More public pension funds are hiring third-party securities lending agents rather than bundling those services with their custodians and Deutsche Bank Agency Securities Lending appears to be getting the lion’s share of the unbundled business.
Several pension fund executives, speaking under anonymity for this story, said that they’ve seen Deutsche Bank apply for and win most RFPs from public pension funds choosing to go with an unbundled lending agent.
Their view is supported by a review of hirings reported by Pensions & Investments in the past two years. So far in 2014, the following public plans hired Deutsche Bank as an unbundled securities lending provider:
- The South Carolina Retirement System Investment Commission, Columbia. The duties had been handled by Bank of New York Mellon Corp., which remains the $29.9 billion system’s custodian;
- Iowa state Treasurer Michael L. Fitzgerald, on behalf of the $26.9 billion Iowa Public Employees Retirement System, $329 million Iowa Public Safety Peace Officers' Retirement, Accident and Disability System and the $129 million Iowa Judicial Retirement System, all of Des Moines. BNY Mellon, which was retained as custodian, had also handled securities lending.
- Chicago Public School Teachers’ Pension & Retirement Fund, which also replaced its custodian, Northern Trust Corp., with BNY Mellon. Northern Trust had handled securities lending for the $9.7 billion pension fund.
Last year, the $27.1 billion Connecticut Retirement Plans & Trust Funds, Hartford, $4 billion Colorado Fire & Police Pension Association, Greenwood Village, and $1.4 billion Chicago Laborers Annuity & Benefit Fund also spun off securities lending from their custody agreements, hiring Deutsche Bank as agent. BNY Mellon replaced State Street as custodian in Connecticut; State Street had handled securities lending as well; BNY Mellon was retained as custodian by Colorado Fire & Police, and Northern Trust remains Chicago Laborers’ custodian.
There are benefits as well as drawbacks to using an unbundled securities lending provider, said Joel Brightfield, a senior consultant at Hewitt EnnisKnupp, Chicago. “Our research has found that third-party lending agents offer advantages in the form of customization, specialization, and size,” or the ability to selectively add clients “leading to more attractive portfolios for the borrower community,” Mr. Brightfield said. “Drawbacks of unbundling securities lending include (the) potential for additional costs, an additional organization to monitor, and increased complexity of operations.”
Mr. Brightfield said that custodians are not responding by seeking unbundled securities lending mandates themselves. “For the most part, traditional custody banks remain focused on lending assets for custody clients, and are not aggressively seeking third-party mandates,” he said.
Also, custodians are not cutting their securities lending fees as a way to keep the bundled business, Mr. Brightfield said. “Instead, custody banks continue to leverage their scale in order to provide a wide suite of products and services at a reasonable cost,” he said.
Tennessee Consolidated Retirement System, Nashville, hired Deutsche Bank in 2012 after issuing a stand-alone RFP for securities lending agent, despite what Michael Brakebill, chief investment officer, said was the difficulties of dealing with two separate firms rather than just with its custodian, Northern Trust.
“We believe separating these two services provides transparency and access to best-in-class suppliers,” said Mr. Brakebill. “We believe we will receive superior services in a more cost-effective and transparent manner due to the separation.”
The $40 billion TCRS issued an RFP earlier this year for a custodian as Northern Trust’s contract expires on June 30; that RFP did not include securities lending services. Northern Trust was allowed to rebid.
Lee Ann Palladino, Connecticut chief investment officer, said the pension system chose Deutsche Bank for what she called “conservative nature of the management of the cash collateral proceeds.”
“We felt that they had a compelling business model that allowed for the effective lending of our securities,” Ms. Palladino said.
Anthony Toscano, New York-based managing director and head of U.S. trading for Deutsche Bank Agency Securities Lending, said the company was not focusing specifically on unbundled public plan business. “We’re focusing on clients who were frustrated with their securities lending business post-crisis. Though they may like their custodians, they hadn’t considered the necessity, or the degree in which they had to monitor, their securities lending.”
“What we like about public pension plans is they have diverse, global portfolios,” added Joseph Santoro, director, agency securities lending marketing and client services at Deutsche, also in New York.
Deutsche Bank also markets its securities lending services as a risk-based approach, which resonates well with public plans coming off the 2008-2009 global financial crisis and the subsequent losses securities lending programs sustained. Major selling points include managing collateral assets in separate accounts rather than in a collective pool, said Mr. Santoro. That caters to asset owners who now are applying the same criteria for securities lending agents as they do when selecting money managers — after all, he added, in the case of some public plans that have a securities lending agent with $1 billion or more out on loans, managing the collateral for that could make that agent the largest money manager for that pension fund in terms of asset size.
In a November interview, Scott Simon, chief investment officer of the Colorado Fire & Police pension fund, said the focus on credit risk in its securities lending program increased after the financial crisis. “In changing this focus, we saw more value from a third-party lender, like Deutsche Bank,” Mr. Simon said (Pensions & Investments, Nov. 11, 2013).
Mr. Simon could not be reached for further comment.
Chicago Teachers pension fund, in a news release issued after Deutsche Bank was hired, also said the firm’s emphasis on risk was the reason it was chosen, on the recommendation of investment consultant Callan Associates. Deutsche Bank “offered the best combination of risk and reward — delivering the same returns CTPF now earns, but with less risk,” according to the release. Carmen Heredia-Lopez, the pension fund’s CIO, could not be reached for comment.
Neither Hewitt EnnisKnupp’s Mr. Brightfield nor officials at Callan would comment on whether Deutsche Bank is receiving most of the unbundled pension fund business
Neither BNY Mellon nor Northern Trust would comment on any specific changes being made to their securities lending offering as a result of the increase in unbundled agent hirings.
In a statement, BNY Mellon said the third-party signings were evidence of “the highly competitive nature of our business. We continue to win our share of new business away from others.”
Michael A. Vardas, managing director and head of Northern Trust Capital Markets, said “Securities lending has been a core business for Northern Trust since 1981” adding that it delivers optimized lending solutions through its proprietary securities lending trading platform and global expertise.