Netherlands
07 February 2012
Dutch pension funds are scrutinising their securities lending programmes more than ever as a result of economic and regulatory pressures
Image: Shutterstock
Securities lending providers are reporting big changes in the Dutch securities lending market place as a result of the post-Lehman pull back and sovereign debt crisis fallout.
The domestic economy is punctuated by weakening demand as financial turmoil makes investors and consumers more cautious, according to a recent review by the Organisation of Economic Cooperation and Development (OECD). The big concern is that these factors are damaging the solvency of pension funds - possibly the most significant lenders in the Dutch securities lending market.
At the same time, demand to borrow Dutch equities declined over 2011 and currently stands at $6.3 billion, just 10 per cent above the annual low, while average short interest is only 1.8 per cent, according to Data Explorers. The LongShort ratio stands at 11.12, meaning that longs outnumber shorts by just over 11 times.
It is a bit of a muddled picture, but one thing is clear; in a volatile, low interest rate environment, custodians are finding themselves needing to adapt.
In the past few years, KAS Bank has shifted from being a lender only to now becoming a borrower for clients. The market is not at pre-Lehman levels, although slowly and steadily business is coming back and borrowing has become necessary in order to cover the needs of internal clients, explains Beta Steiner, head of securities lending for the custodian.
Steiner started out her career in trading as a market maker in the open outcry pit at the Amsterdam Stock Exchange, which was founded in 1600 and is regarded as the oldest in the world. Shortly after, she moved to securities lending, found it to be a perfect fit and has been with KAS Bank for 11 years. In September 2011, she became the head of the securities lending desk for both equities and fixed income.
KAS Bank’s biggest clients are insurance companies and pension funds while on the borrower side, it deals mostly with banks and brokers. And though the Dutch market is small, clients are some of the largest parties out there, says Steiner. The biggest difference between the Netherlands and other markets such as the UK or Germany is that banks tend not to be as aggressive towards competitors as can be seen in other countries. Because there are not many participants in the Netherlands, KAS Bank has a close relationship with most of them, Steiner notes.
The biggest change since the Lehman crisis and throughout the subsequent European debt crisis has been a greater emphasis on fixed income, she says. As implications of regulations such as Basel III dawn on the industry, fixed income is becoming more important than the equities side of the business, particularly for quality government bonds.
“I think there is going to be even more need for triple-A government bonds and we see opportunity to lend them out on even higher levels than now, but on the challenges side, we see that in general there is going to be less demand for stocks. Of course, being a lender we want to lend out as much as possible. In general, regulations present both opportunities and challenges in terms of business, but they will also provide transparency in the market and I think we can all benefit from that,” Steiner says.
Another notable change is that lenders are becoming more specific about which collateral is acceptable from a narrowing field of choice. In addition, they are scrutinising the costs of business far more.
Prior to Lehman, the securities lending market was far different from the one we see today. In the past borrowers were willing to borrow as much as possible, but now they first look at the costs involved and if it is worthwhile trading them taking the risk involved into consideration. These days, they are very strict on what they would and would not like to trade mostly depending on the yields and costs involved,” says Steiner, adding that another impact on the market has been tax regulations which restrict dividend arbitrage trading. However, short selling bans have not impacted KAS Bank as much because client demand to borrow for reasons outside of short selling remains strong.
Going into 2012, she sees increased costs for trade finance on the back of continuing Basel III regulatory requirements, with fixed income in particular becoming more expensive to borrow.
Specific to the Netherlands, Steiner also mentions that pension funds in general in the market are facing capital ratio requirements that could hit the securities lending industry. Pension funds are required to keep a 105 per cent coverage ratio, but with volatile markets and low interest rates that has been a struggle. Currently pension funds have coverage ratios of between 90 to 130 per cent.
