A well-managed securities lending programme can be a valuable portfolio management tool, and may enable funds to receive an additional source of income that may add incremental risk-adjusted returns to a fund’s overall investment return objective.
Since 10 July 2018, ABF Pan Asia Bond Index Fund (PAIF) has operated a securities lending programme, which has been designed to manage the fund to the potential benefits of securities lending while mitigating associated risks. The fund may generate income from the securities lending program, which may offset some of the associated costs of fund operations and potentially enhance its returns. The addition of Asian local-currency denominated bonds into the lending pool may deepen liquidity in the secondary markets.
All revenues that may arise from securities lending in respect of an ETF, net of direct and indirect operational costs, will be returned to the fund.
A securities lending transaction involves the temporary transfer of securities from one party (the lender) to another party (the borrower). Securities lending enables funds enrolledin the securities lending programme (the lender) to potentially generate an additional source of income.
In all cases, the securities borrower is a financial intermediary, such as a broker, dealer or market maker. In exchange for borrowing the securities from a fund, the borrower transfers collateral to the lending agent who holds that collateral in an account in the fund’s name. The borrower pays a fee for borrowing the securities and is contractually obliged to return the loaned securities. The loan is usually arranged by the securities lending programme coordinator, known as a lending agent.
During the term of the loan, the borrower must provide collateral to the funds to mitigate against the risk of non-return of any loaned securities. The borrower receives all distributions and dividends arising during the period of the loan and pays these amounts to the lending agent at the same rate as if the securities were held in custody. The lending agent then pays all distributions and dividends on to the underlying lender. The borrower will generally have the right to exercise any voting rights arising during the period of the loan that relate to the loaned securities.
The State Street Global Advisors’ Securities Lending Committee (Committee) oversees and comprehensively reviews performance and effectiveness, and provides oversight of State Street Global Advisors’ Global Securities Lending programmes.
The Committee evaluates the performance of State Street Global Advisors’ securities lending agents. It also reviews and challenges State Street Global Advisors’ Global Securities Lending programmes against industry standards and performance, current risk appetite levels, and current market conditions.
In addition, the securities lending programme for each participating fund is reviewed, approved and overseen by the respective fund boards.
In general the minimum acceptable collateral currently accepted are:
The collateral amount is marked to market daily. If collateral levels are insufficient for a particular loan, the borrower is required to provide more collateral. If the loan is over- collateralised, the lending agent may return some of the collateral to the borrower.
The Securities Lending Report is updated on a monthly basis and available on abf-paif.com.
HSBC PLC (acting through its securities service division) provides a counterparty default indemnity. In accordance with this indemnity, if a counterparty fails to return securities lent by the fund, subject to the terms of the securities lending agreement, HSBC PLC would either purchase replacement securities for the fund, or shall credit to the fund an amount of cash equal to the market value of the securities.
The percentage out on loan will depend on the type of fund and securities held but will be subject to the below limits established by State Street Global Advisors as internal guidelines for the lending programme:
As with all investment activities, securities lending bears risks. Here are some of the key risks and safeguards that are in place:
|Risks||Risk Mitigates and Considerations|
Counterparty or Borrower Risk
Borrowing counterparty default
Failure to provide manufactured income or entitlements
Counterparty credit risk management
Controlling the quality of approved borrowers
Monitoring daily margin requirements
Borrower default indemnification
Marked to market daily
|Failed Trade Settlement||
Agent lender depth of supply
Agent lender can execute buy in to force settlement
|Reputational Risk||Comprehensive oversight and ongoing communication with the lending agent|
|Collateral Diversification||The collateral is sufficiently diversified in terms of country, markets and issuers|
Source: State Street Global Advisors, as of 31 December 2022.
While not without risk, a well-managed securities lending programme can help to unlock an additional source of income in portfolios.
Securities lending programs and the subsequent reinvestment of the posted collateral are subject to a number of risks, including the risk that the value of the investments held in the collateral may decline in value and may at any point be worth less than the original cost of that investment.