan Chase & Co.M & I Global Securities LendingMellon Financial Corp.MetLife Insurance Company

The Northern Trust CompanyPFPC Trust Company

US BankUnion Bank of CaliforniaThe Vanguard Group, Inc.Wells Fargo Institutional InvestmentsWachovia Global Securities Lending

RISK MANAGEMENT ASSOCIATION SECURITIES LENDING COMPOSITE - Averages forthe period of Quarter 1 2007Below is a table showing a year on year snapshot of the industry worldwide. Lendable assets refer to the value ofloanable securities. On loan versus cash collateral refers to the value of securities on loan in return for cash. Onloan versus non-cash collateral refers to the value of securities on loan in return for non-cash collateral.

North American Treasuries/BondsUS Treasuries/UST StripsUS AgenciesUS Mortgage Backed SecuritiesUS Corporate BondsCanadian Bonds (Gov't & Corporates)

North American EquitiesUS Equities (includes ADRs)

Canadian Equities

European EquitiesFrench EquitiesGerman EquitiesItalian EquitiesUK EquitiesScandinavian EquitiesAll Other European Equities

Pacific Rim Equities (Includes Australia)Japanese EquitiesHong Kong Equities

AustraliaAll Other Pac-Rim Equities

All Other Equities (Not Previously Listed)Total Equities (Aggregate Total)

Euro Denominated Sovereign BondsFrench Sovereign BondsGerman Sovereign BondsItalian Sovereign BondsSpanish Sovereign BondsAll Other Euro Denominated Sovereign Bonds

UK GiltsEmerging Market Eurobonds**EurobondsAll Other Sovereign Bonds Total Bonds (Aggregate Total, incl US)

TOTALS

Average Number of Lending Markets

LENDABLE ASSET($m)

$1,753,274$471,880$202,088$212,175$844,225

$22,906

$3,613,708$3,558,676

$55,032

$1,274,195$186,949$158,512

$72,794$427,543$108,280$320,117

$616,818$353,467

$60,881

$113,914$88,556

$57,068$5,561,789

$222,667$51,958$79,984$39,924$11,628$39,173

$145,667$38,198$281,105

$89,577$2,530,488

$8,092,277

19

$548,952$340,178

$82,009$48,884$74,714$3,167

$314,011$309,364

$4,647

$88,106$30,132$13,672$9,120$3,354

$10,974$20,854

$44,093$20,416$6,398

$14,305$2,974

$4,115$450,325

$14,689$4,328$6,301$1,563

$791$1,706

$8,946$8,441$24,352$5,515

$610,895

$1,061,220

$65,178$56,777

$6,726$412$922$341

$12,826$10,981

$1,845

$39,401$5,480$4,678$2,841

$11,816$4,673$9,913

$19,269$10,734

$1,599

$4,874$2,062

$273$71,769

$25,734$6,309

$10,995$6,928

$577$925

$41,719$5,878$4,096

$81$142,686

$214,455

ON LOAN vs CASHCOLLATERAL ($m)

$614,130$396,955

$88,735$49,296$75,636

$3,508

$326,837$320,345

$6,492

$127,507$35,612$18,350$11,961$15,170$15,647$30,767

$63,362$31,150

$7,997

$19,179$5,036

$4,388$522,094

$40,423$10,637$17,296

$8,491$1,368$2,631

$50,665$14,319$28,448

$5,596$753,581

$1,275,675

ON LOAN vs NON-CASHCOLLATERAL ($m)

TOTAL ONLOAN ($m)

35%84%44%23%

9%15%

9%9%

12%

10%19%12%16%

4%14%10%

10%9%

13%

17%6%

8%9%

18%20%22%21%12%

7%

35%37%10%

6%30%

16%

TOTAL ONLOAN (%)

*(Reported in Aggregate) **(Latin America & E Europe) (Not Listed Above)

US dollar $


20/84


21/84



Secur it ies Lending PANEL DEBATE

Guy dAlbrand had been global head of liquidity management at SocitGnrale since the autumn of 2004. He began his career as a futures brokerand then spent several years as an auditor at Socit Gnrale He joined Fimatto run the Tokyo office and was then appointed executive vice president ofSocit Gnrale Securities, North Pacific. He then headed up the online bro-kerage operations in Japan. In 2002, dAlbrand moved back to Socit

Gnrales head office to become global head of audit for the Corporate andInvestment Banking Division of the bank.

