This semi-annual update discusses the current market dynamics that are impacting returns and risk in securities lending, State Street Global Advisors’ core views on securities lending programs, and some client perspectives on securities lending.
On the back of a continuing pandemic, more-than-transient inflation, anticipated Fed tightening, and most recently the outbreak of war in Ukraine, market volatility has ramped up since our last update in September of 2021. This volatility is positive for securities lending markets. Since the turn of the year, lendable assets have declined 11%, largely driven by market value declines, while the market value of assets on loan has increased 2.2%. This reflects a reduction in supply and an increase in demand, which has translated to an increase in intrinsic securities lending returns of 13%.1
Reinvestment spreads also picked up since the start of the year. This is attributable to the steepening of the yield curve, which reflects the expected Fed tightening (potentially 6 rate hikes over the next 12 months) as well as the uncertainty in the markets spurred by the Ukraine conflict. While increasing, these yields do not yet reflect stressed market conditions.
And while the Ukraine conflict has certainly roiled markets and increased volatility in recent weeks, there has been relatively little direct impact on lending operations. Sanctions instituted in the wake of the Crimea annexation in 2014 significantly reduced lending activity in Russian securities, and Ukrainian securities never had an active market. We are keeping a close eye on financial market contagion risks that may impact counterparty credit quality; however, to date both capital and liquidity levels across the banking and financial service sector remain strong.
Sticking to our focus on the demand-side value of securities lending, State Street Global Advisors has taken a conservative approach to management of the cash collateral. As the Fed began to transition to a more hawkish monetary policy approach last fall, we began to position the portfolios for potential rate hikes. Expectations for policy adjustment rose dramatically as 2021 concluded. In the early months of 2022 it was thought the Fed could raise rates by as much as 50bps at the March meeting. With this volatility, the portfolios benefited by shortening durations and building liquidity. As the war unfolded, the portfolios further benefited with increased liquidity levels and shorter-term structure. Now, as we embark on a Fed rate hike cycle, the portfolios will be evaluated each Fed meeting date for the appropriate term reinvestment rate. This will reduce the lag in yield after each Fed rate increase, and enable the securities lending programs to continue to focus on optimizing demand-side value capture. Our view is that the demand value for securities loans in the market is an alpha generator for portfolios, while the reinvestment side of the equation has a more marginal risk-return trade-off.
Demand for securities lending programs as a means of generating incremental returns in portfolios continued over the past six months. Both December and January flows into our securities lending funds were at or near record highs. We take this as a validation that, despite the depressed returns from securities lending in 2021, our clients are confident with our intrinsic value approach to lending, that the risks are well managed, and that there continues to be a positive risk-adjusted return for securities lending in general. Our clients are continuing to educate themselves on securities lending, and are becoming more cognizant of the varied approaches that different asset managers employ. We seek to assist our clients in their education, and provide the transparency into our securities lending programs that enable them to evaluate our program effectively. Do not hesitate to reach out to an State Street Global Advisors representative for any questions you have.
1 Per IHS Markit data comparing 01/01/2022 to 03/11/2022.
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The views expressed in this material are the views of the Securities Lending Group as of 17 March 2022 are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. There is no representation nor warranty that such statements are guarantees of any future performance. Actual results or developments may differ materially from the views expressed. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Securities lending programs and the subsequent reinvestment of the posted collateral are subject to a number of risks, including the risk that the value of the investments held in the collateral may decline in value and may at any point be worth less than the original cost of that investment.
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