Garnering incremental income
07 January 2025
SWIB鈥檚 Mike Stamm and Tim Wirkus sit down with Carmella Haswell to discuss the functioning of its securities lending programme, its work to further collateral optimisation, and how regulatory shifts are influencing the role of pension funds
Image: stock.adobe.com/Henryk Sadura
As a shift in the regulatory landscape transpires, it has left an opportunity for pension funds to take on an even greater role in long securities lending. This stems from the introduction of Basel III Endgame and the potential capital relief for borrowers.
For Tim Wirkus, senior analyst on the Financing and Collateral Management team at the State of Wisconsin Investment Board (SWIB), there is 鈥渦ntapped value鈥� in borrowers recognising a potentially lower risk weighting for pension funds.
He highlights: 鈥淗istorically, we've all been lumped together as lenders in risk weighting, because there hasn't been the need to focus on differentiating lenders until the new Basel III Endgame rules were coming down the pipe.鈥�
Wirkus believes pension funds are 鈥渃oming around鈥� and better understanding that this is not necessarily an adversarial relationship between lenders and borrowers, but it certainly is mutually beneficial. 鈥淎s long as you have your collateral schedules buttoned up, this really can be a win-win for both sides,鈥� he adds.
Evolving with the times
The State of Wisconsin Investment Board, otherwise known as SWIB, is an independent state agency responsible for managing the assets of the Wisconsin Retirement System (WRS), State Investment Fund (SIF), and several other state trust funds.
鈥淲e鈥檙e a big pool of stable assets. Asset owners like us make up a large borrow stock within the industry,鈥� notes Mike Stamm, portfolio manager of the Financing and Collateral Management team at SWIB.
As of 31 December 2023, SWIB managed more than US$155 billion of total assets, approximately 85 per cent representing WRS assets. SWIB鈥檚 management of the WRS trust funds aims to provide a fully funded public pension for over 677,000 current and former employees of state agencies, the university system, and school districts.
Contributing to the functioning of SWIB is its securities lending programme, a tool which has been running for quite some time, and has been agented through its custodian, BNY, as well as third-party lending agent, eSecLending.
鈥淏efore joining SWIB, [Tim and I] were both hedge fund guys for most of our career. It鈥檚 been interesting for us to move from that net borrower position at a hedge fund to SWIB. The existential component that is managed at a hedge fund is access to leverage and the cost of leverage, whereas at SWIB, it's a much more interesting puzzle,鈥� says Stamm.
鈥淣ot only do you have the leverage that we need to fund, but we also have the lending side.鈥�
Speaking to 网爆吃瓜 Finance Times on the programme and what it has to offer for clients, Stamm says: 鈥淚t's an outsourced programme, but we evolve with the times and try to stay competitive in the industry by being creative and flexible.鈥�
The agency鈥檚 broad collateral schedule of what it accepts in its securities lending programme allows borrowers to post cash or Treasuries, as well as equities. This aims to provide a 鈥済ood incremental utilisation鈥� which helps to generate more income through the programme, he adds.
Deeming its use of cash collateral as 鈥渋nnovative鈥�, Stamm pinpoints that instead of simply using cash collateral to reinvest, to earn a spread to pay the borrower, SWIB uses that collateral to fund its internal policy and overlay leverage.
鈥淲e could either reinvest it in classic securities lending arrangements or securities lending reinvest guidelines, or we could just take it ourselves and pay that pool for the use of the cash to pay back the borrower,鈥� he explains. 鈥淏y doing that, we give ourselves a really attractive source of liquidity to use to fund ourselves.鈥�
Reinvestment can present a certain level of risk, and is 鈥済enerally historically where securities lending gets into trouble鈥�, as Stamm puts it. However, Stamm is confident that the agency largely mitigates that risk and allows SWIB not to have to lever much via other means.
Furthering the conversation, Wirkus says: 鈥淭aking the cash collateral onto our own balance sheet to use as leverage, we certainly still have many other relationships to source leverage from, to the extent that there would be some type of disruption in the securities lending market.
鈥淚t's great that we have that cheap source, but there's also a lot of redundancy in the leverage sourcing programme that we could reach to make sure that we can continue to keep that leverage on if necessary.鈥�
The cash used as leverage is additive to SWIB鈥檚 leverage sourcing, Stamm adds, which also uses repo and synthetic exposures such as total return swaps and futures.
