Different Type of Crisis, Some Old Concerns

May 12, 2020
Over the past two months we have witnessed historic turmoil followed by unprecedented intervention by policy makers and central banks in supporting the capital markets (and more). In many ways the 2020 COVID-19 pandemic is very different from the 2008 global financial crisis, but for some, certain old concerns still linger. In the face of short selling bans and worries about market liquidity, we discuss below how best to navigate some of the common objections and concerns related to securities lending and how to position your securities lending program in the current environment and beyond.

Fees and performance remain top of mind

Even more than before, investors in investment funds are increasingly aware of the relationship between fees and performance. Every asset manager faces greater fiduciary pressure to evaluate techniques that can add revenue to their funds and mitigate the impact of fees on performance, and many are incorporating a well-run securities lending program into their engagement policy. It’s therefore imperative to determine whether securities lending can help improve performance for a fund’s investors.

Historically, the decision whether to lend or not has been a philosophical one. But with the introduction of new tools and the availability of more data than ever before, the decision whether to lend is made easier through rigorous analysis paired with data specific to a fund’s circumstances. BBH has worked with some of the world’s most sophisticated asset managers to assess the value of securities lending using these new methods.

“Lending drives prices down by facilitating shorting”

The most common objection that we have heard from portfolio managers and chief investment officers is that securities lending facilitates short selling, which undermines their investment objectives. By using a sample loan portfolio, we can address this point with a few helpful data points. First, let’s look at the distribution of revenue versus short interest in equities. Our analysis reveals that in many cases, asset managers can earn 75% from stocks where short interest is less than 5% and 99% from stocks where short interest is 15% or less*. In other words, shorting is relatively low in these stocks and the holdings in these stocks would not likely be lent into an environment of high speculative interest or aggressive shorting. At this level of short interest, portfolio managers typically take the view that a program may “lend at will.”

Of course, the relationship between short interest and securities lending revenue will vary from security to security and portfolio to portfolio. However, analysing a portfolio in this way enables an objective discussion about the potential guardrails that limit securities loans to those securities the portfolio manager is comfortable lending. This would result in a more objective and thoughtful approach than what is typically a binary decision of to lend or not to lend.

Lending will adversely impact my operations”

One of the most common questions regarding securities lending — and one that is highly relevant in today’s volatile environment — is the potential for securities lending to interfere with the investment process, specifically when a stock on loan is sold and a late returning recall causes the sale to fail.

Borrowers are contractually bound to return positions that are recalled from loan when the lender sells those shares. Typically, most securities loan agreements require the lender to inform the agent of its sale of a loaned security prior to the close of business in the relevant market on trade date (T+0). Sale notifications do not require a special process, simply a copy of the security settlement instruction that would usually be sent to the custodian.

Lenders who provide T+0 sale notifications should typically expect their shares to be returned within the settlement cycle of their share sale. If the borrower fails to return the securities in time, then either the stock exchange or the agent lender will “buy-in” the securities necessary to settle the lender’s sale, with any associated costs being borne by the borrower. Agent lenders may offer slightly differing terms and consequential damages coverage.

Beyond contractual remedies, it is important to consider the number of securities on loan. A “volume lender” may have a significant amount of a portfolio’s assets on loan at any time, while a “value lender” may have just a few high value securities out on loan during that same period. Data analysis can highlight how many securities are likely to be on loan at any given time, the markets in which they trade, and hence, their settlement windows.

A well-managed, value-based program with a limited number of securities on loan at any time should not typically generate settlement issues for the investment process. The level of automation and operational sophistication of agent lenders and custodians result in a highly efficient operational service.

Bottom line

For those asset managers who have decided not to engage in securities lending, the pressure on fees means there’s now more reason than ever to review that decision. In the past, this question might have been resolved at a philosophical level. Today, however, there are far more rigorous and precise methods available to establish the case for or against participating in a securities lending program. More importantly, once a review has been conducted, the asset manager will have fulfilled its responsibility to thoroughly assess the benefit to its fund investors.

To continue this conversation please contact your Securities Lending RM directly.

*BBH analysis 2020

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2020. All rights reserved.

This browser is not fully supported by our public website and may not display or function as expected for this reason. Please note, the Infuse Portal and BBH client applications fully support the IE 11 browser.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com

captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction