Transparency in programme performance
02 September 2014
Beneficial owners continue to return to the securities finance market following the financial crisis. But they do so with more demands for transparency than ever before, says Chris Benedict of DataLend
Image: Shutterstock
In the past few years, securities finance has seen the return of many beneficial owners that had suspended their programmes in the aftermath of the 2008 financial crisis. Prior to the crisis, beneficial owners had enjoyed the rewards of additional income from securities finance programmes with very little perceived risk. Now, as beneficial owners return to the market, they do so with risk management and performance benchmarking in mind.
Risk mitigation is manifested in lending restrictions, the types of non-cash collateral a beneficial owner will accept, what kinds of cash reinvestment vehicles they will allow, and the duration and credit quality of the cash reinvestment. Prior to 2008, many beneficial owners left these decisions up to their agent lenders. These days, beneficial owners are more aware of potential risks and are more questioning of not only how securities finance drives revenue, but where those revenues originate.
The increased beneficial owner involvement and scrutiny has led to an evolution in beneficial owner benchmark performance reporting. Beneficial owners want to understand how well their agent lender is doing for them in the securities finance space—not just against the securities finance market as a whole, but against a peer group sample that is as close to their funds as possible. As a result, the need for securities finance reporting engines to find the best possible peer matches for a client across the tens of thousands of funds participating in lending programmes globally is almost as critical as the calculations producing those benchmarks.
Some of these matching criteria are pretty easy to satisfy. Because of tax issues, beneficial owners will want to compare their performance against funds sharing the same fiscal location. Likewise, they want to compare themselves against funds with the same legal structure. For example, a pension plan is likely going to have more conservative holdings and more conservative lending restrictions than, say, a mutual fund. Beyond that, finding a statistically significant peer group match for a client is a considerable task.
It is not enough to simply say a beneficial owner accepts cash or non-cash collateral. The yield on cash reinvestment can vary widely based on what a beneficial owner allows its cash collateral to be reinvested in. For instance, the yield on cash reinvestment in overnight US treasury repo is going to be different than corporate debt. However, cash reinvestment revenue is usually a separate line item within a performance report, allowing agent lenders and beneficial owners to concentrate on performance and revenue from securities finance activities across asset classes, markets and sectors. A far more nebulous challenge exists in the form of determining how different types of non-cash collateral may impact performance metrics.
Lenders will typically charge higher fees to a broker-dealer pledging riskier non-cash collateral. Those extra basis points can add up to quite a difference in revenue figures over time. Understanding how non-cash collateral plays a role in performance is a virtually untapped opportunity in the current state of beneficial owner reporting. Currently, it is difficult for agent lenders to provide granular non-cash collateral reporting at the transaction level. This is usually because collateral data is housed in systems separate from transaction and inventory management platforms. Collateral substitutions by triparty agents are another challenge.
As a result, data providers infer a ‘risk hierarchy’ of non-cash collateral in an effort to differentiate beneficial owner performance. For example, one Irish UCITS fund may only accept highly rated sovereign debt, while another might take riskier A-rated corporate bonds, or even high-grade equities. Because their non-cash collateral risk profiles are so different, comparing their performance against one another might not be ideal as the UCITS fund accepting corporate bonds may tend to outperform the more conservative peer.
As the securities finance industry continues to evolve as a result of technology and regulations, agent lenders should endeavor to incorporate more specific non-cash collateral details at the transaction level. These details could then be stored by data providers over time to create a more accurate collateral profile for each beneficial owner. Instead of having to deduce what a beneficial owner accepts as non-cash collateral, a data provider would have a much more accurate view of what a beneficial owner is actually accepting as non-cash collateral and be able to determine potential differences in fee premiums from one type of non-cash collateral to another. This would result in more accurate peer group matching, better performance benchmarking and additional risk management benefits for beneficial owners and the securities finance industry.
Thankfully, today’s improving technology allows for increasingly accurate and granular securities finance performance metrics, benefiting both agent lenders and their clients. DataLend’s Client Performance Reporting suite can match up and compare similar beneficial owners based on legal structure, fiscal location, securities in inventory, securities on loan and the even loan duration of those securities for the most possible accurate peer group benchmarking. DataLend can then score underlying beneficial owners against their peers across critical metrics such as fees, utilisation, securities lending return to lendable, cash reinvestment and total revenue.
The final piece of the performance reporting puzzle is more specificity into acceptable forms of non-cash collateral. With the demand for high-grade collateral increasing by the day, more insight into the collateralisation of securities finance trades will benefit not only the underlying principals of those trades but also the securities finance industry as a whole.
When agent lenders are able to supply granular non-cash collateral information in their transaction-level reporting, DataLend is poised to integrate it into our performance metrics.
Risk mitigation is manifested in lending restrictions, the types of non-cash collateral a beneficial owner will accept, what kinds of cash reinvestment vehicles they will allow, and the duration and credit quality of the cash reinvestment. Prior to 2008, many beneficial owners left these decisions up to their agent lenders. These days, beneficial owners are more aware of potential risks and are more questioning of not only how securities finance drives revenue, but where those revenues originate.
The increased beneficial owner involvement and scrutiny has led to an evolution in beneficial owner benchmark performance reporting. Beneficial owners want to understand how well their agent lender is doing for them in the securities finance space—not just against the securities finance market as a whole, but against a peer group sample that is as close to their funds as possible. As a result, the need for securities finance reporting engines to find the best possible peer matches for a client across the tens of thousands of funds participating in lending programmes globally is almost as critical as the calculations producing those benchmarks.
Some of these matching criteria are pretty easy to satisfy. Because of tax issues, beneficial owners will want to compare their performance against funds sharing the same fiscal location. Likewise, they want to compare themselves against funds with the same legal structure. For example, a pension plan is likely going to have more conservative holdings and more conservative lending restrictions than, say, a mutual fund. Beyond that, finding a statistically significant peer group match for a client is a considerable task.
It is not enough to simply say a beneficial owner accepts cash or non-cash collateral. The yield on cash reinvestment can vary widely based on what a beneficial owner allows its cash collateral to be reinvested in. For instance, the yield on cash reinvestment in overnight US treasury repo is going to be different than corporate debt. However, cash reinvestment revenue is usually a separate line item within a performance report, allowing agent lenders and beneficial owners to concentrate on performance and revenue from securities finance activities across asset classes, markets and sectors. A far more nebulous challenge exists in the form of determining how different types of non-cash collateral may impact performance metrics.
Lenders will typically charge higher fees to a broker-dealer pledging riskier non-cash collateral. Those extra basis points can add up to quite a difference in revenue figures over time. Understanding how non-cash collateral plays a role in performance is a virtually untapped opportunity in the current state of beneficial owner reporting. Currently, it is difficult for agent lenders to provide granular non-cash collateral reporting at the transaction level. This is usually because collateral data is housed in systems separate from transaction and inventory management platforms. Collateral substitutions by triparty agents are another challenge.
As a result, data providers infer a ‘risk hierarchy’ of non-cash collateral in an effort to differentiate beneficial owner performance. For example, one Irish UCITS fund may only accept highly rated sovereign debt, while another might take riskier A-rated corporate bonds, or even high-grade equities. Because their non-cash collateral risk profiles are so different, comparing their performance against one another might not be ideal as the UCITS fund accepting corporate bonds may tend to outperform the more conservative peer.
As the securities finance industry continues to evolve as a result of technology and regulations, agent lenders should endeavor to incorporate more specific non-cash collateral details at the transaction level. These details could then be stored by data providers over time to create a more accurate collateral profile for each beneficial owner. Instead of having to deduce what a beneficial owner accepts as non-cash collateral, a data provider would have a much more accurate view of what a beneficial owner is actually accepting as non-cash collateral and be able to determine potential differences in fee premiums from one type of non-cash collateral to another. This would result in more accurate peer group matching, better performance benchmarking and additional risk management benefits for beneficial owners and the securities finance industry.
Thankfully, today’s improving technology allows for increasingly accurate and granular securities finance performance metrics, benefiting both agent lenders and their clients. DataLend’s Client Performance Reporting suite can match up and compare similar beneficial owners based on legal structure, fiscal location, securities in inventory, securities on loan and the even loan duration of those securities for the most possible accurate peer group benchmarking. DataLend can then score underlying beneficial owners against their peers across critical metrics such as fees, utilisation, securities lending return to lendable, cash reinvestment and total revenue.
The final piece of the performance reporting puzzle is more specificity into acceptable forms of non-cash collateral. With the demand for high-grade collateral increasing by the day, more insight into the collateralisation of securities finance trades will benefit not only the underlying principals of those trades but also the securities finance industry as a whole.
When agent lenders are able to supply granular non-cash collateral information in their transaction-level reporting, DataLend is poised to integrate it into our performance metrics.
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