Ahead of the curve
Regulatory initiatives cast a wide net of influence across the securities lending landscape, but for SWIB specifically, Basel III Endgame and the US Treasury clearing mandate have been top of mind.
鈥淲e have been thinking about Basel III Endgame and working with the borrowers to advocate that we can get the best possible treatment there. Trading with SWIB as a pension fund, we have seen some banks be willing to treat us as a less balance sheet intensive collateral provider. And so we have been able to garner more business because of that,鈥� Wirkus comments.
Basel III is a set of measures developed by the Basel Committee for Banking Supervision (BCBS) in the years following the global financial crisis of 2007-09. The measures, rolled out over several years, aim to strengthen the regulation, supervision, and risk management of banks. The final set of rules has been dubbed the 鈥楤asel III Endgame鈥� 鈥� which introduces extensive changes, especially in the calculation of risk-weighted assets (RWA).
It has been a year of conversations with borrowers, namely broker-dealers, to understand what their regulatory needs are and how SWIB can fit within them, and appear attractive.
Stamm suggests: 鈥淭hose conversations have probably led to some specific trades or structures that have been beneficial for both them and us. In a year that had been defined by low utilisation, or lack of any specialness in the market, that has been the way that we've tried to add incremental income.鈥�
In terms of the US 网爆吃瓜 and Exchange Commission鈥檚 (SEC鈥檚) Treasury clearing mandate, the pension fund may already be ahead of the curve in preparation.
The Treasury Clearing Rules are designed to facilitate the implementation of central clearing of US Treasuries, including by requiring covered clearing agencies (CCAs) to adopt policies and procedures requiring their direct participants, or members, to submit for clearing eligible secondary market transactions.
On 13 December 2023, the SEC adopted rule changes that will require direct participants of CCAs to clear repo and reverse repo, as well as certain cash market transactions involving US Treasuries, subject to enumerated exclusions. The clearing of repo transactions will take effect from 30 June 2026.
Commenting on the impact of the regulation, Stamm says: 鈥淭he Fixed Income Clearing Corporation is a key way of 鈥榬epo-ing鈥� our Treasuries that we utilised as we've disencumbered those Treasuries via collateral optimisation, we've then taken them to FICC to repo them for cash.
鈥淭hat's been a way to get those Treasuries moving for us. We see it as a good future proof of our repo activities, as Treasury clearing is likely coming in 2026, so we're already clearing a tonne of our Treasuries.鈥�
While the regulation seems to provide a positive outcome for SWIB鈥檚 repo activities, Wirkus holds reservations over one particular hurdle. He believes if the FICC can clear more than overnight repo trades, it would be a 鈥済reat win鈥� for everyone.
He explains: 鈥淧eople appreciate the counterparty risk upgrade of the clearing house, but term repo is the last big hurdle that I still have reservations about. If the market can鈥檛 get term repo trades done in a clearing house, then I am worried, but to the extent that we can solve that, then it seems like this has been very helpful in providing significant pipes for us to get a lot of business done.鈥�
The numbers quickly get into the billions at SWIB, according to Stamm, who values 鈥渢hose big stable pipes to liquidity鈥�, with the FICC being one of them. 鈥淚t's like Tim said, there are just some details to get ironed out, as far as providing a term market.鈥�
鈥淲e鈥檇 like some way to manage our leverage sourcing term structure to add longer term money, so we know we are funded tomorrow through to 30, 60 or 90 days,鈥� says Stamm. 鈥淩epo through FICC would be a good place to get that, but so far the term market hasn鈥檛 developed.鈥�
Be your own best borrower
Collateral optimisation is a means for further efficiency, it can help clients to better meet funding requirements and collateral delivery considerations, and can come in a number of different forms. For Stamm and Wirkus, a core goal of their work at the Wisconsin pension fund is to try to identify efficient ways to use its balance sheet to SWIB鈥檚 benefit.
鈥淲e try to identify TIPS and Treasuries that we can use as a highly valuable source of collateral, either for leverage means via repo, or for collateral needs that must be met with Treasuries and make sure that we don't have any of that collateral working for us in a less valuable form than what it could be used for,鈥� Stamm highlights.
