The biggest institutional investors in Asia, including central banks and sovereign wealth funds (SWFs), are starting to unbundle securities lending from custody, creating a new business opportunity for some providers, says Paul Wilson, managing director for financing and markets products at JP Morgan in London.
He is visiting institutional clients in Asia, Japan and Australia, and says the conversations are similar to those in the US and Europe several years ago.
"Securities lending has gone from the back office to becoming a front-office overlay investment-management business," Wilson says. "When that happens, sophisticated clients will ask whether their custodian is the right provider, and unbundle the sec-lending buying decision."
In the wake of the global financial crisis, this decision is not about finding a provider that can provide higher returns -- it's more about culture and risk management.
"When you buy a securities-lending programme, you need three things," Wilson says. "Risk management, customisation and operational efficiency. Securities lending is not the tail wagging the dog: it's meant to be a low-risk venture, at the end of the investment chain."
This means unbundling needs to be seamless. The biggest hurdle to such decisions is getting the operational side right -- in other words, deciding that the extra connectivity and layers of decision-making is worth the bother. Interest rates are so low today that reinvesting securities isn't returning an attractive yield.
Unbundling moves may, therefore, not increase until US interest rates rise -- an event that most market participants believe won't happen at least for a year or two. (The vast majority of sec-lending transactions and collateral arrangements for Asian investors involve US securities, particularly bonds; for Australians, it's more equities-orientated.) The Asia-Pacific sec-lending market is also being hobbled by regulatory uncertainty, particularly in the US.
To unbundle securities lending requires the investment manager to work with the incumbent custodian bank to build the connectivity, implement Swift messaging to communicate available inventory of tradable securities, obtain intra-day updates of client positions, send instructions to the custodian to move securities to a dealer; and information for services such as coupon collection, paying fees and handling corporate actions.
The obvious catch is getting the incumbent custodian to cooperate. Custodians may not be happy to do so, considering they are being asked to facilitate the departure of a sec-lending programme they previously ran.
Wilson says, however, that Asian SWFs and central banks are such important clients that most custodians will look at the bigger picture and accept their request to unbundle securities lending. He adds that if JP Morgan wins a sec-lending mandate, it will pay the custodian fees for its share of work and service.
Unbundling has been common in the US for 10 years, and more recently in Europe. It has been slower to develop in Asia, partly because the institutions have only recently become sufficiently large and sophisticated, but also because of cultural changes.
"In Asia, relationships used to be for life," Wilson observes. But now, particularly after the collapse of Lehman Brothers in 2008, Asian institutions are willing to change providers or hire specialists. Relationships still count for a lot, but clients are also benchmarking their providers on the basis of revenue and risk.