“In a way, that is going to hit securities lending, it all depends on what pension funds will feel is going to be important for them. In general, revenues coming from securities lending is only a tiny part of their business model. Going forward it is a challenge to get them involved whereas they have a lot of other things to focus on at this point besides securities lending,” she says. “For obvious reasons this is a shame to us and the whole lending business, but is understandable from their point of view.”
A spokesman from the Dutch Association of Company Pension Funds explains that funds that were in a position of undercover as a result of the crisis in 2008 had to make a recovery plan in which they make clear how they will get on track to be above 105 per cent again by the end of 2013. Funds that run behind schedule as of the end of 2011 have to announce possible cuts that may take effect in April 2013. The issue is being hotly debated in Parliament.
Pension problems
As in much of the world, the pension fund industry in the Netherlands is facing a squeeze from many sides. Retirees are expected to tap into pension benefits at historic levels but markets continue to slump. As a result, pension funds are challenged to fund liabilities. Moreover, securities lending returns aren’t what they might have been leading up to Lehman’s collapse, explains Christopher Holzwarth, senior managing director and head of global sales at State Street.
Before coming back to Boston, Holzwarth was based in London and responsible for business development in EMEA and Asia Pacific regions. He notes that though geographically the Netherlands is small, the country is home to one of the biggest pension fund industries in the world. Consequently, the Lehman collapse had a dramatic impact on business.
“Pension funds in the Netherlands, because they are so big, have traditionally seen very high returns from securities lending. Since 2008, which was the peak earnings year, returns have deteriorated both because of the state of the market and an increase of risk aversion,” he says, adding that clients may be more comfortable operating a more conservative programme and choosing to forgo the returns they had become accustomed to.
Adding to the squeeze, the dividend arbitrage trade too has narrowed as a result of tax harmonisation rules across Europe and it is expected to continue to shrink to fewer markets, he notes.
Some pension funds are adapting to these challenges by redefining the scope of their operations. One notable shift in the pension fund landscape has been a kind of “rebranding”, Holzwarth explains. Instead of continuing to operate as asset managers for a specific industry sector, they are branching out to become more like traditional asset managers, overseeing not just a pension plan for their own industry but also managing money on behalf of other Dutch pension plans from a different industry sector.
Meanwhile, as operations become more complex and risk averse simultaneously, pension funds which had been running their own securities lending programme are increasingly moving towards outsourcing either some or all of it, he adds.
“There is definitely a view by many of the large plans that because there may have been issues with their in-house lending programmes and issues generally in the market, they may not be best placed to manage this function in-house and might want to look to outsource to the larger providers in the market. They are asking, can this be done more efficiently and effectively while still generating substantial returns?” Holzwarth says.
Outside of the pension world, there are also quite a few large asset managers, such as insurance companies and traditional asset managers, which are also considered progressive and sophisticated investors. Even small and mid-size firms tend to be well versed in the securities lending market.
“Across Europe, we have seen interest in securities lending on the rise again generally. There was a quiet period in 2009 and 2010 when clients were trying to figure out what they wanted to do. They may have scaled back their programme, suspended lending or pulled out of lending completlely, but over the course of 2011 and now into this year, many clients are getting more active again and that holds true for the Dutch market. Whether they are going to outsource it or do some of it themselves, we have seen all of the above,” Holzwarth says.
Fixed income demand?
Though quite a few market participants report a significant increase in demand for fixed income, beneficial owners are struggling to generate enough return to make lending worthwhile in a low interest rate environment, which is likely to continue. Meanwhile, with clients opting out of cash collateral or being conservative in how they will reinvest cash collateral, spreads are limited.
“It is sort of a mixed bag of what is going on in the fixed income markets. The bigger piece of it is that many clients aren’t lending because it is harder to generate a return in these markets than it has been traditionally. The optimistic outlook is that when interest rates change it will pick up again,” he says.
The flipside is that for certain markets in Europe, due to instability and volatility, some government bonds are highly desirable to borrow depending on the investment objectives of the fund. The other demand factor could be a flight to quality, though Holzwarth does not see this happening at the same fever pitch observed after the Lehman collapse.