For instance, Stamm does not want to use Treasuries for 鈥渂og standard collateral posting鈥� when he could instead use equities. This has been a theme over the past year, to try to get back those Treasuries so the firm can use them for its own use, and get them out of collateral relationships, so that SWIB can use them for repo.
Stamm continues: 鈥淭hat's been a huge transformational shift in how we collateralise various obligations to try to use our equities as much as possible to free up our Treasuries for our own use.鈥�
The ability to self borrow is core to SWIB鈥檚 success in maintaining an attractive, efficient balance sheet. SWIB will self borrow its equities, short it, and therefore pay itself in transfer pricing costs 鈥� not needing to collateralise through a third-party lender and pay the third-party lender for securities lending fees. Wirkus says the team is able to use collateral to be more efficient.
Stamm believes this is a huge benefit, as firms do not need to collateralise if they borrow internally. He indicates that 鈥渨e鈥檙e our own best borrowers鈥�. He rounded off the conversation by stating: 鈥淎 way to get incremental income is through being a mindful securities lender, so that we can harvest the balance sheet that we're holding.鈥�
Looking ahead
As the market embraces a new financial year, SWIB鈥檚 priorities for the year are three-fold: to focus on collateral optimisation, continue to identify complimentary needs of banks and broker-dealers, and consider the unsecured debt markets.
On the theme of collateral optimisation, SWIB is constantly looking for ways to get 鈥渙ther slices of our portfolio鈥�, or other types of asset classes that are generally harder to finance, into financing arrangements, confirms Stamm.
鈥淲e may not use them, but we're always looking to try to find routes to market with those assets so that we can bolster our liquidity positioning by having more options to go to,鈥� he adds. 鈥淚t鈥檚 a big theme, diversifying that sourcing through mobilising various asset classes.鈥�
Focusing on the needs of banks and broker-dealers, Stamm indicates that SWIB鈥檚 understanding of their needs has developed through conversations. He questions: 鈥淚s it more bespoke, negotiated arrangements that allow them to face SWIB more directly and realise our RWA benefit? Or is there some way that we could use securities lending to help them with their net stable funding arrangements?鈥�
Talking through those types of needs and seeing if SWIB can find a way that works for it operationally and from a counterparty risk perspective, is something the team is always thinking about.
For Tim Wirkus, senior analyst on the Financing and Collateral Management team at the State of Wisconsin Investment Board (SWIB), there is 鈥渦ntapped value鈥� in borrowers recognising a potentially lower risk weighting for pension funds.
He highlights: 鈥淗istorically, we've all been lumped together as lenders in risk weighting, because there hasn't been the need to focus on differentiating lenders until the new Basel III Endgame rules were coming down the pipe.鈥�
Wirkus believes pension funds are 鈥渃oming around鈥� and better understanding that this is not necessarily an adversarial relationship between lenders and borrowers, but it certainly is mutually beneficial. 鈥淎s long as you have your collateral schedules buttoned up, this really can be a win-win for both sides,鈥� he adds.
Evolving with the times
The State of Wisconsin Investment Board, otherwise known as SWIB, is an independent state agency responsible for managing the assets of the Wisconsin Retirement System (WRS), State Investment Fund (SIF), and several other state trust funds.
鈥淲e鈥檙e a big pool of stable assets. Asset owners like us make up a large borrow stock within the industry,鈥� notes Mike Stamm, portfolio manager of the Financing and Collateral Management team at SWIB.
As of 31 December 2023, SWIB managed more than US$155 billion of total assets, approximately 85 per cent representing WRS assets. SWIB鈥檚 management of the WRS trust funds aims to provide a fully funded public pension for over 677,000 current and former employees of state agencies, the university system, and school districts.
Contributing to the functioning of SWIB is its securities lending programme, a tool which has been running for quite some time, and has been agented through its custodian, BNY, as well as third-party lending agent, eSecLending.
鈥淏efore joining SWIB, [Tim and I] were both hedge fund guys for most of our career. It鈥檚 been interesting for us to move from that net borrower position at a hedge fund to SWIB. The existential component that is managed at a hedge fund is access to leverage and the cost of leverage, whereas at SWIB, it's a much more interesting puzzle,鈥� says Stamm.
