Netherlands
30 November 2010
As one of the most advanced securities lending markets in Europe, the Netherlands has faced the downturn better than most. But there’s still some work to do before it returns to its peak.
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The Dutch equity market is currently the fifth-largest in Europe, some achievement for a relatively small country. But it’s not surprising; as one of the world’s most advanced countries when it comes to pension funds, there is a huge amount of investment opportunity.
However, there have been significant changes since the start of the financial crisis. By the end of 2008, many money market funds were reporting losses on securities lending collateral of at least EUR10 million, with rumours that some had lost considerably more. While some funds threatened legal action or provider change, some of the service providers went the extra mile to help the market. Northern Trust, for example, came up with strategies to help clients whose assets were invested in certain instruments that had been affected by the turmoil.
But no-one was unhurt. The Netherlands saw an almost total lack of liquidity across all asset classes, and a complete loss of confidence in the financial markets in general, with securities lending hit hard.
Over the last couple of years, however, the market has begun to recover. The Netherlands has always been thought of as a relatively stable jurisdiction, and while there were losses at the start of the downturn, investors are making a cautious return.
Regulation
Short selling became a major issue, at least in the eyes of those who didn’t understand its benefits, in the early days of the financial crisis. As a result, regulators instituted a temporary ban, which was repealed from June 1 2009. This, however, was replaced by a temporary rule that required any short positions in Dutch financial institutions to be automatically reported to the Netherlands Authority for Financial Markets (AFM). Market makers are exempt from the rules.
The AFM also tightened up the rules on many financial transactions that, while generally not directly aimed at the securities lending market, certainly had an impact.
2009 was relatively quiet, but increased dividend activity - particularly from Royal Dutch Shell - and some takeover speculation has increased the opportunities in the market.
Confidence
According to Data Explorers, the strength of securities lending within the country is also pretty good, with supply outweighing demand in the Netherlands by a factor of seven, compared to a European average of nine. But education remains an issue.
“We have a lot of pension funds in the Netherlands, and many of them are not of a large size,” says one prime broker in the country. “They are naturally quite conservative in the sense they don’t like to work in areas they don’t fully understand. And because securities lending is a relatively small part of their business, they haven’t taken the time to get a real knowledge of it. If
we want more firms to participate in securities lending, we need to get them to know more about it.”
The market is dominated by the global oil giant Royal Dutch Shell, but there are other firms that are seeing interest from securities lending participants. Crucell NV, a pharmaceutical firm, faced a takeover bid earlier this year, leading to a flurry of activity, while banking group BinckBank and construction firm BAM Groep are also popular.
However, not everyone remains so confident. Stichting Pensioenfonds Vopak, a hybrid DC/DB pension fund with assets of around EUR 630 million, continued to transact securities lending deals throughout the crisis, but has recently pulled out.
“We had been undertaking securities lending for around 10 years before we stopped it in August,” says Cees Blokzijl, pensions director at the fund, speaking to IPE. “Over a decade ago it was brought to us as an additional return without risk. Of course, the financial crisis showed that risks are involved, but 10 years ago they were very limited.
“The last tranche of securities lending in our passive mandate has just ended. Our euro equities contained some restrictions, meaning we were not able to get rid of the securities lending within that portfolio. But our passive asset manager lifted those restrictions and as a result we terminated securities lending.
“However, that does not mean that we are not going to undertake securities lending again. We will probably look at it from another perspective though, particularly with regard to risk management.
“There is no guarantee that we will enter the market again but it will probably be a discussion point in the investment proposal for 2011.
“While the passive asset manager was responsible for securities lending in our passive mandates, our former fiduciary manager undertook the lending programme in our active portfolio. We used to lend both equities and bonds – we had a long bond portfolio, which we used for securities lending, as well as our equity portfolio in Europe and North America. The amount that could be lent was at the discretion of the fiduciary manager.
