First, he states that pension fund trustees may be unaware that their fund managers are lending shares. This is incorrect. An asset manager or custodian bank can only lend securities on behalf of a client if that client has given its authority. Clients will also receive regular reports from their lending agent detailing the lending activity.
Second, he states that shares are being loaned out by banks to hedge funds ‘whose primary aim is then to drive down the price of those shares so that... they are paid back to the pension fund at a lower value’. Hedge funds may sell shares short on the view that prices will fall but this selling does not cause prices to fall. If hedge funds really had magical powers to ‘drive down prices’ they would have an infinite money making machine! Prices fall because of changing views about the fundamental prospects of a company. Academic studies of the recent regulatory bans on short selling have shown that they had no impact on share price movements. Similarly, an individual pension fund’s decision whether or not to lend a share has no affect on its future market price.
Third, he questions why banks borrow gilts and how this affects their regulatory reporting. If a bank gives other securities as collateral in order to borrow gilts, the accounting treatment is to keep the other securities on its balance sheet. So there is no opportunity to hide risky assets from the regulator, as Mr Field suggests. Banks borrow gilts primarily for the purpose of meeting regulatory liquidity requirements and in order to use them as collateral to borrow cash in the gilt repo market. At a time when the government is urging banks to continue lending to creditworthy customers and the FSA is tightening bank liquidity requirements, a liquid gilt lending market is crucial to enable banks to finance their activities.
Fourth, Mr Field states that pension funds are being given collateral that is ‘by definition of less value’ than the lent gilts. This is wrong. Lenders will always take collateral of greater value than the lent securities. Over the past year, this requirement has risen to 105% or even up to 120% of the lent securities, depending on the type of collateral provided. The robustness of these arrangements was demonstrated following the collapse of Lehman, when lenders were able to sell collateral and buy back lent securities in the market at no loss to themselves.
Overall, securities lending offers pension funds a relatively low risk way of gaining additional returns from their securities portfolios. In its recent Discussion Paper on short selling, the Financial Services Authority found ‘no link between negative stock returns and increased levels of stock lending’. A number of academic studies of the recent bans on short selling have found that they had the effect of reducing liquidity and increasing trading costs for investors. For anyone interested in finding out more, ISLA has published a booklet Securities Lending: your questions answered, available at www.isla.co.uk.
Yours sincerely
David Rule
Chief Executive
International Securities Lending Association
