Securities Lending Market Guide 2009

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2009

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SECURITIES LENDING MARKET GUIDE 2009 INVESTOR SERVICES JOURNAL 1

Welcome to the 2009 edition of Investor Services

Journals annual Securities Lending Market Guide. Ithas been a challenging year for global finance, withno shortage of press coverage on the credit crunchand its effects on the market. However, securitieslending and borrowing has fared well, with contin-ued growth in the number of market participants, theamounts lent and borrowed and its expansion intonew markets. This guide aims to bring you up tospeed with the latest developments and act as a ref-erence handbook to the vagaries of this ever-chang-ing business. Our special feature profiles MarkFaulkner of Data Explorers, who discusses the

changes to the buyer-seller relationships amid thecredit crunch, the resistance to electronic trading,the complexities of the agreements between partiesand the potential impact of the recent FinancialServices Authoritys ruling on disclosure require-ments for short positions in the shares of companiesundertaking rights issues. He also discusses theexpansion of securities lending and borrowing intonew markets and how successful it has really been(page 8).

Securities lending is a relationship business of hightouch and complex negotiations, making the

automation of transactions sometimes difficult toachieve. Liquidity requirements in recent times havefurther highlighted the importance of the symbioticrelationships between broker dealers and their coun-terparts. However, there is great opportunity in using

electronic systems to drive down cost and improveefficiency, for risk management, netting, and straightthrough processing. Risk management is the legacyof the credit crunch. Automation and electronic sys-tems in securities lending and borrowing is seen bymany as a way to achieve this, as well as increasetransparency and competition in a MiFID-like way.Francisco Gonzalez, head of Eurex SecLend, dis-cusses the benefits of its electronic market place andthe movement towards the increased use of technolo-

gy (page 36), and Felix Oegerli, an executive com-mittee member of COMIT assesses how far technol-ogy can help manage risk (page 42).The growth in the market over the past 12 months

has been widely acclaimed. There has been anincrease in the demand for securities globally as aresult of the growing size and number of hedgefunds and 130/30 funds as well as the increasingsophistication of trading strategies used by banks,

proprietary trading desks, and investment managers.The involvement of emerging markets has also

boosted growth, and Luke McCabe, managing direc-

tor at eSecLending discusses this on page 38.Liquidity has also been a defining feature of the pastyear. Although the injection of liquidity by central

banks in March tempered markets, indices remainedunstable. We analyse the impact of volatility onsecurities lending on page 14.The FSAs ruling on short selling concerned many

in the industry, not least David Rule, chairman ofISLA, who explains the self-correcting nature of themarkets in his foreword. Further, he explains, only asmall percentage of lent securities are used to coverdirectional short sales, and that if institutional

investors decide not to lend they would not onlymiss out on that return, to the detriment of theirinvestors and market liquidity at large. The RMAand PASLA have also written forewords for theguide, reviewing the growth of the market in Asiaand the effects of the market turmoil on securitieslending over the last 12 months.

Market experts from APG Investments,Brown Brothers Harriman, CaLPERS, ICGN andOPERS also offer their opinions on securities lend-ing as an investment strategy, the credit crisis, usingequity repo for diversification in an illiquid market,

fund governance and the affect of cash collateral onsecurities lending performance measurement,respectively, starting on page 28.

Catherine KempEditor

SECURITIES LENDING

MARKET GUIDE2009

EDITORIAL SECURITIES LENDING MARKET GUIDE


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As I sat down to writethis article, I couldn'thelp but think aboutthe past twelve monthsand the turmoil in thefinancial markets. Inthe securities lending

industry, however, itwas a year in whichmany saw solid earn-ings, in large part dueto significant reinvest-ment returns resultingfrom the FederalReserve rate cuts. Butit was also a year of

uncertainty in the money markets, which were plagued by credit and liquidity issues related to

subprime mortgages and structured investmentvehicles along with a succession of asset write-downs & banks posting losses.

The difficulties in the credit markets areprompting pension and mutual fund boards to takea closer look at the investment guidelines for thecash collateral pools related to their securitieslending programs and to ask questions about bor-rower exposures. These boards are also askingabout counterparty credit, fees and relative per-formance. Regulators have also been makingenquiries, and it all reflects the continuing themeof increased transparency across the industry.

The financial market turmoil has had other far-reaching effects. For lending agents, I believe theissues underscore the value of credit diversifica-tion achievable through an agency securities lend-ing structure, where they have the ability to man-age credit in a more flexible and timely way.

The list of new markets continues to grow. LatinAmerica, for example, continues as a promisingand yet largely under-penetrated region for bor-rowing and lending. In January, RMA and the

Stock Loan Division of the Securities Industry andFinancial Markets Association (SIFMA) co-spon-sored the first annual conference on LatinAmerican Securities Lending. The conference washeld in January in Florida and attracted around

130 participants, representing borrowers, lenders,regulators and exchange officials from the region.Since the conference, there have been manyfollow-up discussions among those of us who

attended, with a focus improving the environmentfor securities lending in Brazil.

Other markets to watch include Eastern Europe,Greece, Israel and a few in in Asia. Generalthemes in these markets include the potential toearn significant spreads in the early stages,often less well-developed legal, tax and regulatoryregimes, and a shortened market develop-ment cycle.

The push to introduce new products is anotherimportant dimension of change. There is, as

expected, continued growth in the hedge fundspace, albeit at a somewhat slower pace. Activeextension products (also known as 130/30), con-tinue to contribute incremental short demand.Indemnified cash reinvestment structures - cashreinvestment pools that are indemnified against

principal loss - have also drawn attention amid therecent uncertainty in the money markets.

The industry is not without its challenges, how-ever. One major challenges is the ongoing discus-sion surrounding corporate governance, proxyvoting and securities lending. RMA, in coopera-tion with SIFMA, has recently offered funding towork on a project with the Center for the Study ofFinancial Market Evolution (CSFME) that wehope will support the industry's argument thatsecurities lending does not facilitate inappropriate

proxy voting activity on the part of borrowers.RMA, the International Securities LendingAssociation (ISLA) and SIFMA have been vocalin responding to uninformed, incomplete and, insome case, misleading information in the press.During my two-year term as chairman of the RMA

Committee on Securities Lending, I have beeninvolved inclarifying information about the corpo-rate governance and proxy voting issues. But thereis still more to be done.

I am near the end of my term as chairman,although I will still be involved as ex-officio com-mittee chairman. It has been a wonderful two yearsand I look forward to a continued involvement insecurities lending.

Tred McIntire oversees Goldman Sachs Agency Lendingin the US and Europe. He is a BA graduate in Economics

from Harvard University and an MBA graduate inFinance and Accounting from Columbia University. Heis also president and a director of The Goldman SachsTrust Company, a director of Goldman Sachs CaymanTrust and is a member of RMA's board of directors.

New chapterTred McIntire, president ofGoldman Sachs Agency Lendingand chairman of the RMACommittee on Securities Lending

Tred McIntire

FOREWORD RMA

2 SECURITIES LENDING MARKET GUIDE 2009 INVESTOR SERVICES JOURNAL


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In last year's fore-word, ISLA chairmanLaurence Marshallwrote that securitieslending is at the heartof the financial sys-tem, providing liquidi-

ty to markets andtouched on how vital

borrowing securitieswas to the servicesdealers offer their cus-tomers. He also men-tioned its core role inthe trading strategiesof dealers, hedge

funds, asset managers, pension funds, insurancecompanies and banks.

The truth of those statements has been thor-oughly demonstrated over the last year. Securitieslending volumes have remained high, providingliquidity to markets in short supply. For example,

problems in the unsecured bank financing mar-kets led banks and dealers to increase their collat-eralised financing, primarily through the govern-ment bond repo markets. The ability to borrowgovernment bonds against the collateral of othersecurities such as corporate bonds and increas-ingly equities has been critical to the success ofsuch financing strategies, particularly in Europe.

On the supply side, the market's longstandingfocus on risk management - with fully collater-alised, legally robust transactions - helped tomaintain the confidence of lenders, such as pen-sion and investment funds. Many lenders have re-examined and, in some cases, tightened collateralguidelines and cash collateral reinvestment man-dates. And the credit crunch has also broughtopportunities for lenders. For example, potentialreinvestment returns on cash collateral have risenfor those able to manage the risks.