Equity markets continue to remain stable and clients are still seeing good returns, even with a very conservative approach to collateral management, Holzwarth adds.
The domestic economy is punctuated by weakening demand as financial turmoil makes investors and consumers more cautious, according to a recent review by the Organisation of Economic Cooperation and Development (OECD). The big concern is that these factors are damaging the solvency of pension funds - possibly the most significant lenders in the Dutch securities lending market.
At the same time, demand to borrow Dutch equities declined over 2011 and currently stands at $6.3 billion, just 10 per cent above the annual low, while average short interest is only 1.8 per cent, according to Data Explorers. The LongShort ratio stands at 11.12, meaning that longs outnumber shorts by just over 11 times.
It is a bit of a muddled picture, but one thing is clear; in a volatile, low interest rate environment, custodians are finding themselves needing to adapt.
In the past few years, KAS Bank has shifted from being a lender only to now becoming a borrower for clients. The market is not at pre-Lehman levels, although slowly and steadily business is coming back and borrowing has become necessary in order to cover the needs of internal clients, explains Beta Steiner, head of securities lending for the custodian.
Steiner started out her career in trading as a market maker in the open outcry pit at the Amsterdam Stock Exchange, which was founded in 1600 and is regarded as the oldest in the world. Shortly after, she moved to securities lending, found it to be a perfect fit and has been with KAS Bank for 11 years. In September 2011, she became the head of the securities lending desk for both equities and fixed income.
KAS Bank’s biggest clients are insurance companies and pension funds while on the borrower side, it deals mostly with banks and brokers. And though the Dutch market is small, clients are some of the largest parties out there, says Steiner. The biggest difference between the Netherlands and other markets such as the UK or Germany is that banks tend not to be as aggressive towards competitors as can be seen in other countries. Because there are not many participants in the Netherlands, KAS Bank has a close relationship with most of them, Steiner notes.
The biggest change since the Lehman crisis and throughout the subsequent European debt crisis has been a greater emphasis on fixed income, she says. As implications of regulations such as Basel III dawn on the industry, fixed income is becoming more important than the equities side of the business, particularly for quality government bonds.
“I think there is going to be even more need for triple-A government bonds and we see opportunity to lend them out on even higher levels than now, but on the challenges side, we see that in general there is going to be less demand for stocks. Of course, being a lender we want to lend out as much as possible. In general, regulations present both opportunities and challenges in terms of business, but they will also provide transparency in the market and I think we can all benefit from that,” Steiner says.
Another notable change is that lenders are becoming more specific about which collateral is acceptable from a narrowing field of choice. In addition, they are scrutinising the costs of business far more.
Prior to Lehman, the securities lending market was far different from the one we see today. In the past borrowers were willing to borrow as much as possible, but now they first look at the costs involved and if it is worthwhile trading them taking the risk involved into consideration. These days, they are very strict on what they would and would not like to trade mostly depending on the yields and costs involved,” says Steiner, adding that another impact on the market has been tax regulations which restrict dividend arbitrage trading. However, short selling bans have not impacted KAS Bank as much because client demand to borrow for reasons outside of short selling remains strong.
Going into 2012, she sees increased costs for trade finance on the back of continuing Basel III regulatory requirements, with fixed income in particular becoming more expensive to borrow.
Specific to the Netherlands, Steiner also mentions that pension funds in general in the market are facing capital ratio requirements that could hit the securities lending industry. Pension funds are required to keep a 105 per cent coverage ratio, but with volatile markets and low interest rates that has been a struggle. Currently pension funds have coverage ratios of between 90 to 130 per cent.
“In a way, that is going to hit securities lending, it all depends on what pension funds will feel is going to be important for them. In general, revenues coming from securities lending is only a tiny part of their business model. Going forward it is a challenge to get them involved whereas they have a lot of other things to focus on at this point besides securities lending,” she says. “For obvious reasons this is a shame to us and the whole lending business, but is understandable from their point of view.”
