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San Francisco scraps sec lending

Decision to end securities lending follows a recent review involving consultant Callan

Investment staff at San Francisco City & County Employees’ Retirement System (SFERS) have voted to end the fund’s securities lending programme.

An internal memo, seen by Global Investor/ISF, says stock loan operations will wind down over the next few months as the $20 billion fund switches custodians from Northern Trust to BNY Mellon.  

The pension fund has earned $118 million through securities lending since the program began in 1996. However, securities lending led to $80 million worth of losses for the fund during the financial crisis. 

A recent review, involving consultant Callan, found that SFERS could modify its programme to make it more conservative but doing so would reduce returns to $3 million annually - compared to $4.2 million achieved in 2015.

"Boosting our income from securities lending would require putting more lower quality securities on loan, which increases the risk of incurring a large loss," states the memo, signed by chief investment officer William Coaker.

“We believe the retirement board, staff and our consultants need to focus our time and resources on the aspects of the portfolio with larger risks and expected returns than securities lending, whose risks can occasionally be surprising and whose expected returns are very low."

In addition, the fund noted it has less control of its liquidity due to securities lending, because it is not choosing which securities to lend. 

Investment experts at the fund recommended that securities lending be re-evaluated if short-term interest rates rise to the level seen before the financial crisis.

They added that interest income is a key component of the earnings from securities lending.

Speaking on condition of anonymity, a senior executive working on an agency securities lending desk said the move was unexpected.

"This is a surprise firstly because they went through the effort to hire a very good experienced consultant in Callan and conduct a very thorough search looking at both third party lenders and bundled solutions. 

"Therefore, they already did the heavy lifting and the effort to then implement a new programme which met their new conservative parameters should be relatively quick and straight forward."

In addition, the New York-based individual added that interest rates should not be a huge factor in re-starting a new program. 

"Many pension funds who suffered cash collateral losses during the credit crisis eventually came back but with programmes focusing on intrinsic value lending.

"In fact, many insisted on only non-cash collateral or ultra conservative cash overnight guidelines and in some cases clients even set minimum lending hurdle rates of 100 bps insuring a specials only program."

Another US-based securities finance expert described SEFS' decision as unique and isolated, adding that it goes against the industry trend of increasing participation in securities lending. 

"If anything, we see things going in the opposite direction. Funds that have not lent previously are engaging and expressing interest.

"Opportunistically, with more of a yield curve, it's a good time for clients to be engaged.

"However, it becomes challenging when clients haven’t grown or developed programmes. Invariably they get stagnated and, as a result, are not able to earn the revenue they once did."

This content is provided by Euromoney Seminars for informational purposes only, and it reflects the market and industry conditions and presenter’s opinions and affiliations available at the time of the presentation.