Falling equity markets raised the familiar criti-cism that facilitating short selling drives equity

prices lower. In the United Kingdom, theFinancial Services Authority recently introduceddisclosure requirements for short positions in the

shares of companies undertaking rights issues,without consultation, and threatened restrictionson lending of those shares on the basis that 'therights issue process provides greater scope for

what might amount to market abuse'.Three responses can be made to such argu-

ments. First, short selling should have no long-term net effect on share prices. If short sellerscaused a share price to fall below its fair value,other investors would quickly try to buy.Academic research has shown that placingrestrictions on short selling reduces the efficiencyof price formation, and in particular that share

prices may overshoot. Second, only a small per-centage of lent securities are used to cover direc-

tional short sales. Securities are also borrowed formany other reasons - for example, to avoid settle-ment failures. Third, institutional investors lendsecurities in order to earn additional returns atlow risk. If they decide not to lend they not onlymiss out on that return, to the detriment of theirinvestors, and reduced securities lending wouldlower market liquidity. That is the last thing anyinvestor should want.

The International Securities LendingAssociation (ISLA) represents the common inter-ests of participants in the securities lendingindustry. ISLA has more than a hundred memberscomprising insurance companies, pension funds,asset managers, banks and securities dealers rep-resenting around 4,000 clients in more than 20countries in Europe, the Middle East and NorthAmerica. ISLA's priorities for 2008 includeworking with regulators to provide a safe andefficient framework for securities lending, open-ing new markets, providing information to mem-

bers, developing good industry practices andgood relationships with other associations,

enhancing the public profile of the securitieslending industry, completing its review of theGMSLA and promoting use of the Agreement.Finally, ISLA will implementing its model forAgent Lender Disclosure in Europe to meet theneeds of securities borrowers under Basel II.

Raising the profile of securities lending is toensure that policymakers, regulators and com-mentators understand its importance to the widerliquidity of modern financial markets. We need todo more to get the message across.

David Rule was appointed as ISLA's first chief execu-tive in May 2007. Previously, he was head of Sterling

Markets Division at the Bank of England and has alsochaired the Securities Lending and Repo Committee

from 2002 until 2006.

David Rule

FOREWORD ISLA

Timely boostDavid Rule, chief executiveofficer of ISLA, looks at howsecurities lending hasstrengthened the market

SECURITIES LENDING MARKET GUIDE


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In March 2008 thePan Asian SecuritiesLending Association(PASLA) elected anew executive com-mittee, which included

a change of guard inthe Chairman's seat.After three years ofleading PASLA, SunilDaswani has relocated

back to London, andPASLA thanks him forhis invaluable contri-

butions. Sunil leaves behind both a strong

association, as well as a vibrant Asia securities

borrowing and lending (SBL) market that has seenlendable assets grow to some USD957 billion as atJune 2008, up 16% from the previous year, accord-ing to figures from Data Explorers.

This increase comes on the back of the highgrowth in Asian market-focused hedge funds,where Eurekahedge estimates the total size of theAsian hedge fund universe at USD160 billion as atend-2007, up 21% from the previous year, andwhere Asia has also continued to see positive netinflows in recent months (USD 400 million in Mayand USD500 million in April).

We can expect this inflow of capital to Asia tocontinue to help drive industry and regulatory sup-

port for SBL and enhanced hedging capabilities,as regulators in the region increasingly recognisehow their capital markets can benefit from an effi-cient and effective SBL market.

In this, we are seeing the result of years of activecampaigning by PASLA. The opening of new mar-kets has been a continuing focus and is expected togather pace this year.

Malaysia looks set to introduce a bilateral OTC

model (similar to Korea and Taiwan), which willimprove access for overseas investors. The intro-duction of guidelines last year by the Philippineswill similarly provide greater clarity for overseas

investors in lending their Philippine equities.Thailand is working to improve the depth of itsdomestic SBL market and Indian regulators haveintroduced a SBL platform; PASLA continues tomonitor the further development and evolution of

their model.While these are all welcome developments,

PASLA is also acutely aware of the heightenedfocus on SBL and short-selling amid the currentdownturn in world equity markets.

Since the beginning of the year, the MSCI WorldIndex and the S&P 500 Composite are down 12%and 11% respectively, while in Asia, the MSCI EMAsia Index fell 19%. Stock markets in Australia,Japan and Hong Kong similarly saw declines of15%, 10% and 18% respectively, and even the

Asian stars of 2007 were not spared - China haslost 47% while India has shed 30%.

The market downturn has created someheadwinds for SBL regionally and globally. TheUK's FSA has recently announced and introduceddisclosure rules for short-selling in companiesengaged in rights issuance, which is alreadyimpacting the investment community.

Earlier this year, SBL in Australia has alsoexperienced intense scrutiny from investors, regu-lators and the local media, arising from local retailmargin lending incidents. The Australian MasterSecurities Lending Agreement (AMSLA) wasupheld in a court case testing its enforceability,which is a strong positive message to the viabilityof the SBL industry in Australia.

The heightened attention being paid to SBLaccentuates the role of PASLA, as the collectivegroup of major industry players in Asia, in cham-

pioning the growth of Asia SBL markets. PASLAremains committed to monitoring these develop-ments and in helping the industry navigate thechanging market landscape in the year ahead.

Lawrence Komo is managing director and Asia Pacifichead of securities finance at Citigroup, with responsibil-ity for directing and managing Citigroup's agency secu-rities lending program in the region.

He has extensive experience in regional and global securities lending markets, particularly from thebroker-dealer industry, where he had previously headedthe equity finance desks of Citigroup Global Markets in

London, Tokyo and Hong Kong, as well as managedequity finance desks at Goldman Sachs, Lehman

Brothers and Daiwa Securities in Hong Kong and Tokyo.

Komo earned his BA degree in Economics atYale University and an MBA from Emory Universityin Atlanta.

In March 2008 Komo was elected chairman of PASLA.

New horizonLawrence Komo, PASLAchairman, and securities finance

head at Citigroup AsiaPacificGTS, looks at the vibrancy ofAsia's securities borrowing andlending market.

LawrenceKomo

FOREWORD PASLA


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Special Features

10 Interview Mark C Faulkner of Spitalfields Advisors talks to ISJ

14 Statistics Lending by numbers

Section One16 Sec Lending panel debate Six discuss the key issues in securities lending

28 Ask the Experts We put the best to the test

Market view: Features36 Eurex SecLend If its not broken, still fix it

38 eSecLending Growing in sophistication

40 Societe Generale All in one and one in all?Securities Services

42 COMIT Technology and risk management

44 One Chicago SSFs

46 Northern Trust Risk management in securities lending programmes

Section Two

48 Technology panel debate Five discuss technology in securities lending

54 Securities lending guide For those who want to know but were afraid to ask

64 Glossary The definitive details of definitions

66 Market Update FinTuition


CONTENTS SECURITIES LENDING MARKET GUIDE 2009

contents


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Mark C Faulkneradmits he entered into securi-ties lending almost by accident. With a backgroudin operations, he entered the industry in 1986 in

Royal Bank of Scotland in the corporate actions andoperations department based in Angel, London.His introduction to money broking came about in

one crucial conversation with Adrian Tomlinson, aninternal customer at the bank. He said, would youlike to come and be a money broker? I'm leaving the

bank and am going to do that. I said, What's amoney broker? and he replied, It's where you bor-row and lend stock. I said, does that really exist - Ididn't know anything about it!

But his business origins, he admits, are commonamong practitioners of securities lending. I thinkquite a lot of people in the industry come from anoperational background, which is why to someextent the business hasn't really grown and becomeas high profile, successful and dynamic as perhapsit could be. The gene pool is quite shallow and veryoperationally focused. And it's only recently,

because of the enormous profitability of the busi-ness, the global scale and its applicability to capitalmarkets, that people have actually recognised thatthe more technical, front office type people, withderivatives expertise and so on, have begun to enter

the market.But the progress has been slightly slower than

expected. So I guess that I'm typical, of what somemight call an operations person made good andstill learning.

