FIS’ David Lewis notes that there are already many fund providers where the fund management fees are low or even zero and where securities lending revenues are used to keep the lights on and the funds managed
Four basis points does not sound like a lot. Four hundredths of one per cent sounds even less. US$10 billion, however, sounds significantly better to many people. In recent years, the securities finance and collateral management industry has made more than US$10 billion for its participants and their clients. It is likely that 2022 will also create revenues north of that important watermark. The basis points figure comes into play when the assets employed to make that revenue are considered. US$10 billion of revenue sounds great, but as a percentage of assets available or employed at, say US$25 trillion, the margins appear paper thin.
Few who are reading this would likely argue that statistics cannot be presented to suit most needs, and these are no different. Many of the available assets in the securities lending markets are rarely if ever lent, bringing into play the concepts of assets that are “actively lendable” etc. Removing those funds or assets that for various reasons never get lent pushes up the yield averages for those that do, brightening results and performance figures. Taking one revenue item and comparing it to the entire pool of assets is a very blunt measure after all, especially considering the almost infinite combination of factors that can affect the lendability of a given asset and the levels of demand in the market for it, many of which are simply out of the sphere of control of lenders and borrowers in the market.
It is more than fair to say that the activity of lending securities has not always been a popular one, particularly in times of financial crisis. The common linkage made between the lending of a security and the shorting of that asset, permitting the short seller to gain as the value of the stock falls, has been debated extensively for decades. Many have even described the practice as immoral and evil (despite their own pension funds benefiting from that very activity) while others are convinced that short selling drives down asset prices rather than fundamentals or wider economic patterns.
One major financial organisation that has taken action to back up such concerns was the Japan-based Government Pension Investment Fund (GPIF). This major fund, with around ¥200,000 billion (US$1.55 trillion) under management according to the latest Q3 2021 performance statement, exited securities lending very publicly in 2019, citing its incompatibility with its long term investment strategies as well as raising the moral flag regarding the support of short selling. Having already restricted lending domestic securities, the 2019 action extended that ban to its non-Japanese fixed income and equity assets. As at Q3 2021, the allocation of funds between the four categories of domestic and international equities and bonds was almost exactly 25 per cent each.
As such, notwithstanding changes since the withdrawal, we can broadly say that GPIF removed some US$750 billion of lendable assets from the international markets. In terms of its domestic holdings, GPIF was a substantial segment of the market with, for example, equity holdings representing close to 40 per cent of the availability. However, in non-domestic markets, their withdrawal will have made less of an impact. Using current valuations, the circa US$750 billion would have represented a fraction under 3 per cent of the lendable pool globally. Isolating fixed income increases that impact to a little over 8 per cent.
It was announced recently that the GPIF has issued a Request for Information (RFI) looking for research into the effect its ban on lending their securities had on the market. Focusing on equities as the larger revenue driver, and not wanting to pre-empt the results of any research that will be commissioned, removing their (on average) 3 per cent holdings would not be likely to have had a measurable impact. For example, non-Japanese equities lent today where utilisation exceeds 97 per cent number just 271, or less than 1 per cent of the market in terms of active securities.
What can be relatively safely predicted as an outcome of the research, should the RFI result in that work being undertaken, is that the GPIF has forgone around three years' return of 4 basis points on US$750 billion, or a total of around US$900 million. To a fund the size of the GPIF, that is a small percentage of course, but that US$900 million is not an insignificant sum and perhaps a large price to pay for the stand it took.
Looking to more recent events, short sellers — and by association securities lending — was back in the spotlight due to the GameStop debacle. Many column inches have been written on the democratisation of finance and specifically the marketplace for trading equities and bonds. Equal access for all, and the erosion of some of the advantages provided by the size of institutional players, has been enabled by the lowering of the barriers to entry. Stock trading apps on your mobile device, combined with fee-free trading facilities, has opened the markets to many more players. However, a pattern that has been seen before is emerging again. While it is laudable to keep lowering the barriers to entry to any free market, nothing is really for free, and the costs of the services provided “free” to the consumer at the point of that consumption do need to be paid for.
Enter fully paid lending. There are already many providers of funds where the fund management fees are either very low or even zero, where securities lending revenues are utilised to keep the lights on, and the funds managed. Newer entrants to the financial services arena that have brought market access to a new group of individual participants are now looking to pay their bills and offer additional incremental income to their clients through a simple check box on their trading app. Sign me up for lending my shares is now as simple as clicking a box on a screen, providing liquidity to the market, income to your pocket and assets to those taking up short positions in the securities you hold.
Standing up for your principles is to be admired, whether you are one of the world’s largest investment funds or an individual amateur trader. But every participant needs to play their part in the market if it is to be truly a free and democratic place — and you may get between a few dollars and a few hundred million dollars a year for your involvement.