鈥淣ot only do you have the leverage that we need to fund, but we also have the lending side.鈥�
Speaking to 网爆吃瓜 Finance Times on the programme and what it has to offer for clients, Stamm says: 鈥淚t's an outsourced programme, but we evolve with the times and try to stay competitive in the industry by being creative and flexible.鈥�
The agency鈥檚 broad collateral schedule of what it accepts in its securities lending programme allows borrowers to post cash or Treasuries, as well as equities. This aims to provide a 鈥済ood incremental utilisation鈥� which helps to generate more income through the programme, he adds.
Deeming its use of cash collateral as 鈥渋nnovative鈥�, Stamm pinpoints that instead of simply using cash collateral to reinvest, to earn a spread to pay the borrower, SWIB uses that collateral to fund its internal policy and overlay leverage.
鈥淲e could either reinvest it in classic securities lending arrangements or securities lending reinvest guidelines, or we could just take it ourselves and pay that pool for the use of the cash to pay back the borrower,鈥� he explains. 鈥淏y doing that, we give ourselves a really attractive source of liquidity to use to fund ourselves.鈥�
Reinvestment can present a certain level of risk, and is 鈥済enerally historically where securities lending gets into trouble鈥�, as Stamm puts it. However, Stamm is confident that the agency largely mitigates that risk and allows SWIB not to have to lever much via other means.
Furthering the conversation, Wirkus says: 鈥淭aking the cash collateral onto our own balance sheet to use as leverage, we certainly still have many other relationships to source leverage from, to the extent that there would be some type of disruption in the securities lending market.
鈥淚t's great that we have that cheap source, but there's also a lot of redundancy in the leverage sourcing programme that we could reach to make sure that we can continue to keep that leverage on if necessary.鈥�
The cash used as leverage is additive to SWIB鈥檚 leverage sourcing, Stamm adds, which also uses repo and synthetic exposures such as total return swaps and futures.
Ahead of the curve
Regulatory initiatives cast a wide net of influence across the securities lending landscape, but for SWIB specifically, Basel III Endgame and the US Treasury clearing mandate have been top of mind.
鈥淲e have been thinking about Basel III Endgame and working with the borrowers to advocate that we can get the best possible treatment there. Trading with SWIB as a pension fund, we have seen some banks be willing to treat us as a less balance sheet intensive collateral provider. And so we have been able to garner more business because of that,鈥� Wirkus comments.
Basel III is a set of measures developed by the Basel Committee for Banking Supervision (BCBS) in the years following the global financial crisis of 2007-09. The measures, rolled out over several years, aim to strengthen the regulation, supervision, and risk management of banks. The final set of rules has been dubbed the 鈥楤asel III Endgame鈥� 鈥� which introduces extensive changes, especially in the calculation of risk-weighted assets (RWA).
It has been a year of conversations with borrowers, namely broker-dealers, to understand what their regulatory needs are and how SWIB can fit within them, and appear attractive.
Stamm suggests: 鈥淭hose conversations have probably led to some specific trades or structures that have been beneficial for both them and us. In a year that had been defined by low utilisation, or lack of any specialness in the market, that has been the way that we've tried to add incremental income.鈥�
In terms of the US 网爆吃瓜 and Exchange Commission鈥檚 (SEC鈥檚) Treasury clearing mandate, the pension fund may already be ahead of the curve in preparation.
The Treasury Clearing Rules are designed to facilitate the implementation of central clearing of US Treasuries, including by requiring covered clearing agencies (CCAs) to adopt policies and procedures requiring their direct participants, or members, to submit for clearing eligible secondary market transactions.
On 13 December 2023, the SEC adopted rule changes that will require direct participants of CCAs to clear repo and reverse repo, as well as certain cash market transactions involving US Treasuries, subject to enumerated exclusions. The clearing of repo transactions will take effect from 30 June 2026.
Commenting on the impact of the regulation, Stamm says: 鈥淭he Fixed Income Clearing Corporation is a key way of 鈥榬epo-ing鈥� our Treasuries that we utilised as we've disencumbered those Treasuries via collateral optimisation, we've then taken them to FICC to repo them for cash.