Faulkner says the appeal of the industry was assomething fresh and new. He describes the year-on-year growth of securities lending as a constant evo-lution. One example of change he cites is the deathof the tax trader, and to paraphrase Mark Twainscomplaint, the rumours of the death of the tax trad-er have been greatly exaggerated, time and again.Every year people talk about it and every year peo-

ple find new ways of trading tax. This is because it'san innovative, progressive, growing business that's

profitable.

Faulkner explains that his enthusiam for theindustry was sustained when he set up his independ-ent consultancy business - Spitalfields Advisors - in1994. Like the industry, the firm has undergonean evolution, progressing from being a consultant toa recruitment organisation, conference organiser,author, and now data provider. It's been such a fas-cinating journey and remains very fascinating.

Despite the unprecedented scale of securities

lending, he muses that it is still an underrated areain the wider financial context. The scale of theactivity in the industry has always been outstanding.I think it's very difficult for people even inside it, tounderstand how big it is. We think it might be an

USD80 billion gross revenue business this year.This is higher than it's ever been, and represents thetotal cost of borrowing stock by proprietary tradersand hedge funds, including the splits that may betaken by prime brokers and agents acting on behalf


Author, conference chairand Spitalfields Advisorsmanaging directorMark C Faulkner talks toCatherine Kemp

INTERVIEW MARK C FAULKNER

I think it's very difficult for people

even inside the industry to under-stand how big it is. We think itmight be an USD80 billion grossrevenue business this year.

Lending advice


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of underlying beneficial owners.The opportunities to continue to develop the

mature markets are still there. So why am I interest-ed? Because it's interesting.

In establishing securities lending into the main-stream, he says people need independent advice inorder to understand what this practice is and to havesomebody to bounce ideas and suggestions off. Inthis, Spitalfields Advisors has its niche. Theycouldn't find that from even the more consultativecounterparties in the market, and certainly notthrough the more generalist consultancies in themarket. All we do is focus on securities financingactivity in its broadest sense. We do not roam intocustody, or foreighn exchange, or money market

activity. We aren't generalists, we are specialists. Ithink the market recognises that securities lending isa specialist activity and needs specialist advisorsand a specialist data provider. This isn't business asusual - this is an unusual business.

Faulkner remembers the firms first assignmentwas from a major pan European clearing organisa-

tion which came about three or four weeks after thefirm first opened. Since then the floodgatesopened - we've been incredibly busy ever since.He says the firm has 65 employees - if things con-tinue as planned he estimates that number will growto more than 100 people by June 2009.

In the wake of the credit crunch, Faulkner saysthe relationship between buyers and sellers has bothstrengthened and changed. He says it is in times ofduress that you really find out who you can counton, and that a number of organisations have devel-oped longer-lasting ties with business partners they

expected to have only short-term dealings. He saysthe relationships have become much higher profilethan before, and are now even more important totheir respective organisations.The liquidity requirements of the broker dealersare of paramount importance, the pressure that their

balance sheets are under is critical to them.Managing this liquidity, managing those balancesheets, and working with partners so that you canswap out of cash and non cash as you see fit, to doterm, special transactions, and structured financing

during trades, is vital. Similarly, for the agents whohave been managing cash collateral on behalf oftheir underlying clients, open dialogue remains crit-ical, along with strong relationships with the brokerdealers to facilitate the ongoing financing of these

books to maturity and avoid liquidations that mightresult in capital losses.

Will relationships always be paramount to securi-ties lending? I believe that securities lending is a

relationship business, but it's perhaps been toomuch of a relationship business in the past. Someuneconomic things have happened, cross subsidisa-tion of funds occurs. There's a whole range of issuesabout allocation algorithms, the balances for fees,trade-off, a whole range of different things whichraise questions about the way in which the businessis run.

He explains that the operational legacy of thebusiness has been the cause of these questions. Amore front office technical approach would have

less of a relationship component. Regulatory imper-atives and client inquisition will drive for moretransparency, best execution will eventually beadopted in securities lending. With USD80 billionworth of fees at stake, it's too much to not have bestexecution.

To some extent, all business are relationship businesses. But certainly in the securities lending business the transactional/business element willcome more to the fore in the next few years.Interestingly, current economic conditions havereinforced the importance of the relationship side ofthe business; it has tied firms closer together towork through the challenges they face. But I viewthis trend more as a way to deal with the current liq-uidity and credit crunch issues, rather than as a per-manent state of affairs.

Why has there been a resisitance to electronictrading? I think conceptually, everybody believesthat it will happen in time - it's just a question ofwhen it happens and when the tipping point isreached. At the senior management level, that tip-

ping point has been reached, but at the desk execu-

tion level there are a number of different reasonswhy this hasn't taken off as much as it could have.

It's a complicated business. For example, whenyou say you'd like to borrow a stock, there aren'tnormally standard lots for how much is traded, orstandard terms for how long. It could be open forany length of time, whether, cash or non-cash collat-eral. If cash stock, what currency? If you know thecurrency, what kind of investment terms? If non-cash - what kind of security? What kind of margin?Where do you want it delivered? All of these types

of things make for a high touch business. None ofthese are insurmountable problems but they requireaddressing.

He says the automated markets that have seensuccess are for cold securities that demand little dis-

Regulation written in haste is notnecessarily the best regulation.

INTERVIEW MARK C FAULKNER


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cussion of value. The US, UK and to an extentFrance and fixed income are starting to move quitenicely in this direction with significant potentialvolumes.

By contrast, he says when a stock starts tomigrate into the warm/hot space it is oftentaken off of the broadcast capabilities of the suppli-ers because they are worried that they are going toeffectively be lifted at the wrong price andwon't be able to re-price at a later stage. This leadsto gaps for price discovery, including reference

pricing.The hot, on-the-run securities are almost certain-

ly at this stage dealt with on a manual, phone bro-kered, electronic communication bases, rather than

in a fully automated way. But that too will migrateto the winning platform or platform over time indue course, all markets digitise over time.

He says the market is well within the remit ofdigitisation, but is hampered by what he calls his-toric inertia. He adds that it may need a genera-

tional change of traders, the X-BOX generationwill think it mad and old fashioned to pick up a

phone to do things when you could just transactelectronically, as he puts it, colourfully. But it'svery normal for this kind of stand off between themarket and electronic transactions. It's surprising tome that there aren't more people looking at it.

Electronic systems also face opposition based onrisk issues, he believes, but adds that a central coun-

terparty may play a key role in enhancing the stand-ing of technology. I see great opportunity in theelectronic markets not least to drive cost, andimprove efficiency, risk management, netting,straight through processing.

He cites the Financial Services Authoritys snapdecision to impose disclosure requirements forshort positions in companies undertaking rightsissues as an example of why the industry is intrigu-ing. He says the ruling may adversely affect marketliquidity, and would not like to see some lenders

making similar snap decisions and withdrawingfrom the market.Like others, he emphasises the differentiation

between securities lending and short selling. Aninvestor or traders' ability to borrow securities and

short sell them and express their view on a compa-ny's performance is important - even during a rightsissue. There are more significant timetabling issuesto be addressed and some interesting work done

comparing UK rights issues with US placings. Andwho knows - it might have some short-term posi-tive impact on the share prices, which may be con-strued as a positive impact of the regulations.

He suggests that the shock of the FSAsrequirements might have caused any price risesrather than any change in behaviour or scale ofactivity. Regulation written in haste is notnecessarily the best kind of regulation.

As Asian markets tentatively enter into securitieslending, Faulkner says he was struck by a recent

PASLA presentation from a really fascinating,amazingly well-educated and dextrous presenterfrom China. When asked after his 45 minute pres-entation how many lending transactions had beencompleted, the speaker first evaded the question.When pressed, he admitted there had only been asingle transaction. He says developed markts haveso far shown concern with the market structure inIndia - but its early days.

He explains that new countries structure theirmarkets in an esoteric fashion, diligently research-ing established markets before throwing thatresearch in the bin and do it the way they want to doit. This can mean the countries do not take intoaccount risk management, netting, margins toler-ances, reporting, which are essential forInternational investors, this in turn limits their mar-ket's growth.

