Confidence is king
02 September 2014
With the 19th Annual European Beneficial Owners’ Íø±¬³Ô¹Ï Lending Conference in London coming up, PGGM’s Roelof van der Struik and Aberdeen Asset Management’s Matthew Chessum reveal what’s going on with their programmes
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How would you describe your 2014 so far—has it been strong for securities finance business?
Roelof van der Struik: Lackluster but not too bad would be what comes to mind. Because of the Alternative Investment Fund Managers Directive (AIFMD) status of our funds, since the beginning of this year we finally have relief at source for French dividend tax, which is good for our clients but of course it hurts lending income. The rules for yield enhancement trades in general seem to be changing, which makes the all-in levels more volatile. As always, there is a lot of talk about a few opportunities in emerging markets.
Matthew Chessum: The revenues that our programme generates from securities lending have so far remained in line with what we achieved in 2013. We have seen very stable balances on our discretionary book with less turnover than in the past few years. We have seen some good specials in the American depository receipt (ADR) market, which have been very profitable for our funds and we have benefitted from stronger demand in some of our Asian-based holdings.
In relation to our exclusive book, we have seen fewer counterparties bidding on our assets in relation to last year but the bids that we have received have been stronger. The auction process remains important to our overall lending strategy as it offers us both transparency and flexibility in relation to route to market.
Where are you seeing the most interest from borrowers, and what would you put this down to?
Chessum: We are seeing particularly high demand for high yield and emerging market corporate debt along with the traditional European equity portfolios. We have seen an uptick in activity in the ADR and global depository receipt (GDR) space, which has generated some significant revenues for the funds this year. The demand for these portfolios is mainly down to more active market making and arbitrage activities.
In the ADR/GDR space, these arbitrage opportunities work well for us as the revenues are often significant and the trades are short lived. This means the stock is on loan for a reduced period of time, which tends to better suit the appetites of our fund managers that are involved in securities lending.
As a beneficial owner, how is securities finance viewed in-house today, compared to just after the financial crisis?
Van der Struik: It depends with who you mean when you say in-house. If you mean in-house as in PGGM as an asset manager, then sentiment has improved as we have shown that we truly run a high value/low volume trouble/risk-free programme.
When you speak with the boards of the pension funds that are our ultimate clients, you see that they are not always as enthusiastic. Regulators are requiring boards to have a clear policy on all investments they oversee so they are very critical of what value securities lending adds and if it is enough to merit their attention.
Chessum: Íø±¬³Ô¹Ï lending is very much viewed as a ‘nice to have’, but not as an essential part of portfolio management process. Lending has always been a very emotive subject within fund management and this will probably never change. Our fund managers recognise the benefits that securities lending can bring through a well-managed, risk adverse programme, but they are also aware of issues faced by others during the financial crisis.
Therefore, as long as the funds continue to generate meaningful returns in a low risk fashion then securities lending within Aberdeen will continue to be viewed as an attractive proposition.
What effect has the increased importance of collateral had on your securities finance business, and why?
Van der Struik: For our securities lending program, a very limited effect, as we run a high value/low volume programme. On the treasury side, however, the impact has been significant. We have gone from a predominantly unsecured deposit environment to a €10 billion-plus reverse repo book.
Chessum: Collateral needs haven’t directly impacted our securities lending programme. As we only lend on behalf of UCITS funds, the re-use of cash collateral for margining purposes is not permissible so we have had no need to change our collateral profile. In addition, we do not currently lend our government bonds as we do not see sufficient revenues from lending them, so the programme has not been impacted.
How strict are your requirements around collateral, and do you anticipate any relaxation?
