Earlier today one of the GSL journalists sent me an email entitled “Big Seclending News” and referred to an article in today’s FT. I am really lucky as I am now editor in chief of Global Securities Lending magazine (www.gsl.tv) and we have had people digging into the story all day long. Now back in my office, I thought I would give you my personal views.
Norma Cohen, the FT article’s author advised us that the UK Pensions Regulator is urging retirement scheme trustees to review their stock lending arrangements. Nothing wrong with that, trustees are required to know what is happening with the assets they oversee and they should maintain stringent controls on the safety of the funds.
However the regulator’s advice seems to have arisen as a result of information it had received from a member of the UK Parliament, Frank Field. I checked out his blog which raised the issue yesterday.Early on in his post Mr Field raises the spectre of Robert Maxwell employing stock lending and the negative impact on the Maxwell pension funds. Just to clarify, Maxwell did those movements of securities without collateral and without an agreement. That is more appropriately called “fraud” not “stock lending”. That’s like referring to the Madoff scandal as “fund management” instead of fraud.
Now to the meat of his article. Frank Field alleges that “a medium size pension fund that was using a high street bank as the custodian for its pension funds” and that bank was lending “both shares and gilts owned by this pension fund” without the knowledge of the Trustees. He goes further to suggest that the collateral was “gilts from third-world countries which, while they had the nominal value of the UK gilts, would have proved almost valueless had the bank gone under and the pension fund tried to sell the replacement assets.” Mr Field also writes the fund was earning miniscule amounts of money quoting “a return of £900 in every £1M pounds lent” and that he believed that the bank was pocketing practically the whole of the fee it gained from lending out the pension fund shares.
Wow! That’s a pretty heavyweight set of allegations and it raises some interesting questions that we can now examine.
Was the pension fund lending activity being carried out directly as part of the fund, or was the fund part of a pooled pension fund? If part of a pool, then the pooled fund documentation should have made it clear that it would engage in lending. If the pension fund didn’t want to be part of the lending business it should not become part of the pool. By agreeing to be invest in the pool, the pension fund would have been deemed to accept the terms and conditions outlined by the fund including lending. No specific Trustee approval of lending would be sought or required.
If the pension fund was acting as a stand-alone fund and not part of a pool, then the question is simple: “Did the Trustees allow its custodian to lend out the pension fund’s assets?” A simple Yes or No will suffice. If yes, then skip to the further points below. If no, then why was the custodian lending the assets? The only time that I have ever come across anything remotely similar is where an institution is a creditor of a client and uses that client’s securities in its normal trading operations. Even in this scenario though, there would be documentation in place advising the client of those conditions and setting out the parameters of access and utilisation.
It is a very serious situation if the custodian didn’t have the client’s approval and I suspect there could be a legal case in such a scenario.
Further, if the custodian is using the securities without the client’s permission, and it is trading under the standard industry documentation, it would also likely be in breach of contract with its borrowing counterparties. The warranties given within the document include reference to being duly authorised and empowered to enter into the transactions which would patently not be the case.
Let’s turn to the collateral. I will leave aside the easy cheap shot that given our government debt level, many would consider the UK a third-world country. If the fund had approved the lending activity, it would also have been asked to approve the collateral profile. This is somewhat less clear-cut as some beneficial owners have claimed ignorance and lack of understanding of collateral choices while custodians and other lenders maintain that they expend significant time and energy discussing collateral implications with their clients. Assuming the client said “yes” to lending, did it also approve the collateral profile? (If the fund didn’t say yes, then collateral is irrelevant as it should not be legally exposed to the transaction). If lending was approved, but the collateral profile wasn’t approved, then the custodian has another case to answer and would then appear to be in breach of contract here as well. [There is also a point on the collateral in the event “the bank went under”, but I don’t want to be distracted from the pension fund issues.]
Mr Field’s comments on fees are a bit confusing. If the pension fund hadn’t approved lending, then why did it think it was collecting fees? Surely that should have been an early indicator that something odd was going on. If the pension fund hadn’t approved lending then why are the fees relevant? Moving on from that, the nature of securities lending is that properly conducted, it is a low-risk, low reward business. The fees Mr Fields quotes – 9 basis points – can’t be judged as high, low or somewhere in between without further information on which assets were being loaned out, the collateral being held (third-world gilts being not particularly helpful) and margin levels (the extent to which the collateral held exceeds the value of the securities loaned out). It also doesn’t explain whether the 9 b.p. was before or after the bank’s share.
As an aside, I don’t know how Mr Fields defines high street bank, but given my understanding of the term, there aren’t many that engage in custody for pension funds.
He makes a couple of other allegations, but this post is already about three times as long as the experts say a blog post can be .... so I will come back another day with those items ... and watch for the full story on www.gsl.tv !
PS...These are exactly the sort of questions that we expect Beneficial Owners will be asking at our Nordic Securities Lending Summit next week in Stockholm. It is also why there has been demand for the Securities Lending Seminar I am running the day before the Summit,