THE SECURITIES LENDING

PANEL DEBATE

Paul Wilson is senior vice president and global head of Sales and ClientManagement for Securities Lending and Execution Products (SLEP) for JPMorganWorldwide Securities Services (WSS). He is based in London. Wilson is responsi-ble for new business development and initiation as well as client managementacross the entire SLEP product range, which includes securities lending, foreignexchange, transition management, futures and options clearing and commissionrecapture within JPMorgan WSS. Additionally, Wilson is the SLEP regional busi-

ness executive for the Europe, Middle East and Africa region. He joined Chase in1984 and has carried out a number of roles within JPMorgan WSS includingproduct development, client services and operations.

Mark Fieldhouse serves as head, Technical Sales, Americas at RBC Dexia. Histeam is responsible for overall growth and development of the Global Productsclient base, as well as the product level management of its strategic clientsin North America. Global products include securities lending, foreignexchange, cash management and portfolio management services. Fieldhousebrings to his role 12 years experience in the Global Products environment.Prior to heading up Technical Sales for the Americas, Fieldhouse served as

director, Technical Sales, Securities Lending. He has previously held a num-ber of progressive positions within the securities lending business, with afocus on client management and business development.

Elizabeth Seidel is senior vice president, co-manager of Brown BrothersHarriman Global Securities Lending. Seidel joined BBH in 1999 and wasrecently appointed department co-manager for Global Securities Lending. Inher new role, Seidel has management responsibility for RelationshipManagement, Risk Management, Sales, and Marketing groups. Seidel hasover 15 years experience in the industry, 11 of which involve securities lend-

ing. Prior to joining BBH, she worked at Boston Global Advisors and was incharge of Client Service and at State Street Bank in their Securities LendingDivision in both Trading and Operations.



What are the main issues affecting thesecurities lending market this year?

dAlbrand: Supported by a strong overall globaleconomy and high investor confidence, thesecurities lending market continues to thrive, asit demonstrates an increase in liquidity andmarket efficiency. As the practice gets morepopular among beneficial owners, theirdemands are on the rise and they expect higherperformance and instantaneous churning out ofdetailed reporting. Although considered general-ly low risk transactions, a key issue has been

risk management, which is resulting in a pushfor technological improvements to better man-age associated market, operational and creditrisks. Change within the compliance and regula-tory arena has also been a main focus, aimingto better manage capital, as we can see withsuch initiatives as Basel II, which is beneficial to

securities lending, as it will enable more preciseassessment of collateral quality and suitability.

Fieldhouse: We see several major issues thatcould have a significant impact on the securitieslending industry this year. The first would beBasel II, arguably the most important regulatoryinitiative to have impacted securities lending inthe recent past. Basel II will mandate a verystructured risk management process. However,as long as beneficial owners have the right riskframework and work with lending partners whohave built a comprehensive risk model, therewill be opportunities to benefit from higher utili-sation and increased lending revenues.Institutional investors are also actively search-ing for better returns through the execution ofalpha-based strategies and seem willing to bemuch more aggressive with their investmentstyles. The rise in popularity of hedge funds hasgalvanised the securities lending industry, withservice providers and beneficial owners develop-ing new techniques to satisfy their exacting

needs. Providers have been challenged to deliv-er an integrated service offering, which not onlymaximises revenues but also simultaneouslymanages risk and maintains operational trans-

parency.Wilson: New sources of supply continue to

come into the market via investors making theirsecurities available for lending for the first time.While this is positive, it does tend to put down-

ward pressure on fees in conjunction with theever increasing competitiveness of the market.As a separate matter, there is continued debateand discussion regarding corporate governanceand the impact of securities lending. Best prac-tice remains where lenders and investors vieweach event and determine whether to keep secu-rities on loan and benefit from the fee or to

recall the loan in time to vote the proxy.On the tax front, we continue to see new casescome before the European Courts of Justice(ECJ), which point toward greater tax harmoni-sation across Europe. These cases should befollowed closely as they may have significantimplications for lenders and borrowers. And the

buzz phrase of 2007 has been the 130/30 funds,which are seeing traditional long only managerslaunch funds that short up to 30% of the valueof the fund and then invest the 30% short pro-ceeds to obtain a 130% total long position and a30% short position. This should increasedemand for securities borrowing and create newopportunities for service providers across thesecurities financing business.