鈥淭hat's been a way to get those Treasuries moving for us. We see it as a good future proof of our repo activities, as Treasury clearing is likely coming in 2026, so we're already clearing a tonne of our Treasuries.鈥�
While the regulation seems to provide a positive outcome for SWIB鈥檚 repo activities, Wirkus holds reservations over one particular hurdle. He believes if the FICC can clear more than overnight repo trades, it would be a 鈥済reat win鈥� for everyone.
He explains: 鈥淧eople appreciate the counterparty risk upgrade of the clearing house, but term repo is the last big hurdle that I still have reservations about. If the market can鈥檛 get term repo trades done in a clearing house, then I am worried, but to the extent that we can solve that, then it seems like this has been very helpful in providing significant pipes for us to get a lot of business done.鈥�
The numbers quickly get into the billions at SWIB, according to Stamm, who values 鈥渢hose big stable pipes to liquidity鈥�, with the FICC being one of them. 鈥淚t's like Tim said, there are just some details to get ironed out, as far as providing a term market.鈥�
鈥淲e鈥檇 like some way to manage our leverage sourcing term structure to add longer term money, so we know we are funded tomorrow through to 30, 60 or 90 days,鈥� says Stamm. 鈥淩epo through FICC would be a good place to get that, but so far the term market hasn鈥檛 developed.鈥�
Be your own best borrower
Collateral optimisation is a means for further efficiency, it can help clients to better meet funding requirements and collateral delivery considerations, and can come in a number of different forms. For Stamm and Wirkus, a core goal of their work at the Wisconsin pension fund is to try to identify efficient ways to use its balance sheet to SWIB鈥檚 benefit.
鈥淲e try to identify TIPS and Treasuries that we can use as a highly valuable source of collateral, either for leverage means via repo, or for collateral needs that must be met with Treasuries and make sure that we don't have any of that collateral working for us in a less valuable form than what it could be used for,鈥� Stamm highlights.
For instance, Stamm does not want to use Treasuries for 鈥渂og standard collateral posting鈥� when he could instead use equities. This has been a theme over the past year, to try to get back those Treasuries so the firm can use them for its own use, and get them out of collateral relationships, so that SWIB can use them for repo.
Stamm continues: 鈥淭hat's been a huge transformational shift in how we collateralise various obligations to try to use our equities as much as possible to free up our Treasuries for our own use.鈥�
The ability to self borrow is core to SWIB鈥檚 success in maintaining an attractive, efficient balance sheet. SWIB will self borrow its equities, short it, and therefore pay itself in transfer pricing costs 鈥� not needing to collateralise through a third-party lender and pay the third-party lender for securities lending fees. Wirkus says the team is able to use collateral to be more efficient.
Stamm believes this is a huge benefit, as firms do not need to collateralise if they borrow internally. He indicates that 鈥渨e鈥檙e our own best borrowers鈥�. He rounded off the conversation by stating: 鈥淎 way to get incremental income is through being a mindful securities lender, so that we can harvest the balance sheet that we're holding.鈥�
Looking ahead
As the market embraces a new financial year, SWIB鈥檚 priorities for the year are three-fold: to focus on collateral optimisation, continue to identify complimentary needs of banks and broker-dealers, and consider the unsecured debt markets.
On the theme of collateral optimisation, SWIB is constantly looking for ways to get 鈥渙ther slices of our portfolio鈥�, or other types of asset classes that are generally harder to finance, into financing arrangements, confirms Stamm.
鈥淲e may not use them, but we're always looking to try to find routes to market with those assets so that we can bolster our liquidity positioning by having more options to go to,鈥� he adds. 鈥淚t鈥檚 a big theme, diversifying that sourcing through mobilising various asset classes.鈥�
Focusing on the needs of banks and broker-dealers, Stamm indicates that SWIB鈥檚 understanding of their needs has developed through conversations. He questions: 鈥淚s it more bespoke, negotiated arrangements that allow them to face SWIB more directly and realise our RWA benefit? Or is there some way that we could use securities lending to help them with their net stable funding arrangements?鈥�
Talking through those types of needs and seeing if SWIB can find a way that works for it operationally and from a counterparty risk perspective, is something the team is always thinking about.
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