Index fund providers and other big securities lenders that have had trouble redeeming cash collateral from securities lending operations were offered a glimmer of hope in the Federal Reserve’s expansion of its money market investor funding facility — but just a glimmer.
In a Jan. 7 announcement, the Fed said securities-lending cash-collateral reinvestment funds, securities lenders and certain local government investment pools would be allowed to sell impaired assets to the facility.
But because the facility will only buy a limited list of securities — namely commercial paper, bank certificates of deposit and bank notes — it will not provide much liquidity for investments tied up in securities lending programs, according to investment consultants.
“It’s too early to tell whether the Fed can solve the problem without knowing what exactly they’re offering to buy and at what price they are going to pay,” said William Schneider, managing director of investment consultant DiMeo Schneider & Associates LLC, Chicago.
“It’s a start, but it does not make the real problem go away,” added William F. Pridmore, a securities lending consultant based in Winnetka, Ill.
The real problem is that index fund managers, or custodians in the case of pension fund securities lending programs, have been parking cash collateral received in return for shares lent (typically 102% or 105% of the value of those shares) in longer-dated investments in an effort to squeeze out a little more return. But as the credit markets froze, the managers were unable to redeem those investments, which in turn created a myriad of other problems for both index managers and pension funds.
“Credit is not a worry, but liquidity is,” said Mr. Pridmore. “The typical large lender would put some money in two- to five-year maturity asset-backed securities that paid a short-term floating rate of interest.”
Those investments, however, would not qualify for the new access to the Fed facility, which will only purchase securities “with a remaining maturity of at least seven days and no more than 90 days,” according to the Fed’s statement last week.
“The Fed is buying only a narrow range of unimpaired money market instruments,” said Alan D. Biller, president of Menlo Park, Calif.-based consulting firm Alan D. Biller & Associates Inc. “These aren’t the ones causing the liquidity problems.”
He added that index managers might have reinvested the cash collateral in something messier, such as paper issued by Lehman Brothers Holdings Inc., which had an actual default or bankruptcy. “It’s impossible to determine the value of those securities and there’s no market to sell the stuff,” he said. “The Fed’s move doesn’t help much at all.”
John O’Connell, spokesman for Chicago-based Northern Trust Corp., said bank officials are “examining” the Fed’s extension to determine whether it will, in fact, have an impact on the firm’s securities lending activities. “Transactions in the normal course of business continue without change in Northern Trust’s common and collective funds,” he said in a written statement.
Officials at other major index fund managers — Barclays Global Investors, San Francisco, New York-based Bank of New York Mellon Corp. and State Street Corp., Boston — were not available for comment by press time.
