International Securities Lending

International Asset Base Fuels Securities Lending Business

The growing asset base of international securities buoyed the securities lending business. The survey reported slightly over $7 trillion in custody assets for 1994, growing to nearly $14 trillion by 1996. During this same period, international asset allocations increased from 14.4% of total assets to today's position of 30%, representing an international securities custody base of $4 trillion !

assets move offshore [Ed. Note. For purposes of analysis, international securities were defined as non-U.S. securities. Asset growth was also attributed - in part - to the number and mix of global custodians participating in the survey.]

The International Securities Lending Business

Securities lending mushroomed to over $70 billion in outstanding balances for the current survey period. Lending portfolios showed a define swing toward the equity side of the business, with equities gaining in popularity over fixed income securities, accounting for outstanding balances of 57% vs. 43%, respectively. (Last year's survey sample reported slightly over $30 billion on loan, with equities lagging fixed income balances at approximately 30% and 70%, respectively.)

S/L Amount on Loan

rev. 1-2-97

Reported balances are from eight custodians as the remaining six custodians expressed reservations about releasing securities lending information to a third-party, although complete anonymity was guaranteed. (On a conservative basis the six "non-reporting" custodians represent an additional $30 to $40 billion in outstanding loan balances based on last year's survey and industry sources.)

Outstanding balances on a country-by-country basis show similar results as compared to last year, with "top five" lending activity in the markets of Japan, Canada, Germany, France and Italy. The U.K. reported balance seems low - the result attributed to the lack of survey data from several major custodians choosing not to release country-by-country data. Australia, Hong Kong, Sweden and Switzerland showed significant improvement over last year.

Top spots in the "equities" category were held by Japan, France and Germany at 24%, 16%, and 13% of outstanding loans in the equity category. Compared to last year, France gained position over Canada, with Japan holding the top equity spot.

In the "fixed income" category, Canada, Germany and Japan held top spots at 31%, 14% and 12% of outstanding loans in the fixed income category.

A Good Deal?

"Securities lending income provides customers with an opportunity to offset significant portions of annual trust and custody fees. On average, over the past five years our clients have offset one-hundred percent of fees with securities lending income," says one custodian. Most custodians generally agree that securities lending returns from an investor's portfolio can offset a meaningful portion of custody fees.

S/L BP Spreads

However, the calculation of the exact return can be elusive. Expected portfolio return from securities lending were said to depend on a number of factors, most often mentioned were:

Individual client portfolio holdings
International tax laws
Local market regulations
Size and mix of government holdings
Market conditions
Varied collateral arrangements
Restrictions on type of collateral
Number of borrowers

"Securities lending commissions vary considerably between securities' domicile and the actual issue. It would be impossible to give any indicative quotes as to the amount of commission which could be earned from a particular portfolio without having a full breakdown of assets held," said one custodian. Most custodians tend to agree. "All securities lending fees are totally negotiable and dependent upon the actual requirements of all individual clients," concludes another custodian.

Another custodian advises clients that "...specific restrictions on type of collateral and number of borrowers may adversely affect the revenue predictions by up to 75%." This custodian - like most - does not guarantee returns.

Investors shopping for a guaranteed return will be hard pressed. No custodian reported a guaranteed return on a lending program, primarily because of market volatility. One custodian came close, whereby clients were offered a guaranteed monthly income. The "guarantee" is reviewed every three months by this custodian to make necessary adjustments. The review process includes passing the client's portfolio information - on anonymous basis - to moneybrokers to gauge levels of stock lending activity and to provide potential income figures by market. The service was reported to simplify the maintenance of income projections for the client.

However, having mentioned all the prerequisite qualifiers on the apparently sensitive issue of portfolio returns from securities lending, a handful of custodians shared practical experiences. For example, one custodian said, "The investment income - less the payment of the rebate rate to the borrower - generally results in average earnings on loaned securities of 20 to 50 basis points (BP) for U.S. securities, and 50 to 200 BP for non-U.S. securities." When averaged across the entire client's portfolio, the rate earned on the outstanding balances was typically in the range of two to three BP for U.S. domestic assets and closer to ten BP for non-U.S. securities.

The experience of another custodian was in the ballpark with aggregate performance, before custodian securities lending fees, improving from slightly over five BP in 1993 to almost eight BP in 1996 on lendable portfolios.

One significant factor determines the investor's return, namely the commission split. Commission earned on loans are split at an agreed percentage with the client. One custodian says "...commission from stock lending is typically split between the client (75%) and the custodian (25%)." Another custodian indicated the commission split for the client in the range of 60% to 40%. The variation in client share was attributed to "...individual differences in indemnification and contract arrangements." In most cases, actual percentages are negotiable on a client-by-client basis.

An important issue - risk control - was emphasized by another custodian. "Overnight liquidity is adjusted daily to securities lending demand. The term structure of the assets and liabilities are managed to earn income subject to the constraint of stability of earnings," she said. This custodian monitors permissible investments, concentration limits, liquidity requirements, diversification, duration limits, and credit quality. The effect of potential interest rate shifts on the assets (investment pools) and liabilities (loans) is modeled to optimize income while reducing risk to clients.