High-quality, low-yielding liquid assets languishing in European pension fund portfolios are being put to use in securities lending programs, as borrowers search for the bonds they need to satisfy regulatory requirements, industry sources said.
While pension funds may be more familiar with lending equity holdings, certain fixed-income assets are increasingly needed by banks to cover their Basel III regulatory demands, including the need to hold collateral against parts of their balance sheets under the liquidity coverage ratio. Banks need high-quality liquid assets they can quickly turn into cash in the event of systemic stress.
That demand is expected to increase annually alongside increases in the LCR requirement, until 2019, sources said.
Such borrowers are turning to pension funds to put their bonds out for loan — something asset owners might be increasingly keen to do as it adds a stream of revenue on assets that, in some cases, don't yield much above zero.
According to data provider DataLend, both equity and fixed-income securities lending appears to be up in Europe and could be driven by higher asset prices as well as more supply. European fixed-income lendable average balance stood at $1.69 trillion this year to July 20, up from $1.05 trillion for all of 2016. European equity lendable average through July 20 of this year is $2.37 trillion; it was $2.06 trillion for all of 2016.
Roelof van der Struik, investment manager at PGGM in Amsterdam, the money manager of the €185 billion ($211 billion) Pensioenfonds Zorg en Welzijn, Zeist, Netherlands, said the opportunity to create revenue out of fixed-income assets is particularly attractive this year. While being paid 20 basis points for lending a high-quality liquid asset might not seem like much, at a time when a bond portfolio yields close to zero, "this is beautiful yield."
Demand is so high, in fact, that pension funds can earn returns even on a small pool of fixed-income assets out on loan.
With this metric at play, investors that run securities lending programs — including money managers — also are finding they are in the sweet spot of lending less volume than in prior years, at a higher rate.
"This is better in terms of risk-adjusted returns," said Matthew Chessum, investment dealer at Aberdeen Asset Management in London. "Aberdeen in 2016 earned more from our lending program than in any other year, even when assets under management were lower than in previous years. Revenues from the lending program were up 20% year on year," Mr. Chessum added.
In July, Fondo Pensione Prevedi, Rome, a €527 million Italian pension fund for construction industry workers, launched its first securities lending program with custodian BNP Paribas Securities Services.
"The bank picks government bonds from our financial portfolios and pays a fee to the fund for each security lent," said Diego Ballarin, director general of the pension fund. "BNP Paribas provides Prevedi a warranty ... (of) 105% of the securities by time borrowed. Those fees are then included to the NAV of the pension fund, increasing, by this way, the fund's financial performance."
And the terms of the contract mean Prevedi executives can recall securities at any time, without any penalties.
"The securities lending activity does not interfere with asset managers' activity," said Mr. Ballarin.
The increase in passive investing is also a boon for securities lending. Mr. Chessum said. "The rise of passive funds has helped the business to grow as (active) funds rely upon securities lending to keep their costs low. Active managers are under pressure to keep costs under control given the increased competition from the passive funds and securities lending is an obvious way to help to do this."