“The securities lending programme in our active portfolio stopped when we changed our fiduciary manager in spring 2009.
“We were not affected by negative returns with respect to securities lending. All our collateral was very well placed, posted daily and we therefore did not lose any money with our securities lending. Nevertheless, the risks that popped up during the crisis made us review it. Before we enter the market again we will now have to have the full picture about the risks and how we are going to manage them.
“A lot of Dutch funds used to have a securities lending programme but have re-evaluated it – and many of them, like us, have downgraded or stopped it altogether.”
These comments have been backed up by research from J.P. Morgan, which was looking at the role of the custodian in the Dutch funds market. The survey found that 84 per cent of the pension funds canvassed either did not participate in securities lending at all, or have recently stopped lending securities.
There were three reasons for this, says J.P. Morgan’s Roel van de Wiel: “First, some participants have suffered significant collateral shortfall without any proper indemnification policy in place from their securities lending provider when lending fixed income securities and accepting equities as collateral. Some securities lending providers have made their clients whole for this collateral shortfall. This has put pressure on the financial stability of some local custodians with securities lending programmes and some of the survey participants have indicated that they will not reenter such programmes.
“The second reason is exposure to securities lending related commingled cash collateral reinvestment vehicles, which has led to significant and unexpected unrealised losses due to investments in instruments that were not well understood in terms of risks. Some pension funds believe that switching custodians or securities lending provider in the short term is not possible without realising these losses.
“The final reason is the unforeseen risk related to allowing an external investment manager to execute securities lending from their investment pools without clear and communicated securities lending guidelines — including the lack of indemnification against any potential collateral shortfall.
“Respondents have also indicated that there are many misconceptions harboured by their investment committees and boards of trustees about the role of securities lending in modern capital markets and how to overcome and mitigate the associated risks. Some of them believe securities lending providers should reeducate the market.”
The future
With such a large pension fund pool of assets, the securities lending market in the Netherlands should have a positive future. But as in much of the rest of the world, education about how the system works is vital if the assets available is to grow.
The Netherlands has long been a popular destination for international players, with hedge funds keeping a watching eye. It’s been punching above its weight for many years, and is likely to continue to do so.
However, there have been significant changes since the start of the financial crisis. By the end of 2008, many money market funds were reporting losses on securities lending collateral of at least EUR10 million, with rumours that some had lost considerably more. While some funds threatened legal action or provider change, some of the service providers went the extra mile to help the market. Northern Trust, for example, came up with strategies to help clients whose assets were invested in certain instruments that had been affected by the turmoil.
But no-one was unhurt. The Netherlands saw an almost total lack of liquidity across all asset classes, and a complete loss of confidence in the financial markets in general, with securities lending hit hard.
Over the last couple of years, however, the market has begun to recover. The Netherlands has always been thought of as a relatively stable jurisdiction, and while there were losses at the start of the downturn, investors are making a cautious return.
Regulation
Short selling became a major issue, at least in the eyes of those who didn’t understand its benefits, in the early days of the financial crisis. As a result, regulators instituted a temporary ban, which was repealed from June 1 2009. This, however, was replaced by a temporary rule that required any short positions in Dutch financial institutions to be automatically reported to the Netherlands Authority for Financial Markets (AFM). Market makers are exempt from the rules.
The AFM also tightened up the rules on many financial transactions that, while generally not directly aimed at the securities lending market, certainly had an impact.
2009 was relatively quiet, but increased dividend activity - particularly from Royal Dutch Shell - and some takeover speculation has increased the opportunities in the market.
Confidence
According to Data Explorers, the strength of securities lending within the country is also pretty good, with supply outweighing demand in the Netherlands by a factor of seven, compared to a European average of nine. But education remains an issue.
“We have a lot of pension funds in the Netherlands, and many of them are not of a large size,” says one prime broker in the country. “They are naturally quite conservative in the sense they don’t like to work in areas they don’t fully understand. And because securities lending is a relatively small part of their business, they haven’t taken the time to get a real knowledge of it. If
we want more firms to participate in securities lending, we need to get them to know more about it.”