A spokesman from the Dutch Association of Company Pension Funds explains that funds that were in a position of undercover as a result of the crisis in 2008 had to make a recovery plan in which they make clear how they will get on track to be above 105 per cent again by the end of 2013. Funds that run behind schedule as of the end of 2011 have to announce possible cuts that may take effect in April 2013. The issue is being hotly debated in Parliament.
Pension problems
As in much of the world, the pension fund industry in the Netherlands is facing a squeeze from many sides. Retirees are expected to tap into pension benefits at historic levels but markets continue to slump. As a result, pension funds are challenged to fund liabilities. Moreover, securities lending returns aren’t what they might have been leading up to Lehman’s collapse, explains Christopher Holzwarth, senior managing director and head of global sales at State Street.
Before coming back to Boston, Holzwarth was based in London and responsible for business development in EMEA and Asia Pacific regions. He notes that though geographically the Netherlands is small, the country is home to one of the biggest pension fund industries in the world. Consequently, the Lehman collapse had a dramatic impact on business.
“Pension funds in the Netherlands, because they are so big, have traditionally seen very high returns from securities lending. Since 2008, which was the peak earnings year, returns have deteriorated both because of the state of the market and an increase of risk aversion,” he says, adding that clients may be more comfortable operating a more conservative programme and choosing to forgo the returns they had become accustomed to.
Adding to the squeeze, the dividend arbitrage trade too has narrowed as a result of tax harmonisation rules across Europe and it is expected to continue to shrink to fewer markets, he notes.
Some pension funds are adapting to these challenges by redefining the scope of their operations. One notable shift in the pension fund landscape has been a kind of “rebranding”, Holzwarth explains. Instead of continuing to operate as asset managers for a specific industry sector, they are branching out to become more like traditional asset managers, overseeing not just a pension plan for their own industry but also managing money on behalf of other Dutch pension plans from a different industry sector.
Meanwhile, as operations become more complex and risk averse simultaneously, pension funds which had been running their own securities lending programme are increasingly moving towards outsourcing either some or all of it, he adds.
“There is definitely a view by many of the large plans that because there may have been issues with their in-house lending programmes and issues generally in the market, they may not be best placed to manage this function in-house and might want to look to outsource to the larger providers in the market. They are asking, can this be done more efficiently and effectively while still generating substantial returns?” Holzwarth says.
Outside of the pension world, there are also quite a few large asset managers, such as insurance companies and traditional asset managers, which are also considered progressive and sophisticated investors. Even small and mid-size firms tend to be well versed in the securities lending market.
“Across Europe, we have seen interest in securities lending on the rise again generally. There was a quiet period in 2009 and 2010 when clients were trying to figure out what they wanted to do. They may have scaled back their programme, suspended lending or pulled out of lending completlely, but over the course of 2011 and now into this year, many clients are getting more active again and that holds true for the Dutch market. Whether they are going to outsource it or do some of it themselves, we have seen all of the above,” Holzwarth says.
Fixed income demand?
Though quite a few market participants report a significant increase in demand for fixed income, beneficial owners are struggling to generate enough return to make lending worthwhile in a low interest rate environment, which is likely to continue. Meanwhile, with clients opting out of cash collateral or being conservative in how they will reinvest cash collateral, spreads are limited.
“It is sort of a mixed bag of what is going on in the fixed income markets. The bigger piece of it is that many clients aren’t lending because it is harder to generate a return in these markets than it has been traditionally. The optimistic outlook is that when interest rates change it will pick up again,” he says.
The flipside is that for certain markets in Europe, due to instability and volatility, some government bonds are highly desirable to borrow depending on the investment objectives of the fund. The other demand factor could be a flight to quality, though Holzwarth does not see this happening at the same fever pitch observed after the Lehman collapse.
Equity markets continue to remain stable and clients are still seeing good returns, even with a very conservative approach to collateral management, Holzwarth adds.
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