Nevertheless, Faulkner is a supporter of variety.I'm not saying that every market should be like amature Western market. But this kind ofreluctance to embrace established globalstandards often goes too far for them to be success-

ful and some of these markets are effectively stillborn. He cites Singapore as having made signifi-cant progress, and is now popular among Asianhedge funds. Australia, by contrast is going througha troubled adolescence, withgreater scrutiny once again being a positive long-term influence.

But over time, the emerging markets will relaxand open up, he believes. When you look at Brazil,India and China, those have the mostexciting future ahead of them in the capital markets

arena. One would hope that they would be able toembrace and develop securities lending functional-ity. Securities lending is the lubricant of the capitalmarket machine; if you don't have lubricants,machines don't work. SLMG

Current economic conditions havereinforced the importance of therelationship side; it has tied firms

closer together to work through thechallenges they face.




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Below is a table showing a year on year

snapshot of the industry worldwide, courtesyof the Risk Management AssociationSecurities Lending Composite - Averages forthe First Quarter of2008.Lendable assets refer to

the value of loanable securities.

On loan versus cash collateral refers to thevalue of securities on loan in return for cash.On loan versus non-cash collateral refers tothe value of securities on loan.

Lending by numbers

STATISTICS SECURITIES LENDING

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 EquitiesAustraliaAll Other Pac-Rim Equities

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

Euro Denominated Sovereign BondsFrench Sovereign BondsGerman Sovereign BondsItalian Sovereign Bonds

Spanish 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

$1,918,074$512,581$180,837$186,822

$1,014,888$22,945

$2,695,899$2,637,800

$58,100

$1,175,178$153,032$148,351$55,114

$398,886$90,990

$328,804

$496,669$264,015$75,350

$112,329$62,975

$98,366$4,466,112

$263,452$60,664$81,988$42,188

$12,991$65,622

$118,207$32,080

$385,995$55,616

$2,773,424

$7,239,536

17

$546,708$316,996$75,140$45,284

$108,249$1,038

$274,235$269,034

$5,201

$47,834$17,146

$8,405$3,412$2,328$5,361

$11,181

$28,146$12,060

$4,302$10,241

$1,542

$13,477$363,692

$66,455$16,938$25,996

$5,278

$3,295$14,947

$16,872$4,793

$18,575$8,025

$661,428

$1,023,120

$85,522$67,755$9,250$1,019$5,006$2,492

$13,556$11,565$1,991

$65,675$6,667$8,553$3,400

$18,126$4,928

$24,001

$40,360$15,034$7,477

$12,008$5,841

$4,768$124,359

$39,243$9,078$9,922$5,065

$2,695$12,483

$43,328$398

$37,348$9,768

$215,606

$339,966

$632,230$384,751

$84,390$46,303

$113,256$3,530

$287,791$280,599

$7,192

$113,509$23,813$16,959

$6,812$20,454$10,289$35,182

$68,506$27,094$11,779$22,249

$7,384

$18,245$488,052

$105,698$26,016$35,918$10,343

$5,990$27,430

$60,200$5,191

$55,922$17,793

$877,034

$1,365,086

33%75%47%25%11%15%

11%11%12%

10%16%11%12%5%

11%11%

14%11%16%20%12%

19%11%

40%43%44%25%

46%42%

51%16%14%32%32%

19%

This survey reflects data provided by:

AIG Global Investment CorpBarclays Global InvestorsBoston Global AdvisorsBrown Brothers Harriman & Co.Citibank, Frost National Bank

Investors Bank & Trust Company

JP Morgan Chase & Co.M & I Global Securities LendingMellon Financial Corp.MetLife Insurance CompanyThe Northern Trust Company

PFPC Trust Company

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

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

LENDABLE ASSET($m)

ON LOAN vs CASHCOLLATERAL ($m)

ON LOAN vs NON-CASHCOLLATERAL ($m)

TOTAL ONLOAN ($m)

TOTAL ONLOAN (%)


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Volatility of US bondsThe graph demonstrates thetotal return of US bonds

from seven months beforethe credit crunch up to June2008. Just prior to April theinjection of cash liquidity bythe US Federal Reserveserved to renovate tradingin different assets andsharply reduced the price ofbonds. The price has beendeclining since.

Averages of lendable assets for Q1 2008 compared to Q1 2007

The graph shows thedecrease in lendable assetsfor the first three months of2008 compared to 2007.Though the decrease (exceptfor North American

trasuries/bonds) may appearat odds with the generalgrowth of securities lending,observers have commentedthat this may constitute a risein the quality of the assetsbeing traded.

North AmericanTreasuries/Bonds

Pacific RimEquities (inc

Australia)

North AmericanEquities

EuropeanEquities

All OtherEquities

USD

Percentage of assets on loan for Q1 2008 compared to Q1 2007

North AmericanTreasuries/Bonds

Pacific RimEquities (inc

Australia)

North AmericanEquities

EuropeanEquities

All OtherEquities

The graph shows the overallpercentage increase of lendableassets are on loan. The drop inNorth American treasuries/bonds overall for the first quar-ter of 2008 may be accountedfor by the liquidity injectionmid-way through the period.Elsewhere, the lending increase

for Pacific Rim (includingAustralia) and other equitieshints at the growth of securitieslending in the Far East adn inother new markets.



18/84

THE SEC-LENDING PANEL DEBATE


Eugene Picone, is managing d irector of global distribution at Wachovia GlobalSecurities Lending and is a member of the firms executive, investment, and cred-it committees. He is responsible for distribution, client service and product devel-opment in the western hemisphere as well as expansion of business in Europeand Asia. Previously he spent 19 years at JP Morgan and in served various seniorroles within the securities lending product during which time JPMorgan and itsheritage firms grew from USD12.5 billion on loan to over USD300 billion in 2006.

Guy dAlbrand has been global head of liquidity management at Socit GnraleSecurities Services since June 2004. He began his career in 1988 with SocitGnrale as a futures broker in Tokyo, then spent five years in Paris as a juniorauditor before being appointed inspector in 1995. He joined Fimat in 1997 to runthe Tokyo office. In 1999 he was appointed executive vice president and specialadvisor to the CEO, for Socit Gnrale, Japan. He subsequently headed-up theonline brokerage operations in Japan as deputy CEO and then CEO. In 2002 GuydAlbrand moved back to Paris to become global head of audit for the corporateinvestment banking division of Socit Gnrale.

Sunil Daswani is international head of client sales & relationship management,securities lending at Northern Trust Global Investments. He is responsible for allNorthern Trusts clients outside of North America that participate in securities lend-ing and leads the sales efforts for any new clients. Previously director and regionalmanager of securities lending in Asia for Northern Trust Global Investments hewas responsible for addressing and evaluating securities lending initiatives for

lenders and borrowers and focused on building the supply of Asian assets forNorthern Trust global securities lending program.

James Slater, is senior vice president and head of capital markets, CIBC Mellon.He is also a member of the companys executive management committee. Jamesis responsibile for CIBC Mellons capital markets function, which includes global

securities lending, treasury and cash management. He provides strategic clientservice engagement in relation to his trading and financial markets responsibilitiesand chairs the companys asset liability committee. Mr. Slater has 20 years ofexperience in the financial services industry with CIBC World Markets and CIBCMellon. While at CIBC World Markets, he was part of the team charged with theformation of CIBC Mellon.

Jane Karczewski joined Deutsche Bank as managing director and head of supplysales in Europe for the global prime finance desks in 2007. Prior to thisKarczewski spent 13 years at Morgan Stanley, spending three years on the equityfinance trading desk before becoming a senior sales person for all outperformanceand yield enhancement products across the European client base. Jane alsoworked at Cavendish SAM in Monaco after completing her degree in EuropeanStudies with Combined Languages at Kent University.

Elizabeth Seidel is senior vice president and global head of relationship manage-ment at Brown Brothers Harriman. She is also one of the founding members ofthe BBHs securities lending program and currently serves as global head of rela-tionship management for BBH's offices in US, Europe and Asia. She has over 15years of experience working in the securities lending industry.


