2. Risk Management
The risks associated with a securities lending program can be complex to identify and measure. Investors should understand and consider three primary types of risk associated with securities lending:
Reinvestment risk derives from the reinvestment of cash collateral received to secure a loan.
Borrower default risk derives from a borrower’s inability to return securities in accordance with agreed terms.
Operational risk derives from the increased transaction volumes and management complexity associated with a lending program.
Questions to ask:
- Do your collateral reinvestment funds adhere to quality, maturity and diversification requirements set forth in Rule 2a-7?
- What are the maximum weighted average life (WAL) and weighted average maturity (WAM), and other liquidity guidelines for the collateral reinvestment pools? What are the credit quality guidelines and permissible instruments for the reinvestment pool?
- Do you accept non-cash collateral? What types of noncash collateral do you accept?
- Is there borrower default indemnification? What entity provides it?
- Do you have dynamic lending limits at the fund and position level? What determines those limits?
There can be significant costs associated with managing a securities lending program, and it is important to understand where the costs are borne, and who is receiving compensation. While the “fee split” is often the headline expense communicated by an investment manager, there are many ways this fee can be calculated.
Additionally, the “fee split” may not be the only expense paid in a lending program. There are often fees embedded within the cash reinvestment pool, or additional operational or administrative fees applied to the program either by the lending agent or the lending fund manager. This all needs to be understood to make an informed decision regarding a securities lending program.
Questions to ask:
What is the fee split with the lending agent? Are there other fees charged to the lending program?
Are all transactional costs borne by the lending agent? Does the lending fund manager charge any additional fees?
What are the total expenses of the cash collateral reinvestment vehicle?
Does the lending fund manager (or an affiliate) benefit from the fees charged to the reinvestment fund?
Are there any conflicts of interest inherent in the lending program?
Please contact us for the full report.