Maximizing returns through securities lending, regardless of markets

In securities lending, the lender transfers securities from his or her portfolio to a borrower, or counterparty, who in return pays a lending fee. The borrower also furnishes collateral which is greater than the underlying and which minimizes the risk of the securities lending. The fees from securities lending flow into the portfolio as extra returns, boosting the overall return without restricting availability. When yields on bond markets are low or equity markets erratic, these earnings prove especially valuable given the unchanged costs and performance pressure.

In broad principle and depending on the type of collateral there are two sub-markets: one for general collateral and one for special collateral. The first focuses on the quality of the asset classes rather than on certain securities. Accordingly, the fees that can be generated on this market are lower than on the market for specials where the spotlight is on specific assets: for example, a lender can generate fees of up to 20 basis points for German sovereign bonds which are greatly sought after at the moment.

KAGplus is a system of Clearstream Banking Frankfurt which was developed especially for securities lending of separated trust assets. It is ideal for starters. The separated trust assets contract a counterparty directly from its list of brokers. Metzler Bank uses KAGplus for the processing and realization. Clearstream handles the entire collateral management, including the margining. The collateral demanded by KAGplus is defined in the collateral matrix of Deutsche Börse which itself offers additional guarantees. In recognition of the safety of the processes, the Federal Financial Supervisory Office (BaFin) certified Clearstream Banking Frankfurt as an "organized system". The decisive advantage of this classification is that, in theory, up to 100% of the fund assets can be assigned to a borrower and not just 10%

KAGplus is used at Metzler Bank and has proven to be safe and simple. The market penetration of the system and number of borrowers is permanently rising; Clearstream is currently examining the possibilities of expanding the system internationaly.

The second alternative is a bilateral contractual relationship between the separated trust assets and selected counterparties on the securities lending market. Metzler Bank handles the collateral management, contract initiation and negotiation and the fee management. The advantages of bilateral lending over the KAGplus version are the reduced cost and that the current volume of assets is higher as more securities are permitted.

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This article appeared in Metzler Portfolio Insight – the magazine for the institutional investor, published by Metzler Asset Management, 4th Quarter 2010.