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1. How is risk managed in your lendingprogramme?

Slater: Risk management is a core focus in all of ourbusiness activities. In securities lending we carefully

manage reinvestment risk, borrower risk, and opera-tional risk. The overriding objective of our cash rein-vestment risk strategy is the preservation of capital.We maintain a substantial amount of overnight liquidi-ty in our reinvestment pools to reduce the potential forforced sales. We analyze each issuer for credit qualityand maintain strict portfolio diversification standards.Our cash reinvestment trading system monitors eachtrade against predefined limits to prevent compliance

breaches against stated mandates. CIBC Mellon con-ducts comprehensive and on-going credit reviews of

borrowers, and has established borrower limits that aremonitored in real-time. We mark-to-market collateralfor each loan on a daily basis to ensure adequatecoverage of the value of each loan. We have estab-lished policies and procedures incorporating daily rec-onciliation of back-office activities, strict segregationof duties between operations and trading teams tomaintain adequate internal controls, and rigorousemployee training. CIBC Mellon is committed to fur-ther automating our back-office ensuring less manualintervention and so reducing the potential for human

error.Daswani: Risk management is the cornerstone of our

program. Northern Trust employs stringent approvalprocesses, including ongoing monitoring by dedicatedrisk management resources and senior managers whoare actively engaged in managing business riskthrough committee structures. Both qualitative andquantitative measures are used to control and monitor

borrower, investment and collateral risk.

dAlbrand: Risk management is a critical part of allof our services for securities lending, repurchase

agreements (repo), FX and cash reinvestment. Ourrisk and compliance department closely monitorscounterparty, market liquidity and operational riskscontinuously, with clear reporting flows to risk man-agement entities within SG. We aim to avoid marketliquidity risk by increasing collateral quality and rein-vesting cash within diversified and high qualityinstruments. Counterparty risk is managed initially bythe borrowers choice, then is mitigated through ouragency lending programmes that offer diversificationand indemnification in case of counterparty default.

Risk and compliance also plays an important part inthe development of new products and activities.

Picone: Risk management at Wachovia is afirm-wide endeavour. There are internal systems, pro-cedures and individuals responsible for risk

management. We use investment and counterpartyrisk management using the broader Wachovia fran-chise. Evergreen, our investment management sub-sidiary, is utilized for both credit research and overall

market risk management. The credit team facing off tothe investment bank is our major source of counter-

party risk management. Day to day exposure to riskis managed through a combination of the WGSLoperations and trading teams to ensure that all marginlevels, recalls and entitlements are executed on a time-ly basis. Our internal risk and compliance team under-goes compliance checks against all lending guidelines,not just collateral, on a daily basis.

Karczewski: Deutsche Bank has stringent risk con-trols across all of our business platforms.

Counterparty, market and operational risks areassessed daily. Deutsche Bank borrows on a principal

basis so the beneficial owners counterpart isDeutsche Bank. Our long term ratings are Aa3(Moodys), AA- (S&P) and AA- (Fitch). Counterpartexposures, be it verses our hedge fund clients or ourlenders, are analysed by a dedicated risk team withinglobal prime finance and credit. Our models take intoconsideration issuer exposure (earnings warnings,credit downgrades, mergers/acquisitions and down-grades) and macroeconomic risks (sovereign default,

energy price shocks, political instability and disas-ters). The level of risk control at Deutsche Bank hasmeant that our lenders are usually happy to acceptflexible forms of collateral and margin. Operationalrisk in securities lending will always exist, even if lim-ited. Automated recall processing and monitoring,coupled with a dedicated client service team who

proactively monitor and react to settlement and corpo-rate action queries, serve to mitigate operational risk.Any operation exposures are monitored by operationalcontrollers and credit officers within the firm.

Seidel: Our focus is on the main risks inherentwithin securities lending: counterparty risk,collateral risk, reinvestment risk, operational risk andregulatory risk. The management of each of theserisks involves a detailed set of disciplines we adhereto throughout the lifecycle of a loan transaction andinclude our decision to lend to a limited number oftop tier borrowers, our focus on extracting maximumintrinsic value in each loan transaction, and prudentcollateral reinvestment. This set of disciplines hasserved our clients well during both the recent periodof market turbulence and similar challenging periods

in the past.

2. How has the credit crunch changed themarket?

Slater: The credit crunch has brought greater oppor-




20/84

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21/84

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22/84

SECURITIES LENDING PANEL DEBATE

tunities to enhance returns and has opened the door tomore informed dialogue with clients around theunique risk/reward characteristics of lending againstcash collateral. Higher incremental returns as a result

of wider credit spreads have stimulated greater interestin lending against cash. Collateral costs haveincreased, so borrowers have increased their use ofnon-cash collateral to mitigate pressure on their bal-ance sheets. This highlights the importance of a flexi-

ble collateral management program, which incorpo-rates both cash & non-cash collateral.

Daswani: The credit crunch has changed the securi-ties lending market in numerous ways. Investmentspreads have expanded, borrowers are de-leveraging,and a flight-to-quality has increased demand and

spreads for US Treasuries. With the changes in themarket environment over the past year, regular com-munication with our clients has been a top priority.Clients now take a keen interest in refreshing theirunderstanding of securities lending, their program, aswell as specifics such as our approach to fixed incomeresearch, collateral characteristics, borrower reviews,and the dynamic drivers of demand.

dAlbrand: The credit crunch has stressed the impor-tance of efficient risk and collateral management.Affected by uncertainty and credit downgrades, securi-

ties lending equity markets have, in fact, celebratedgreater returns because of the increased focus on thegeneration of cash collateral and returns through thereinvestment of cash. Our clients understandable cau-tion about the quality of collateral, requires us tofocus on more diversified investment strategies inorder to obtain a certain level of stability.

Picone: We have seen three significant changes. Theflight towards increased quality, along with a normal-ization of rates has produced returns that are more rep-resentative of the risk the client is taking. Second, in

order to meet balance sheet requirements, dealers haveput pressure on agents and our clients to accept notonly less cash collateral, but also more types of collat-eral. Third, the market has been re-awakened to riskand should allow for better differentiation in product.

Karczewski: Since August last year, various majorevents including sub-prime, inflation and trader losseshave changed the dynamics of the markets across alltrading activities. Investors confidence has beenaffected and there has been a distinct flight to quality.Deutsche has seen a marked increase in new client

business over the last 12 months. Fund managers aredivsersifying their risk and partnering with organisa-tions with whom they feel safe. In securities lendingand equity financing volumes have increased as bor-rowers have sought to move balances to lenders

accepting forms of non-cash collateral. GC (generalcollateral ) is being sourced at discounted levels, andvia synthetic structures. Specials (or hot stocks) are

becoming more volatile and costly due to increased

sensitivity around corporate governance. It is thereforeimportant to deal with the market leaders who havethe appropriate operational infrastructure and detailedmarket knowledge to maximise the profitability ofyour portfolio.

Seidel: In early 2007, the focus was on how to gener-ate higher returns from enhanced collateral reinvest-ment vehicles and new routes to market. Eighteenmonths on, the posture of many beneficial owners hasunderstandably changed. They still value the benefitsof lending but they are much more focused on ensur-

ing their principal assets are protected properly.Owners are zeroing in on the investments in their cash

collateral vehicles, the credit quality of borrowers intheir program and their contractual protections.

3. How has changing liquidity affectedborrowing/lending spreads?

Slater: In August 2007 liquidity tightened becauselenders were increasingly reluctant to extend credit toinstitutions. This caused credit spreads to widenacross the board impacting all issuers including banks,corporations and ABCP conduits. Confidence is nowreturning to the credit markets in response to the

aggressive action of central banks and the willingnessof financial institutions to replenish their balancesheets with new capital. These wider spreads haveresulted in greater revenues for our clients. Prudentmanagement of our reinvestment process, ensuredCIBC Mellon avoided adverse impact on returns frommore risky, higher-yielding non-bank sponsoredABCP issues. Although credit spreads remain higherthan we have seen historically, they are moderating asrelative normalcy returns to the credit markets.