Van der Struik: Relaxation would not seem to be the right word because that would insinuate that the strict requirements are unnecessary. Risk though doesn’t have to be a bad thing as long as you can quantify it and get rewarded for it. Our requirements are strict, maybe even very strict, but as long as it is difficult for us to calculate and monitor collateral risk in a timely, aggregate and granular manner, this forces us to take the best collateral we can get. Examples of blind spots are:
The frequency of reporting, which is virtually never real time (as I always say, I am not interested in yesterday’s newspaper), while collateral can be ‘refreshed’ many time a day; and
Also, we want to include the underlying investments of liquidity funds in our total exposure to counterparties, but at the moment can only do this on a weekly basis.
When we have beefed up our capabilities and the industry stops trying to convince us that yesterday’s newspaper is good enough, we may be in a position to diversify our collateral requirements.
Chessum: Our collateral profile remains very conservative, but last year we did make it slightly more flexible. We still only receive high-quality government bonds as collateral, but we have expended the number of countries we will now accept. In the medium term, I believe that we will review our collateral policy but we will continue to insist on holding high quality, liquid assets.
We may look at the advantages of lending versus blue chip equities. There are a number of obvious arguments for this such as the positive correlation between the loan and the collateral and their embedded liquidity, but for us to make any changes there would have to be a real benefit either in terms of returns to the funds or further risk reduction.
What is on the horizon for you in terms of regulation, and what steps are you taking to address any issues?
Van der Struik: There is no horizon! Regulation is just starting to kick in (EMIR, shadow banking, money market funds, etc) and there are no signs of the increase slowing down any time soon. Let’s just try to help make the regulation relevant.
Chessum: We have finally come out at the other end of the tunnel with regards to regulation but remain cognisant that regulation bears a significant shadow over the lending and financing industry in general (ie, outside of Aberdeen). We spent a lot of time and made a number of internal changes in response to the recent the European Íø±¬³Ô¹Ï Markets Authority guidelines on efficient portfolio management. Aberdeen no longer takes any share of the securities lending fee and the stock lending information in our annual accounts and prospectuses has more information available than ever before. We aim to continue to be completely transparent in relation to securities lending and I believe that our fund accounts and prospectuses show this.
We are keeping a close eye, like everyone, on the developments in regards to the Financial Transaction Tax, but in general, regulatory issues are taking up a lot less of our time than previously over the last two to three years.
Roelof van der Struik: Lackluster but not too bad would be what comes to mind. Because of the Alternative Investment Fund Managers Directive (AIFMD) status of our funds, since the beginning of this year we finally have relief at source for French dividend tax, which is good for our clients but of course it hurts lending income. The rules for yield enhancement trades in general seem to be changing, which makes the all-in levels more volatile. As always, there is a lot of talk about a few opportunities in emerging markets.
Matthew Chessum: The revenues that our programme generates from securities lending have so far remained in line with what we achieved in 2013. We have seen very stable balances on our discretionary book with less turnover than in the past few years. We have seen some good specials in the American depository receipt (ADR) market, which have been very profitable for our funds and we have benefitted from stronger demand in some of our Asian-based holdings.
In relation to our exclusive book, we have seen fewer counterparties bidding on our assets in relation to last year but the bids that we have received have been stronger. The auction process remains important to our overall lending strategy as it offers us both transparency and flexibility in relation to route to market.
Where are you seeing the most interest from borrowers, and what would you put this down to?
Chessum: We are seeing particularly high demand for high yield and emerging market corporate debt along with the traditional European equity portfolios. We have seen an uptick in activity in the ADR and global depository receipt (GDR) space, which has generated some significant revenues for the funds this year. The demand for these portfolios is mainly down to more active market making and arbitrage activities.
In the ADR/GDR space, these arbitrage opportunities work well for us as the revenues are often significant and the trades are short lived. This means the stock is on loan for a reduced period of time, which tends to better suit the appetites of our fund managers that are involved in securities lending.
As a beneficial owner, how is securities finance viewed in-house today, compared to just after the financial crisis?
Van der Struik: It depends with who you mean when you say in-house. If you mean in-house as in PGGM as an asset manager, then sentiment has improved as we have shown that we truly run a high value/low volume trouble/risk-free programme.