Seidel: Over the past year, one of the issues thatwe have seen heightened client awareness of iscorporate governance and the need to voteproxies. This has made invaluable the efficien-cies BBH has created through our securitieslending system infrastructure and recallprocess. We are not only able to recall securitiesin a timely manner for voting purposes, but canactually flag those securities in advance of cor-porate events to ensure no opportunity ismissed. Our clients seem to take great comfortin our streamlined approach. The down side ofthis trend in the industry, of course, is the

impact of recalls on income derived from lend-ing, but our goal is to support our clients' prior-ities and broader investment objectives and tomake lending as seamless to them as possible.

Supported by a strong overall global economy and high

investor confidence, the lending market continues to thrive, asit demonstrates an increase in liquidity and market efficiency



What impact is industry consolidation havingon the market?

dAlbrand: Industry consolidation, especiallywith the recent large American mergers, isbringing all participants, large and small, toexamine and redefine their business modelsand service offerings. Consolidation bringscomplementary companies together, integratingtraditional functions, such as fixed income andequity lending. Securities lending desks are

becoming one stop shops and we shall see howthese new global entities will do in terms of cus-tomer satisfaction. In this highly competitivemarket, beneficial owners want to maximisetheir portfolios, but it may not always be in their

best interest to be part of a pool, with longerqueues and possible lower utilisation rates.Credit issues also arise, since an increase inlendable securities does not necessarily meanan increased credit limit for each counterparty,potentially reducing market liquidity. In thistight market, barriers to entry are tough, howev-er, small players have their own niche, focusedon their specific expertise, performance, tech-nology, risk management and client relation-ships.

Fieldhouse: While consolidation is reducing thetotal number of players in the market, we con-tend that under the right circumstances, it canhelp contribute to a higher overall quality ofsecurities lending providers. What youre seeingas a result of ongoing consolidation is a reduc-tion in the number of regional players, but anincrease in the number of truly global opera-tions. The implications of this trend are quitepositive for the client organisations, as they arepositioned to benefit from everything those

global shops have to provide, including newmarkets, new sources of demand, increasedinvestment in the infrastructure driving thebusiness, top notch risk management frame-

works and more.

Wilson: In the short term, this should be mini-mal. There are plenty of providers operatingacross all spectrums of the industry. Bank merg-

ers are, of course, just one reason for consolida-tion, but others factors such as the potential forgreater tax harmonisation in Europe, possiblyresulting in the erosion of the yield enhance-ment transaction, could affect the profitability ofsome providers and cause them to either mergeor reconsider their position in the business. But

at this time, for investors and beneficial owners,there is plenty of choice in providers and routesto market, and that is healthy for the industry.Seidel: Strategically, we are encouraged with thisfurther consolidation in our industry and believe

that there is ample space for BBH and muchlarger asset service firms to coexist in the cur-rent industry environment and pursue theirrespective strategies. In the securities lendingindustry, beneficial owners who are clients of anacquired financial institution may find them-selves part of a new lending program with a dif-ferent profile than the one they originally chose,triggering an evaluation of whether the new pro-gramme aligns with their objectives. In somecases, consolidation may be the catalyst for newopportunities for both beneficial owners andlenders depending on the results of those evalu-ations.We distinguish BBH through continuity, highquality service, integrity, and relationship excel-lence. We operate as a flat, agile organisationproviding comprehensive solutions for ourclients that help them meet their businessobjectives. BBH remains uniquely client-centricand committed to continuing to grow organical-ly by pursuing a select group of clients thatvalue our focused strategy and client service

excellence. We believe that a firm which under-stands and capitalises on its unique competitivestrengths can pursue a differentiated strategythat delivers success in the form of client and

New sources of supply continue to come into the market viainvestors making their securities available for lending for thefirst time. While this is positive, it does tend to put downwardpressure on fees in conjunction with the ever increasingcompetitiveness of the market



25/84

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employee satisfaction.

