BlackRock has overhauled a small but increasingly important part of its business that is proving popular with banks under pressure from regulators.
The world’s largest asset manager has cut the amount of collateral it requires when it lends equities from its European funds, which experts say is a move to court banks wanting to offload riskier assets from their balance-sheets.
The change will make it cheaper for companies to borrow securities from BlackRock, which, according to industry figures, will make the US giant more competitive in the field of securities lending, where asset managers loan out stocks or bonds from their funds in return for collateral.
BlackRock has also scrapped a 50 per cent limit on securities lending for European-domiciled funds, enabling it to loan out a greater number of stocks or bonds. The investment house, which made $477 million from lending out its clients’ securities last year, says the overhaul comes as part of an ongoing review. It declined to comment on why it was making these changes and whether it hoped to increase revenues generated from stock lending.
The update comes as the International Securities Lending Association (Isla), a trade association for securities lenders, says 1.8 trillion euros of securities were on loan at the end of June, up 100 billion euros on December 2014.
In the wake of the financial crisis, banks have come under much greater regulatory pressure to get higher-risk securities, such as corporate bonds and emerging market equities, off their balance-sheets. The squeeze means banks are trying to borrow high-quality liquid assets, such as government bonds or blue-chip stocks, from asset managers, while offloading their less-liquid securities as collateral.
“Banks that naturally have held assets on their balance-sheets such as equities and corporate bonds are looking at other options now,” says Andrew Dyson, chief operating officer of Isla.
At the same time, asset managers faced with low bond yields are under pressure to find other sources of revenues and returns, making securities lending programmes more attractive, says Dyson. “All lenders of securities are probably looking at securities lending revenues more [now than in the past],” he says.
Ben Seager-Scott, director of investment strategy at Tilney Bestinvest, a UK-based wealth manager, adds: “It is very clear that BlackRock and iShares are keen to revamp their securities lending programme.”
In the past, if a borrower provided equities as collateral, BlackRock required at least 110 per cent of the value of the equities on loan, which is more than the industry average. BlackRock has lowered this to 105 per cent.
Peter Sleep, senior portfolio manager at 7IM, the UK wealth manager, says BlackRock wants a “bigger share of the equity-to-equity business that is around”. “By moving to 105 per cent collateralisation, [BlackRock] can expect to increase its revenues,” he adds.
Questions have been raised in Europe about the money asset managers are making for themselves from securities lending. Under European rules introduced in 2012, income gained from securities lending should be returned to the fund after direct and indirect costs. Companies are allowed to deduct fees for securities lending activities.
Investors and consumer groups are concerned asset managers are not living up to the spirit of the rule. Guillaume Prache, managing director of Better Finance, the investor rights group, and vice-chairman of the financial services user group at the European Securities and Markets Authority, the EU watchdog, says he has raised concerns with Esma about asset managers not returning income to investors. Prache expects “detailed answers” to be provided during a meeting between securities and markets stakeholders and Esma in December.
BlackRock keeps 37.5 per cent of a fund’s securities lending income for every single product in which it carries out stock lending. Globally, the company made $376 million in the first nine months of this year from securities lending, up from $16 million during the same period in 2014.
The fund house’s changes to its securities lending programme have angered some investors, who say BlackRock is taking unnecessary risks with its clients’ resources.
“[BlackRock’s] arguments in favour of these programmes highlight the split of the revenue/profit from these programmes as benefiting end clients and the benefit of providing liquidity to the market,” says Seager-Scott. “While there is some truth to this, I am not convinced the very limited cost reduction is worth the potential counterparty risk.”
The biggest concern with securities lending, according to commentators, is that if a fund loans out a stock to a company and the company goes bankrupt, investors could lose money if the collateral is not of sufficient quality. Sleep says BlackRock’s reduction in collateral requirements when accepting equities for equities exaggerates this issue.
A spokesperson for BlackRock says: “BlackRock continues to select only highly creditworthy borrowers based on conservative credit standards defined by our risk team, which operates independently from our securities lending business.”
The fund house also provides an indemnity to cover losses linked to securities lending. Since it started its securities lending programme in 1982, BlackRock says only three borrowers with active loans have defaulted and no investors lost money.
But Dyson believes asset managers need to examine any collateral they accept carefully. “Clearly if you are lending out a particular asset class or asset category that is high quality and taking back something that is regarded as riskier or lower quality, you need to think about the risk profile of that,” he says.
BlackRock says the overhaul of its securities lending programme is good news for investors. The changes to its collateral requirements are “designed to enable clients to benefit from additional securities lending returns in funds where there is more borrowing demand”, a spokesperson adds.
Europe’s watchdog is facing calls to launch an investigation into whether asset managers are complying with securities lending rules, amid fears that fund houses are hoarding investors’ money for themselves.
Many mutual funds and exchange traded funds engage in securities lending, where they loan out stocks and bonds in return for collateral, allowing the funds to make a profit on securities that would otherwise sit idle.
— Financial Times