Daswani: As the credit markets deteriorated in late

2007, there was a flight to buy US Treasuries and USTreasury lending spreads were extremely wide in thefourth quarter of 2007 and first quarter of 2008.After the Federal Reserve provided credit facilities to

promote liquidity in the markets, US Treasury lending


The flight towards increasedquality, along with a normalizationof rates has produced returns thatare more representative of the riskthe client is taking.Eugene Picone


23/84


spreads tightened significantly. In addition, thedemand side created liquidity and reduced leverage,which reduced overall loan volumes. A greaterdemand for cash in general and we experienced an

increase in reinvestment spreads, which benefited ourclients who are willing to accept cash collateral.

dAlbrand: With the changing liquidity there hasbeen a widening of the spreads, which has requiredagent lenders to re-examine their lending strategies. AtSGSS, we are getting away from specials and haveadopted a general collateral approach, focusing moreon cash flows to remain as liquid as possible. In orderto obtain the best rates however, we need to be able toquickly switch between cash and non-cash trades.Most recently, we have seen some trades which have

actually been backed by securities collateral asopposed to cash in order to increase the non-cash net

balance.

Picone: In terms of liquidity of supply, we have seenvery little pull back for programs, thus the dealersseem to have no trouble finding securities. What hashappened is that the early flight to quality put pressureon the high-quality US Treasury market raising intrin-sic spreads by 20-75 basis points at times. The lack ofcollateral investment product lead to a greater demandfor overnight repo backed by almost any high quali-

ty collateral, pushing up spreads for general collater-al. Product that does remain is scarred, so we seespreads on 1-3 month CP over 20 basis points or moreto Fed Funds.

Karczewski: The spreads in the securities lendingmarket have certainly been affected by the dynamicsof the market over the last year. The cost of collateralhas in some cases driven GC trades into negative prof-itability; hence GC levels have been subject to great

pressure. The european lenders who accept non cashcollateral, especially equities and converts have been

the main beneficiaries, with more of their GC beinglent due to the attractiveness of their collateral profile.

4. Do you anticipate any changes to your relation-ship with the regulators - will it be closer?

Slater: Canadian regulators recognize the importanceof securities lending in facilitating the efficient opera-tion of the market, and have expanded the range of

permitted markets for securities lending transactions,and have worked with industry players to expand therange of institutions allowed to lend. Regulators havealso supported the introduction of short strategies to

the retail mutual fund market. Bill C-28, passedDecember 2007, is expected to drive growth in lend-ing against cash collateral with non-Canadian counter-

parties. It eliminates cross-border withholding taxeson securities lending rebates.

Daswani: Regulators have become much moreknowledgeable about securities lending over the pastfew years. They are now operating in a more coordi-nated way globally which is vital, as the industry

becomes more global. Northern Trust works directlywith regulators and industry associations to stayinformed and to work directly on solutions.

dAlbrand: We expect closer regulatory monitoringas a result of the MiFID directive, effective in Francesince 1 November 2007. MiFID has altered the wholeregulatory landscape for financial services. Forinstance, we are now required to file comprehensivereports regarding our activities and evidencing ourcompliance with MiFID rules.

Picone: Wachovia has always subscribed to a policy

of full transparency when dealing with our counter-parts, clients, regulators and auditors. It will be inter-esting to see how the regulators of our clients willreact, if they tighten scrutiny of programs and ifgreater focus is placed on examinations. With Basil II

just around the corner, I am sure the Fed and the OCCwill be watching closely to see what effect this has ontheir constituents, both on the securities lending andthe asset management side.

Karczewski: Deutsche Bank has always workedclosely with market regulators, but has been especially

close to the FSA, BaFin and similar organisations over

the last year as part of the firms compliance withBasel II regulations and ALD.

5. What have you found to be the best system forhelping beneficial owners manage collateral? Hasthe last 12 months changed this process?

Slater: The steady growth in cash collateral balancesover the past few years demonstrates that theCanadian market is moving toward a more balancedand flexible approach to collateralization.Traditionally Canada was a non-cash (fee-based lend-ing) market but now cash collateral loans account for

around 20% of outstanding loans, which is closer tothe 60% seen globally. We have dramatically increasedthe amount of resources dedicated to servicing clientswithin our cash collateral lending program. We arehaving more one-on-one meetings to review our


Regulators have become muchmore knowledgeable aboutsecurities lending over the pastfew years, which is vital, as theindustry becomes more global.Sunil Daswani


24/84



investment strategy, credit research capability and per-formance track record. We have also significantlyincreased the amount and quality of reporting to meetour clients governance objectives.

Daswani: We maintain higher levels of overnight liq-uidity and allocate investments towards high qualityissuers such as US treasuries and agencies. Our invest-ment process is also now more selective and has adeeper focus on principal preservation.

dAlbrand: The best way to help beneficial ownersmanage collateral is to first determine the right collat-eral type, in accordance to their needs and risk will-ingness, and then adapt the collateral structure on aday-to-day basis to meet this. Maintaining an appro-

priate split between non-cash and cash collateral is

critical, as is knowing when to avoid risk. A perma-nent dialogue with beneficial owners enables us tooffer flexible solutions such as collateral held with usor another custodian and provide client reporting on

their underlying investments. Liquidity is increasinglyimportant, so we aim to stay as liquid as possible byselecting safer investments, according to maturity andrating.

Picone: Wachovia has always abided by the philoso-phy that separate accounts are the best system in thelong run. While some preach the benefits of liquidityvia combined funds, the fact is that controlling the

parameters and guidelines still falls in the hands of theagent. Over the last year, our clients have had full dis-cretion over their portfolios.

Karczewski: Choice of counterpart is key in manag-ing collatoral risk. Tri-Party enables borrowers to man-age their collateral in a cost effective and efficientway. Additionally the beneficial owner has assuredcollateralisation at all times through the Tri-Party auto-mated process. There is now increased use of Tri-Party

product both on the equity and bond side as the primebrokers and broker dealers seek to re-hypothecate

internal pools of assets and do collateral upgradetrades.

Seidel: Our approach has been one of close commu-nication and transparency. Across the broader indus-

try, beneficial owners are closely scrutinizing theinvestments made by their cash collateral vehicles andtaking decisions based on their level of comfort rang-ing from moving to a self managed model or a higher

level of non-cash collateral.6. Malaysia & India are two of the newest Asianmarket opening up to securities lending on a signif-icant scale. Are you in or do you have plans to enterinto these or neighbouring markets?

Slater: Malaysia and India both have restrictions onthe scope of eligible lending activity for offshore par-ticipants. CIBC Mellon continues to review opportuni-ties for penetrating these markets, although currentactivity for offshore lenders is generally limited to

American Depositary Receipts (ADR) or syntheticequity-linked strategies.

Daswani: Northern Trust was an active lender in theMalaysian securities lending market prior to the 1998regulatory changes that effectively closed this marketto offshore participants, and is currently re-evaluatingits plans for this market. We have been actively work-ing with the Bursa Malaysia, closely reviewing theirsecurities borrowing and lending system, which waslaunched in January 2007. India recently, implementedits long-awaited short-selling and SBL system applica-

ble to institutional investors, which previously wasonly open to retail investors. The new model is heavilyreliant on onshore participants entering into on-exchange SBL transactions with a fixed-term transac-tion (7 days), the mechanics of which can represent ahurdle to offshore entrants. However, the increasing

profile of the Indian economy, means it is important toexplore any opportunities that we can offer.

dAlbrand: Countries like Malaysia and India pres-ent significant opportunities as regulators strive toincrease market liquidity and foreign investment.

Especially with the growth of hedge funds, theselargely untapped markets drive up the demand forsecurities lending. With implantations already in Asia,it is logical for us to expand our securities lendingactivity into this zone, and timing will have a lot to dowith our business development there. Along withopportunities come risks - operational, regulatory andcountry stability risks, however, with ourknow-how and experience in more mature marketslike the US and Western Europe, we are well equippedto enter new markets at the right time and with theright strategy.