Following Electronic Trading Groups lawsuitlast year, how have the attempts at achieving

greater price transparency in the securitieslending market been received? What progresshas been made?

dAlbrand: The so-called lack of price trans-parency of lending fees due to the power of theprime brokers over the industry is quite dis-putable. The securities lending industry is anOTC market and fees are based on various fac-

tors, such as creditworthiness, whether thestock is callable and ease of location. Increasedmarket transparency, agent borrowing and lend-ing offers, benchmarking tools and trading plat-forms are giving beneficial owners and shortsellers a better view on market prices. In any

case, independent intermediaries offering trans-parent pricing are emerging as competitors toprime brokers.

Wilson: Transparency means many things tomany people. At JPMorgan, we have seen alarge increase in requests from our clients formore detailed information and understanding oftheir securities lending activities. Gone are thedays of a single monthly or quarterly report.Clients are looking for daily, and sometimes real

time, information relating to loan activity, rev-enues, risk and exposures. We are seeing a shiftto a more front office asset managementapproach to lending by many of our clients, andso detailed performance reviews are now com-monplace. This focuses on where the return iscoming from, where and why superior perform-ance was generated and what risks were takenin the process. There is also more informationavailable today regarding industry wide activity.This is useful in benchmarking or understand-

ing the size of the overall market, as well asprices for a given asset class, and in given mar-kets and for specific securities.

How have moves towards introducing greaterEU tax harmonisation affected the market?Have any particular recent decisions of theEuropean Courts of Justice had a significant

impact on this?dAlbrand: The tax and regulatory environmentis complex and challenging. The Focusbank andDenkavit cases have definitely reminded theindustry that nothing should be taken for grant-ed. It is evident that tax treaties could be recon-sidered, with a potential to reduce the crossborder flows. We understand that a number of

principal market participants both lenders andborrowers have for a long time started diversi-fying their activity to adjust and/or compensatefor any changes in the industrys business mod-els.

Fieldhouse: While tax harmonisation will cer-tainly have an impact on the market, its onlyone factor in a constantly evolving marketplace.It could be inferred that tax harmonisationcould potentially negatively impact revenuestreams from certain markets. At the sametime, however, its important to keep in mindthat major players are constantly investing innew sources of demand and new markets inorder to capture additional revenue opportuni-ties as they arise.

Wilson: Various decisions by the ECJ have sug-gested a degree of tax harmonisation amongEuropean Union member states. However, mostrecent decisions issued by the ECJ, combinedwith the action currently underway by theEuropean Commission, have all hinged on thecomparability between the entities claiming therelief. To date, this point has not been fullyproven and therefore the direct impact on secu-rities lending has been limited. Rather than the

cases having a dramatic and immediate impacton tax rates, it is more likely that the actions ofthe ECJ and the European Commission will leadto individual member states amending their

Industry consolidation, especially with the recent largeAmerican mergers, is bringing all participants to examine andredefine their business models and service offerings



27/84

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domestic tax legislation to create a more levelplaying field for cross border, intra-EU investors.For example, early in 2007, the Netherlandsreduced its standard tax withholding rate, provid-ing exemption for EU resident pension funds and

tax exempt entities (such as charities).

In 2004, the SEC proposed changes in regula-tion to relax short-sale constraints and the pilotprogramme began on 2 May 2005, whatimpact has this had on the market?

dAlbrand: The SEC Regulation (SHO in January2004), where short sellers of equities arerequired to locate securities to borrow before sell-

ing, has given a greater role for securities lendingdesks. Hedge funds are putting increased pres-sure on prime broker services. More than ever,finding the right stock at the right moment is animportant part of the service a prime brokermust give to their clients. All sources of informa-tion, electronic or personal relationships, mustbe used to their full extent.

