Sovereigns taking closer look at securities lending

Sovereigns taking closer look at securities lending

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Sovereign wealth funds (SWFs) are looking to expand their use of securities lending, a BNY Mellon study claims.

The US custody bank, along with the Official Monetary and Financial Institutions Forum (OMFIF), polled two dozen SWFs with combined assets of $4.7trn.

Seventy-five percent said they are willing to allocate 10 to 15 percent of their assets to securities lending and most expect an additional return of five to eight basis points from doing so.

SWFs have suffered of late from low or negative global interest rates, geo-political tensions, slowing global growth and a slump in commodity prices.

As a result, these large state-owned investment funds appear to be taking a closer look at their portfolios to find intrinsic value.

Liquidity

Besides seeing securities lending as an opportunity to grow returns and reduce costs, sovereigns see themselves as having the ability to "mitigate some of the threat to global liquidity that market participants are facing," according to Hani Kablawi, BNY Mellon's EMEA head of investment services.

Brian Ruane, BNY Mellon executive vice president and chief executive officer of the company's broker-dealer services business, said that increasing sovereign fund participation in securities lending activities would benefit the financial markets by enhancing the liquidity in a wide range of assets.

“Doing so could compensate somewhat for the reduction in market-making activities by banks and broker-dealers," said Ruane, adding that traditional suppliers of liquidity have reduced their activities as a result of increased regulations and central bank policies.

The report notes that regulations such as Basel III implemented after the financial crisis have raised the cost of balance-sheet intensive activities such as securities lending for banks and dealers, leading to greater risk aversion.

It also points to actions taken by central banks that have contributed to lower liquidity such as highly accommodative monetary policy, low interest rates and asset purchase programs.

"The bond buying programs have removed just the type of safe assets that are in high demand, while the demand for these assets has increased significantly," Ruane added.

Sovereigns seeking to increase their capital markets roles need to become more connected with key market participants such as custody banks, central clearing counterparties, and tri-party repo providers, according to the report.

The report also notes that such actions will help the sovereigns overcome challenges regarding counterparty risk, credit risk, collateral risk and cash collateral reinvestment.

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