Picone: Like any other agent and any other market,Wachovia will listen to the market demands, theinventory we have at hand, the risks involved in open-ing a new market and will make a decision to moveforward or not. The controls often placed on securities

Countries like Malaysia and Indiapresent significant opportunities...these largely untapped marketsdrive up the demand for securities

lending.Guy dAlbrand


25/84

Western Hemisphere William Smith at 212-623-5664Europe, Middle East andAfrica Michael Foxat 44-207-742-0256Australia/Japan Stewart Cowan at 61-2-9250-4647Asia Andrew Chengat 85-2-2800-1809

>>


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27/84


28/84

making it difficult to find cross-industry standardisa-tion, and further raising benchmarking issues. AtSGSS, we offer our clients our Global PerformanceBenchmarking Tool, which analyses their portfolio

performance and compares it to the market. Overall,the use of electronic platforms can optimise returnsand the uptake has been positive. One cannot ignore,however, the fact that the value of a service provider

boils down to their ability to know when to makejudgement calls according to client requirements andmarket nature on an ongoing basis.

Picone: The two major alternatives to the ICAP plat-form, SunGard and Equilend, both offer unique capa-

bilities, particularly when it comes to US vs. non-USassets and the ability to execute trades, maintain loans

and reconcile positions. ICAP is more in the auctionor trading end of the spectrum and seems to be mak-ing some in-roads there but only time will tell if themarket if ready for full transparency. I think what will

be really interesting, is if one of them can develop andsustain a central counterparty model to help with bothsupply sourcing and in satisfying demand. While anargument can be made that the cost efficiencies ofsome of these platforms could result in more demand,the platforms themselves do not seem yet to be creat-ing exponential demand.

Karczewski: The development of electronic platformshas substantially increased the efficiency of the mar-ket, especially for GC flow. However this does relyupon there being an STP process at the user endwhich is not always the case. This has been prohibitivefor some of the mid to smaller tier lenders. Equilend(for international) and Secfinex (for UK business)have been the most widely used by Deutsche Bankwith a significant amount of our GC flow beingdirected via users of the platform. This allows thetraders to concentrate on market analytics, new trading

opportunities, client relationships, specials and alter-native sourcing methods.

Seidel: Electronic platforms are widely utilized inthe marketplace for equity general collateral (GC) andfixed income lending given the static nature of theloan transaction. For example, BBH actively utilizesEquilend and SunGuards Loanet platforms for auc-tion facilitation, GC lending, and to achieve opera-tional efficiencies such as loan marking, contractcompare and dividend compare just to name a few.However, equity special lending and yield enhance-

ment trading operate more as an over the counter(OTC) market from a trading perspective than the GCmarket. This dynamic, in addition to the increasedinterest of beneficial owners to customize their lend-ing programs under defined parameters, creates com-

plexity in loan transactions. These parameters mayinclude restrictions on markets, portfolios and assettypes as well as authorization of borrowers andcollateral options. Given the difficulty in solving for

these nuances and the need for flexible customizationoptions, the electronic exchange vendors willrequire further enhancement to their currenttechnology offerings.

8. Has there been much development in the use andpopularity of 130/30 funds and exchange tradedfunds?

Slater: Canada is not isolated from these globaltrends and we are seeing an upturn in both alternativeinvestment products and ETFs, driven by the growingsophistication of investors. According to Investor

Economics in Toronto, Canadian hedge fund man-agers now control around USD37 billion in assets.These hedge funds are primarily available to affluentCanadian investors, or institutions, and are soldthrough offering memoranda.Pure hedge funds areonly one part of the story and increasingly traditionallong-only managers and institutional investors aredriving additional demand for securities borrowing asthey wade into alternative strategies. Although retailinvestors are not permitted to purchase 130/30 funds,shorting has become more common among Canadian

mutual funds. Mutual funds are now permitted tohold up to 20% of their funds in short positions, pro-

vided they receive necessary regulatory exemptions.In two years, this hybrid segment of the market hasgrown from around USD7 billion in assets to USD15

billion, according to Investor Economics research.Exchange traded funds (ETFs) are also a growingsegment of the Canadian market place bringing withit greater competition and new entrants. There arecurrently three companies active in the space withmore entrants anticipated in the coming years.

Daswani: Exchange Traded Funds (ETFs) havebecome a valuable asset class in our securities lend-

ing portfolio. The number of ETFs available to lendand the demand to borrow the ETFs has grown at astrong pace. The buzz of 130/30 quieted down a bitin the fourth quarter of 2007, however active exten-sion still represents a near and long term advance-



The development of electronicplatforms has substantiallyincreased the efficiency of themarket.Jane Karczewski


29/84


ment both from the demand and supply side. We con-tinuously look to strategically partner with our clientsand counterparties to deliver solutions in this space.

dAlbrand: There appears to be no clear develop-

ment one way or the other for 130/30 funds. The cur-rent credit crisis is working against innovative devel-opments in general, and its a question of timing as towhen the 130/30 funds will really catch on. Like anyfund, the 130/30 extension strategy will only be asgood as the managers running it, keeping in mindthat this strategy will also generate its own risk andcompliance requirements. From a securities lending

point of view, service providers should allow accessto both GC and hot stocks, permitting them to keepan open dialogue with clients in order to offer a more

catered global service. At the appropriate time, the130/30 strategy should enlarge the current securitieslending market and increase transaction volumes for

beneficial owners. For those who are able to meet therequirements, 130/30 should present a real opportuni-ty to build their overall business.

Picone: While it remains a hot topic amongst portfo-lio managers and fund boards, in talking to the bor-rowing and beneficial owner communities, the130/30 concept seems to be on simmer. While sell-ing short and then borrowing the securities is a sim-

ple concept to position, the mechanics and legaldynamics can be extensive. Using synthetics andswap transactions as alternatives to a formal prime

brokerage set-up, have also been discussed. Thatsaid, one survey group has estimated that by 2009,86% of all fund managers will have some form of130/30 or similar strategy. The inherent quandary isthat traditional fund managers have worked very hardover the last 5 years to shed expenses, reduce opera-tions and have become very efficient. They have

burst onto the lending scene as a way of increasing

returns but overall, that has been a net revenue gener-ator, not a cost to the funds. Prime brokerage, whileseeing some indications of commoditization, is stillan expensive operation and I believe many of themare struggling with that concept, thus there is a hesi-tancy to use the 130/30 or similar strategies until theycan truly estimate demand, pricing, and profitability.

Karczewski: Deutsche Bank estimates theActiveEnhanced Product or 130/30 to currently haveUSD90bn (although the debate continues to rage onthe size of the industry). The EU Active Enhance

product launches are mainly offering fundamentalstrategies, whereas conversely US launches favourquant strategies. Although performance has been dis-appointing with most 130/30 managers underper-forming their benchmarks, much has been as a result

of the macroeconomic downturn and stock marketconditions. Nonetheless investor demand for the strat-egy has been up with a recently conducted surveysaying that over 50% of public pension plans are

using, seriously considering, or evaluating 130/30strategies. It would seem that investors continue to

believe that the 130/30 tool has both strong academiclogic and practical implementation efficiency.Although overall inflows in 130/30 have been slightlymore disappointing than many originally predicted acouple of years ago, an asset class experiencing phe-nomenal growth over the last 18 months is the ETF.The number of ETFs worldwide rose by 64% to1,171 ETFs at the end of 2007. Deutsche Banklaunched db x-trackers in January 2007 and during

2007 saw the highest inflow in assets among all ETFproviders in Europe. Not only has this allowed fundmanagers to gain long exposure in a flexible and lowcost manner, but the ETFs have also acted as a usefulinvestment tool in volatile markets, as they haveenabled investors to hedge their portfolios without theuse of derivatives. According to Deutsche Bank,turnover in European ETFs increased by 88% in2007, with assets under management increasing 22%in the same time period. This escalation of interestfrom investors and traders has also generated furtherdemand for borrowing ETFs, giving investors an

opportunity to add incremental returns through lend-ing their ETFs.