Fieldhouse: Overall, the impact has been a posi-tive one for the securities financing and hedgefund industries. Typically, hedge funds like to takeshort positions and therefore need constantaccess to inventory to finance those positions.One of the main drivers has been the growingnumber of institutional investors pursuing alphagenerating strategies such as the 130/30. Thisimportant new source of market demand wasexpected to have a significant impact on pricing,as suppliers capitalised on the growing institu-tional interest in alternative investments.As a result, there has been a strong emphasisand focus on credit and risk, as well as compli-ance by regulatory agencies and internal riskdepartments to ensure a proper risk manage-ment framework is in place. The changing regula-

tory environment and increased focus on risk,credit, compliance and capital usage is now thenorm in the industry, and has forced firms into avery structured risk management process. Firms

will have to make significant investments in tech-nology and infrastructure to better dynamicallymanage associated market, operational and cred-it risk. The ability to have dynamic risk and collat-eral management capabilities will position firms

to be more responsive than ever to a clientschanging strategies.

Wilson: The changes enacted by the SEC (Rule10a-1(a)) were intended to expand liquidity in themarketplace while implementing strict compli-ance on fails and appear to have succeeded.Broker-dealers have adopted additional technicalcontrols on locating intent to sell, which includesclient logs for approvals, archiving of data, andpre-borrows of short sales on trade date ahead of

settlement date. Borrowing securities for faileddeliveries is preferred to effecting a buy-in. Buy-inshave become more efficient, with the introductionof netting through the continuous net settlementsystem (CNS) doing away with fails after buy-ins,as sometimes happened in the past. In summary,the SEC changes have had a positive affect in themarketplace, but with some added overhead costsfor compliance monitoring.

What will the securities lending market looklike in the next five years? Are electronic FXmarkets foreshadowing the evolution of securi-ties lending?

dAlbrand: The securities lending market will bethat much more streamlined in five years, andthe future success will to some extent be linkedto technology. However, I believe that theevolution of the securities lending industry willfollow a different path than that of FX. The twoactivities are simply governed differently. FX ishighly regulated but flexible, while securities lend-ing is much less regulated but more constricted.Take for example the fact that each securitieslending arrangement is bound by a specific con-tract, inhibiting the type of transparency found in

FX transactions. Amongst the several routes tomarket, automation is a strong trend, with differ-ent platforms such as the auction model.However, many participants still prefer to adhere

The so-called lack of price transparency of lending fees due to

the power of the prime brokers over the industry is quitedisputable. The securities lending industry is an OTC marketand fees are based on various factors, such as creditworthiness,whether the stock is callable, and ease of location



29/84

to traditional methods, believing that a relation-ship-based business may attain better results.

Fieldhouse: Its clear that the future of the securi-ties lending market will be inextricably tied to

advances in technology. Technology will continueto serve as the backbone of the industry andthose firms who invest wisely and strategically intheir technology will be the ones who win out inthe end.Going forward, we will continue to see customers

demanding more integrated service offerings thatwill enable them to maximise their revenues andenhance risk management capabilities, whilemaintaining operational transparency. As with allother electronic trading environments, innovation

coupled with robust risk management and theability to integrate internally and externally, will be

the drivers and differentiators in this market.And as the traditionally long only investors con-

tinue to migrate to the alternative sphere ofinvestment activity, there will be opportunities forproviders who can provide a complete set of serv-ices to this client base, as their needs and expec-tations become more sophisticated and complex.And while technology is certainly going to play anintegral role in the future of the industry, whatsgoing to ultimately make or break the individualplayers is their ability to integrate into their oper-ations the flexibility that tomorrows clients (andtheir increasingly diverse investment strategies)are going to require.

Wilson: Technology and balance sheet are goingto become increasingly important factors overthe next five years. Balance sheet and capital aregoing to be essential in delivering to lenders therisk protection they look for via indemnificationsfrom their service providers. As the business con-tinues to grow at a rapid pace, this may start toput a strain on all but the largest and most exten-sive balance sheets. As volumes increase, nothaving the necessary technology to achieve

straight through processing for a high proportionof transactions and downstream processes willmake it very difficult for providers to sustaingrowth. This also relates to connectivity with

industry-wide platforms such as EquiLend, sothat a common standard can be used by industryparticipants. Within five years, those participantsthat can embrace technology, have a large wellcapitalised balance sheet and who can also inno-

