SACRAMENTO, Calif. -- The nation's largest pension fund is about become the first to conduct a live securities lending auction online.
Believed to be the first website of its kind, the California Public Employees' Retirement System's homepage (www.calpers.org) will be hosting auctions on securities, some of which may be held in real time, for the fund's $11.8 billion securities lending program.
But the new process may result in less business for State Street Bank & Trust Co. and Metropolitan West Securities, which now lend securities for CalPERS, said Dan Kiefer, portfolio manager for opportunistic investments.
At issue is the difference between agents (such as the incumbents) and principals. Instead of getting a straight fee from CalPERS, the agency providers take a negotiated cut from the income generated for the fund by lending the securities.
Bids from principals
Principals put in bids promising to pay a guaranteed monthly income for the loan of the portfolio, the entire amount of which is kept by CalPERS.
CalPERS is targeting principals for its online live auction, which may not be done for all types of securities depending on what happens in an offering period preceding the auction. Because agents are strictly middlemen and are not allowed to bid in the live auction, they may be able to put in an offering beforehand. In the offering time before the auction, CalPERS officials may decide whether they use an agent or principal for lending.
According to CalPERS officials, the exact details on how the system will work have yet to be finalized because of the complexity of the auction process.
In some cases and with certain types of portfolios, it may make more sense to go with an agency, such as special types of securities such as small-cap equity or international equity, Mr. Kiefer said.
Staff members are debating whether the fund should benchmark how many lending deals are done through principals vs. agents, said Curtis Ishii, senior principal investment officer for the $161 billion pension fund.
The battle line is drawn between the lending portion and collateral portion of the program. CalPERS officials are taking the view that the separation of the collateral reinvestment and the lending process is a good thing.
In the new program, the key is finding the best cash manager, which might not always be the lending provider.
"We believe lending income drives this equation," Mr. Ishii said. In this case, the use of a principal would allow CalPERS to keep all of the lending income.
Other groups in the marketplace believe collateral reinvestment is paramount, he said. This would drive a lender to use an agency instead of a principal because an agency has an easier time putting out collateral, Mr. Ishii said.
State Street and Met West were hired in 1995 to provide international and U.S. government securities lending to CalPERS. In 1996, Met West gained the lending program for domestic equity and corporate bonds.
The auction, meanwhile, will be an interactive bidding process, like that of eBay.
A test is slated for June, with a final version to follow in July.
"We don't know of anyone doing this in this manner," Mr. Ishii said.
Messrs. Ishii and Kiefer are putting their web skills to work alongside the skills of in-house programmers to develop the special auction section of the homepage.
Officials also are looking for help from external firms.
So far, 23 security lending firms are on a target list. The firms make up about 90% of the securities lending industry, Mr. Kiefer said. Between 10 and 12 would be selected to participate in the auction.
Plans are to put domestic equity portfolios on the virtual auction block first in September, with domestic corporate bonds to be auctioned in April 2001, international equity in May 2001, international fixed income in June 2001 and U.S. government securities in July 2001.
As of Dec. 31, CalPERS had $3.6 billion in domestic stocks and bonds on loan; $3.3 billion in U.S. Treasuries; $612 million in international fixed income; and $4.3 billion in international equity.
The bidding part of the website would be open to firms that have been "pre-qualified" by CalPERS to bid on a specific portfolio. Firms eager to qualify may log on to a special information page on the website.
Bidding firms probably would receive a password or PIN to gain access to a password-protected area of the website. They also would receive a bidding number. The managers that offer the best price for a portfolio would be chosen a month after bidding begins.
This bidding process will be conducted at least yearly for each asset class in accordance with CalPERS' staff recommendations. It also is expected that CalPERS will add another staff person fully dedicated to the project in the coming year.
Mr. Ishii hopes the revamped securities program, which includes new collateral reinvestment guidelines, will generate between $10 million and $20 million without much increased risk to CalPERS.
According to those in the securities industry, all eyes likely will be on the new online process.
"I think what CalPERS is doing is on the cutting edge. I'm not sure anyone is going that far on a limb," said Curtis Knight, manager-securities lending at Robert Morris Associates, a Philadelphia-based international association of credit risk professionals that conducts quarterly analysis of the securities lending market.
"I'm very interested to see what they do with this," said Pat Cestaro III, senior managing director at Bear Stearns & Co., New York, which is one of the firms in CalPERS' candidate pool.
Mr. Cestaro doesn't believe the concept of more than one company bidding at a time on the same portfolio is all that innovative, but the idea of offering real-time access to the bids is enticing.
"This is just a little jazzier feature," he said.
Putting portfolio information online also is a good way for CalPERS to gauge interest from prospective bidders, Mr. Cestaro said.