Cash Management Questions Continue

The credit-turned-liquidity crisis continues to undermine the market, with a not-unexpected negative impact on securities lending.  I’ve mentioned cash reinvestments in previous posts, and will continue to do so.  My fear is that the fallout from losses - whether absorbed by agents or accepted by beneficial owners - will have a bigger influence on the securities lending business than any other single factor. 

Earlier this week the US Fed announced its Commercial Paper Funding Facility which is designed to help relieve the freeze in the money markets and free up liquidity.  GE, the biggest issue of commercial paper in the US has subsequently announced its intention to participate in the program. 

I noted recently that one lender had notified clients of the potential for in-specie return of collateral to beneficial owners under certain circumstances and I have to admit to being surprised.  Looks like I shouldn’t have been.  I have been hearing all week that this practice has become more common in recent months. 

The overwhelming, vast majority of assets in the reinvestment programs will mature and satisfy their initial investment criteria.  The problem is the wider market.  Any sales from reinvestments are done in a market that doesn’t want to buy any paper, from anybody, except at fire-sales prices.  Losses generated from such sales, as well as defaulted paper have led to more reports over the past few days about institutions suing agent lenders.  Let me first say that I don’t know any specifics of any of the situations other than what I read in the press. 

In any case, there are a number of questions that come to mind when assessing the merits of any claims:

• Were the clients of the securities lending programs aware that the investments were made at their risk?
• Did the clients approve the reinvestment criteria?
• Were the investments made by the agent in line with the client approved criteria?
• What processes and procedures were followed in disposing of any assets that were as a result of client withdrawals or borrowers returning stocks?
• How were any assets in default handled?
• Did clients and agents discuss the impact of forced sales of collateral?

In the mid-90s there were some losses suffered as a result of cash collateral reinvestments.  These issues brought the subject of cash reinvestment risk front and center in the minds of beneficial owners and lenders.  That sparked debate, discussions, program reviews and no doubt a number of changes.  This is not a new subject and the majority of clients in programs today were probably lending back then.   Then, like now, many assets that were loss-generating on a mark-to-market basis simply needed to be funded to maturity.

Securities lending remains a low risk business.  The current credit/liquidity/crisis situation we are in is a “once in a hundred year event“, or “once in a lifetime” or “the greatest banking crisis in the history of mankind”.  Take your pick.  This is one of the few businesses that beneficial owners can participate in with such a low likelihood of loss and that generates a positive return even in falling markets. 

My hope is that rational reviews and discussions will prevail over the knee-jerk withdrawals that we have seen in covered in the press.