When you speak with the boards of the pension funds that are our ultimate clients, you see that they are not always as enthusiastic. Regulators are requiring boards to have a clear policy on all investments they oversee so they are very critical of what value securities lending adds and if it is enough to merit their attention.
Chessum: Íø±¬³Ô¹Ï lending is very much viewed as a ‘nice to have’, but not as an essential part of portfolio management process. Lending has always been a very emotive subject within fund management and this will probably never change. Our fund managers recognise the benefits that securities lending can bring through a well-managed, risk adverse programme, but they are also aware of issues faced by others during the financial crisis.
Therefore, as long as the funds continue to generate meaningful returns in a low risk fashion then securities lending within Aberdeen will continue to be viewed as an attractive proposition.
What effect has the increased importance of collateral had on your securities finance business, and why?
Van der Struik: For our securities lending program, a very limited effect, as we run a high value/low volume programme. On the treasury side, however, the impact has been significant. We have gone from a predominantly unsecured deposit environment to a €10 billion-plus reverse repo book.
Chessum: Collateral needs haven’t directly impacted our securities lending programme. As we only lend on behalf of UCITS funds, the re-use of cash collateral for margining purposes is not permissible so we have had no need to change our collateral profile. In addition, we do not currently lend our government bonds as we do not see sufficient revenues from lending them, so the programme has not been impacted.
How strict are your requirements around collateral, and do you anticipate any relaxation?
Van der Struik: Relaxation would not seem to be the right word because that would insinuate that the strict requirements are unnecessary. Risk though doesn’t have to be a bad thing as long as you can quantify it and get rewarded for it. Our requirements are strict, maybe even very strict, but as long as it is difficult for us to calculate and monitor collateral risk in a timely, aggregate and granular manner, this forces us to take the best collateral we can get. Examples of blind spots are:
The frequency of reporting, which is virtually never real time (as I always say, I am not interested in yesterday’s newspaper), while collateral can be ‘refreshed’ many time a day; and
Also, we want to include the underlying investments of liquidity funds in our total exposure to counterparties, but at the moment can only do this on a weekly basis.
When we have beefed up our capabilities and the industry stops trying to convince us that yesterday’s newspaper is good enough, we may be in a position to diversify our collateral requirements.
Chessum: Our collateral profile remains very conservative, but last year we did make it slightly more flexible. We still only receive high-quality government bonds as collateral, but we have expended the number of countries we will now accept. In the medium term, I believe that we will review our collateral policy but we will continue to insist on holding high quality, liquid assets.
We may look at the advantages of lending versus blue chip equities. There are a number of obvious arguments for this such as the positive correlation between the loan and the collateral and their embedded liquidity, but for us to make any changes there would have to be a real benefit either in terms of returns to the funds or further risk reduction.
What is on the horizon for you in terms of regulation, and what steps are you taking to address any issues?
Van der Struik: There is no horizon! Regulation is just starting to kick in (EMIR, shadow banking, money market funds, etc) and there are no signs of the increase slowing down any time soon. Let’s just try to help make the regulation relevant.
Chessum: We have finally come out at the other end of the tunnel with regards to regulation but remain cognisant that regulation bears a significant shadow over the lending and financing industry in general (ie, outside of Aberdeen). We spent a lot of time and made a number of internal changes in response to the recent the European Íø±¬³Ô¹Ï Markets Authority guidelines on efficient portfolio management. Aberdeen no longer takes any share of the securities lending fee and the stock lending information in our annual accounts and prospectuses has more information available than ever before. We aim to continue to be completely transparent in relation to securities lending and I believe that our fund accounts and prospectuses show this.
We are keeping a close eye, like everyone, on the developments in regards to the Financial Transaction Tax, but in general, regulatory issues are taking up a lot less of our time than previously over the last two to three years.
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