vate in areas such as 130/30 funds will be thedominant and successful organisations.Seidel: Transparency and attention will be themajor factors influencing lending in the next fiveyears. As we have seen for the past decade, lend-ing continues to move towards a more main-stream financial product. With that migration willcome greater attention from all involved.Beneficial owners, agents, broker-dealers, regula-tors, vendors, media folks, you name it, will allhave heightened focus on lending. Clients in par-

ticular will be looking for the optimal provider one that can deliver strong returns in a risk miti-

gated environment and deliver this in multipleways. Customisation, once thought of as a privi-

lege for the largest, will be demanded by agreater segment of the market. Clients all havedifferent objectives in lending and soon all will beable to achieve those and will be pushed to find apartner who can provide it. This attention, focus,and push to the front lines by lending will lead toincreased transparency. It will come in the formof price discovery (fees, rates) but more impor-tantly, in total lending transparency. While feesare important, beneficial owners will need to askthe broader question about overall program per-formance. Could my lending program be donebetter? More safely? More efficiently? Can I havemultiple programs? Until beneficial owners cananswer questions like these in the affirmative,only then are we really getting toward transparen-cy. I feel this will be a big change in the next threeyears. Lastly, on electronic trading theres noquestion that its coming. While an importantpart of the maturation and evolution of trans-parency in lending, I do think that unlike otherproducts like foreign exchange price discov-ery in lending will be slower to take full hold. As

noted above, all clients have a different desireand risk profile in lending and price discovery,while an indicator of success, will not be the soleevaluator in the next few years. SLMG

It is likely that the actions of the ECJ and the EuropeanCommission will lead to individual member states amendingtheir domestic tax legislation to create a more level playing fieldfor cross border, intra-EU investors




At pension fund ABP with assets totallingEUR215 billion, we view securities lending asan investment management function.Securities lending is considered an independ-ent investment strategy. We apply all of thesame investment disciplines and rigor to secu-rities lending that would be applied to anyinvestment strategy. Asset allocation, vendorselection, investment guidelines, benchmark-ing, and performance measurement are all partof the ABP programme.

We take an active approach to securities lend-ing and aim to optimise providers and counter-parties based upon their specialties or abilityto pay guaranteed premiums via the auctionprocess for our various portfolios. Thisapproach has been the key to the success ofour program which will top EUR105 million thisyear, up from 43.5 million in 2003 prior to theimplementation of this strategy.

Applying investment management disciplineto the inefficient, bundled, securities lendingindustry has allowed us to maximise perform-ance and create a significant source of alpha.We use three primary vendors for securitieslending services with a best of breed approach,eSecLending, State Street and JPMorgan. TheeSecLending auction model has been a keytool in the management of the programme.The auction provides price discovery, bench-marking and transparency and has been

employed across all asset classes improvingboth lending fees and utilisation rates.

At ABP we have built a robust oversight infra-structure, which has allowed us to maintaincontrol over the programme and make betterstrategic investment decisions. We have usedthis infrastructure to employ a variety of collat-eral management strategies. Key to this hasbeen the unbundling of collateral managementservices and lending. The programme nowuses five distinct, lowly correlated strategies.

All managers must comply with ABPs invest-ment guidelines, but different managers havebeen hired for different strategies. Our pro-gramme is large enough and our auctions are

timed so that we can divide our volatile cashfrom cash that is considered core and we cancommit to a manager for a year or longer.

Risk management is a key part of our over-sight function. We look at guideline compli-ance through a variety of reporting tools andanalytics that standardise program data acrossproviders. We also measure total exposureacross all of our borrowers taking into accountexposure in our collateral reinvestment portfo-lio. Value at risk (VaR) is measured programmewide to ensure that programme risks areappropriate for the funds risk tolerance. Wehave found that our programme VaR is relative-ly small when compared to the alpha that itdelivers. Through our quality managementfunction, we are also constantly working toincrease the programmes operational efficien-cy to reduce operational risk.

While ABP would never underestimate the

importance of operational support in thesmooth administration of our programme, weprimarily view securities lending as an invest-ment strategy that generates considerableamounts of money. Thus, we manage our pro-gramme as we would any of our investmentfunctions.