Seidel: Unregistered 130/30 funds continue to pre-dominate, although they are growing at a slower pacethan anticipated. The interest in registered funds con-tinues although there are some operational and mar-ket issues that are preventing the interest translatinginto actual growth. Firstly, under current regulations,the collateral pledged from a registered funds longassets to satisfy margin requirements at its prime bro-ker must be held in a tri-party account at its custodi-

an. This means the prime brokers cannot access andre-hypothecate the collateral for funding purposes.Until this situation changes, prime brokers will bereluctant, especially in the current markets, to providemanagers with the funding they need for the shortcomponent as it is effectively unsecured. Secondly,the credit crisis has resulted in 130/30 managers fac-ing increased margin calls from prime brokers on thelong component of their portfolios, forcing some toclose out existing short positions to cover the calls.This has forced upward price pressure on the short

portfolio, degrading performance on the short com-ponent and therefore the overall portfolio. In conclu-sion, we think these strategies are here to stay, but thetimeline to reach predicted levels of critical mass has

been extended beyond initial forecasts. SLMG



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28 INVESTOR SERVICES JOURNAL SECURITIES LENDING MARKET GUIDE 2009

At APG Investments,we place the strategyof lending securitiesdirectly within thespectrum of our frontoffice functions.

When our passivesecurities lending program nettedUSD 43 million in2003, we researchedand implemented anactive managementapproach. We applythe same rigorousinvestment disci-

plines to our securi-ties lending program as we would to our otheralpha strategies. We use use a diverse range ofvendors selection and subject them to monthlyand quarterly performance evaluations.

Our program benefits from a three-vendordiversification approach. Three times a year we

bring our attractive asset mix to the marketthrough eSeclendings auction platform. This pro-vides transparency unique in the industry, pricediscovery and benchmarking. Our close vendorrelationships have been paramount in allowingthe growth of the program, and this year we stand

to generate EUR180. Our robust complianceinfrastructure allows us to manage the size of oura program and we also offer a bundled custodystrategy to ensures that we fulfill our securitieslending needs. The program is divided betweenour custodians and our third party lenders.

With more than 80% of our assets being distrib-uted through our auction program, it provides thedesired vendor diversification and allows us toshop for more competitive custody costs. We useJP Morgan and State Street for custodial lending.

As our program has grown, our complianceinfrastructure has grown with the program. Wehave developed a consolidated reporting networkcovering lending and collateral management,which has enabled us to install a multi- style man-

ager approach to the latter. Through the trans-parency of auction process we are able to identi-fy both short and core assets. This has allowed usto diversify our asset concentration and our man-

agers are able to take longer positions with ourcore cash.

Our risk management model is a key control inthe evaluation of our program. We use a variety ofrisk management analytics in our formal bi-week-ly evaluations of the program. We have standard-ised the delivery of program data throughout ourvendor base to facilitate our reporting tools. Weanalyse exposure on multiple fronts, includingcounterparty, fund and country exposures. APGInvestments also reviews quarterly counterparty

credit and, our exposure to unsecured debt and aswell as Value at Risk, the latter allowing allows usto monitor the effect of market fluctuations onour collateral margins.

We also ensure that our securitieslending strategy does not interfere with our otherinvestment strategies. We have built the programso that it requires minimal support from our backoffice.

Over the past decade APG Inverstments hasdeveloped a robust corporate governance policyto ensure sound corporate governance. Our secu-rities lending desk has followed suit, and nowmonitors onloan levels, which is particularlyimportant in the run-up to AGMs.APG Investments sees value in both the initiativethat the securities lending desk is attempting toachieve and that of our corporate governanceteam. We have carefully struck a balance

between the two. The transparency we have devel-oped in our program has been the key in strikingthis balance.

By following the same investment management

principles of our other front office investmentstrategies we have been able to identify andmanage risk throughout our securities lending

program.

Mark Linklater is head of securities lending atAPG Investments. He has 25 years ofinvestment experience in mergers andacquisitions and asset management, both on the

sell side and the buy side; He has been withAPG Investments for just over seven years. Mark

was asked to take over the business of securitieslending at the end of 2003 with the mandate torevitalise and enhance performance. Since tak-ing over the business the team quadrupled thereturn of the program.

APG

InvestmentsSecurities Lending: a back office functionor a front office investment strategy?

ASK THE EXPERTS

Mark Linklater


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For more Information visit us at

the exchange for Single Stock Futures

Single Stock Futures (SSFs)

2008 O neChicago LLC. All rights reserved. The information in this presentation has been compiledby OneChicago, LLC for general information purposes only. Although every attempt has been made

to ensure the accuracy of the information, OneChicago assumes no responsibility for any errors oromissions. Examples herein are hypothetical situations used for explanation purposes only and should

not be considererrors or omissions. Examples herein are hypothetical situations used for explanationpurposes only and should not be consider advice. All matters pertaining to rules and specificationherein are made subject to and are superseded by the official OneChicago rules. The Exchange for

Single Stock FuturesSM

is a service mark of O neChicago, LLC.

A very efficient tool for synthetically getting long and short delta.

SSFs offer much more attractive financing rates than those offeredthrough brokerage accounts.

SSFs offer an attractive alternative to the current stock loan processas beneficial owners can supply the delta to the market that the

short-sellers want without assuming any counter-party risk.

Incr ease y i el ds Decr ease r i sk

www.onechicago.com

or call David G. Downey, CEO, at 312-424-8520


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A healthy securitieslending market pro-tects investors bystriking the right bal-ance between riskand return. Prior tothe credit crisis,increased competi-tion and historicallytight credit spreads

created an environ-ment where, in somequarters, there wastoo much emphasison chasing returnsand not enough on

mitigating risk.As late as the first half of 2007, beneficial

owners were exploring all options that could yieldhigher returns, including direct routes to market,accepting lower grade collateral, and expanding

cash collateral investment guidelines. As thecredit crisis emerged, beneficial owners were sud-denly keen to ensure that their lending providerswere correctly managing their counterparty riskand prudently investing their collateral.Therefore in the short term, we believe there

will be a great deal of reflection on the part ofbeneficial owners regarding what their aims arewith securities lending and whether these arematched by the profile of their program. Forinstance, the primary focus of many securitieslending programs is to lend as much volume as

possible to maximise cash for reinvestment.However, with increased volume on loan comesincreased risk, so beneficial owners may considerwhether they want to shift to a securities lending

program that focuses on optimising rather thanmaximising returns. Its a subtle but importantdifference and involves factoring in the risk pro-file of each transaction to the return opportunity.For instance, total return driven by high portfolioutilisation has long been held up as the bench-mark of a successful lending program. However,

with increased utilisation comes increased risk,so the success of a lending program should be

judged upon a broader set of measures includingthe risk exposure of the program and the intrinsicfee per loan.

Recent issues related to counterparty solvencyhave served to remind the industry of the valuethat a third party agent provides from an over-sight perspective. In the current climate, where

even the most highly regarded organisations canquickly become vulnerable, the importance of anindependent third party agent performing critical

processes like collateral management and bor-rower monitoring cannot be overstated. In thisrespect, lenders who are financially stable withrobust operational and risk management proce-dures should fare particularly well.

Beneficial owners will now have a much bettersense of how protected they really are in theircurrent program, another short term result of

recent events. While lending agents have indem-nifications and risk management practices inplace to deal with borrower default, its not untiltheres an industry crisis that these get stress test-ed and refined. These protections range from anunderstanding of the risk management practicesof an agent to contractual provisions extended tothe beneficial owner.

Longer term, the securities lending industryshould emerge from the crisis stronger than ever.Additional transparency and understanding by the

beneficial owner community will translate intogreater dialogue to understand the exact nature ofthe risks assumed and the associated returns.

Furthermore, there is likely to be greateremphasis on diversification from an economic aswell as a risk perspective, leading to increaseddemand from beneficial owners for flexiblehybrid programs, which can combine the best ofall routes to market depending upon the composi-tion of the asset portfolio and the prevailing mar-ket conditions.

Recent market conditions have provided a great

stress test for the securities lending industry. Thechallenges have provided an opportunity forindustry participants - from beneficial owners,agents and borrowers - to learn valuable lessonsand enhance their risk management processes. Itis important to note that the volatility of the

broader capital markets has created significantreturns from securities

Securities Lending Market Guide 2009

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