The market is dominated by the global oil giant Royal Dutch Shell, but there are other firms that are seeing interest from securities lending participants. Crucell NV, a pharmaceutical firm, faced a takeover bid earlier this year, leading to a flurry of activity, while banking group BinckBank and construction firm BAM Groep are also popular.
However, not everyone remains so confident. Stichting Pensioenfonds Vopak, a hybrid DC/DB pension fund with assets of around EUR 630 million, continued to transact securities lending deals throughout the crisis, but has recently pulled out.
“We had been undertaking securities lending for around 10 years before we stopped it in August,” says Cees Blokzijl, pensions director at the fund, speaking to IPE. “Over a decade ago it was brought to us as an additional return without risk. Of course, the financial crisis showed that risks are involved, but 10 years ago they were very limited.
“The last tranche of securities lending in our passive mandate has just ended. Our euro equities contained some restrictions, meaning we were not able to get rid of the securities lending within that portfolio. But our passive asset manager lifted those restrictions and as a result we terminated securities lending.
“However, that does not mean that we are not going to undertake securities lending again. We will probably look at it from another perspective though, particularly with regard to risk management.
“There is no guarantee that we will enter the market again but it will probably be a discussion point in the investment proposal for 2011.
“While the passive asset manager was responsible for securities lending in our passive mandates, our former fiduciary manager undertook the lending programme in our active portfolio. We used to lend both equities and bonds – we had a long bond portfolio, which we used for securities lending, as well as our equity portfolio in Europe and North America. The amount that could be lent was at the discretion of the fiduciary manager.
“The securities lending programme in our active portfolio stopped when we changed our fiduciary manager in spring 2009.
“We were not affected by negative returns with respect to securities lending. All our collateral was very well placed, posted daily and we therefore did not lose any money with our securities lending. Nevertheless, the risks that popped up during the crisis made us review it. Before we enter the market again we will now have to have the full picture about the risks and how we are going to manage them.
“A lot of Dutch funds used to have a securities lending programme but have re-evaluated it – and many of them, like us, have downgraded or stopped it altogether.”
These comments have been backed up by research from J.P. Morgan, which was looking at the role of the custodian in the Dutch funds market. The survey found that 84 per cent of the pension funds canvassed either did not participate in securities lending at all, or have recently stopped lending securities.
There were three reasons for this, says J.P. Morgan’s Roel van de Wiel: “First, some participants have suffered significant collateral shortfall without any proper indemnification policy in place from their securities lending provider when lending fixed income securities and accepting equities as collateral. Some securities lending providers have made their clients whole for this collateral shortfall. This has put pressure on the financial stability of some local custodians with securities lending programmes and some of the survey participants have indicated that they will not reenter such programmes.
“The second reason is exposure to securities lending related commingled cash collateral reinvestment vehicles, which has led to significant and unexpected unrealised losses due to investments in instruments that were not well understood in terms of risks. Some pension funds believe that switching custodians or securities lending provider in the short term is not possible without realising these losses.
“The final reason is the unforeseen risk related to allowing an external investment manager to execute securities lending from their investment pools without clear and communicated securities lending guidelines — including the lack of indemnification against any potential collateral shortfall.
“Respondents have also indicated that there are many misconceptions harboured by their investment committees and boards of trustees about the role of securities lending in modern capital markets and how to overcome and mitigate the associated risks. Some of them believe securities lending providers should reeducate the market.”
The future
With such a large pension fund pool of assets, the securities lending market in the Netherlands should have a positive future. But as in much of the rest of the world, education about how the system works is vital if the assets available is to grow.
The Netherlands has long been a popular destination for international players, with hedge funds keeping a watching eye. It’s been punching above its weight for many years, and is likely to continue to do so.
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