Finally, of course, the coin of securities lend-ing also has another side: corporate gover-nance. ABP has a policy in place to strike a bal-ance between the returns from securities lend-

ing and the retention of voting rights in casesin which it makes a difference. A minimum of10% of the shares will always be available forvoting at AGMs. In case a company is onABPs full voting list, ABPwill in principle vote with allof its shares. Shares lentwill be recalled for that pur-pose, unless there are nocontroversial issues on theAGM agenda.

Mark Linklater, head ofSecurities Lending, ABP

Investments

Is securities lending a back office or front office function?

ABP Investments

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The growth in stock lending has been one ofthe most spectacular success stories of the cap-ital market liberalisation of the past 20 years. Byproviding the markets with greatly enhanced liq-uidity and greater potential to hedge positions,

facilitating two way bets in equities, and provid-ing long term holders of equity positions with ameans of enhancing revenue, the expandedlending of todays markets has contributed sig-nificantly to the strong performance of equitymarkets over the period.

However, as beneficial as it has been, thisgreatly expanded lending activity has not beenwithout its price. As some of the less fortunateside effects come to the fore, the dangerincreases that regulators will impose rules

which have the effect of dramatically inhibitinglending in order to curb some of those sideeffects. Better that the industry address theseissues itself first, than that they be addressed byunsympathetic legislators responding to pres-sures from outside the investment industry.

Lending has always been predicated upon theassumption that most share owners will notwant to vote. Since the vote is the one thingthat borrowers and their agents cannot indem-nify through their lending contracts, this aspectof lending is usually glossed over in the salespitches made to senior managers and boards oftrustees. Prospective lenders are of courseassured that the have the right to recall shares(be bought back in) for any reason. Theassumption is that they will not have to do thisvery often.

In the event of a bid, rights offering, or othertransaction, the broker can often assent theshares and be on the hook for the substituteequity instead. Dividends and special distribu-tions are provided for in the contract for differ-

ence that the broker has with the hedge fund onthe other side of the trade, and everything isjust fine. Except, of course, for voting, whichrequires that similar shares be delivered to the

customer before a date that is seldom far offwhen the recall order is given.

As it now stands, lending has the effect ofinuring lenders to their stewardship responsibil-ities. Fortunately, most shareholders votes are

non-controversial, because until and unlesssome mechanism is developed to reduce thisconflict between voting and the continuance ofa borrowed position, lending will continue toprovide a powerful disincentive to voting.

The threshold problem is that both theadministrators of a lending programme andtheir counterparts on the borrowing brokersside have a vested interest that the share not berecalled and the loan terminated. They are aptto point out that the loan will bring in real cash

(however little) and that exercising the share-holders franchise has only intangible value. Thethreat that more than very occasional recall maycause the borrower to stop doing business withthe lender is invoked to stifle debate.

It may also be more difficult than advertisedfor the borrower to find the needed shares whena recall is demanded; in the case of voting, fail-ure to recall in time seldom results in any penal-ty clause being invoked by the lender. The netresult of this situation, in which proxy voting ismade subordinate to lending, is that lendersrarely recall for voting, unless a bid is inprospect. Proxy voting teams, and the few port-folio managers who are interested in corporategovernance issues, rapidly become discouragedat this display of corporate priorities. Often con-troversial voting issues are not even reported tohigher levels of management because of theconflict with revenue generation, no matter howsmall.

A further problem is that both investing insti-tutions and their portfolio companies are fre-

quently uncertain as to the size of their actualholdings. An investor soon loses credibilitywhen claiming to represent 3,000,000 shares inan engagement with a company, if only 50,000

What are the implications of stock lendingfor corporate governance?

International CorporateGovernance Network

Ask the EXPERTS



are eventually voted. I have seen senior man-agers of major funds confidently promise theywould vote millions of shares in a certain way,only to see them turn up at an AGM, red faced,with one third that number. The rest were out

on loan.Of course, no one else knows why the broker

wants to borrow stock, but the assumption isthat on the other side is a hedge fund or otherclient who wants to be short. The shares will besold in the market, whoever buys them will beanother legitimate investor, and t

Documents

SECURITIES LENDING MARKET GUIDE 2008