2012 Top International Operations Executives
2012 TOP INTERNATIONAL OPERATIONS EXECUTIVES:
The More Things Change, The More They Stand Out | DIANA CHAN: Shaking Things Up, In European Clearing | CHRIS REMONDI: Increasing Information, Reducing Risk | NEERAJ SAHAI: Marrying Large-Scale Technology With Boutique Service | KEVIN MILNE: Making an Exchange Succeed By Working With Rivals | THOMAS ZEEB: Gold Standard in Securities Processing | CHRISTOPHER JAYNES: Cutting Out the Custodian Bank | PATRICK COLLE: Going Global, But Not Everywhere | TONY FREEMAN: Targeting Two-Day Settlement
CHRISTOPHER JAYNES: Cutting Out the Custodian Bank
December 20, 2011
If a fund manager could eliminate the custodian bank as agent when it lends securities to a broker overnight, would it earn more?
That was a pretty bold question back in 2000. At that time, pension and other plan sponsors simply relied on their fund managers to, in turn, depend on their custodian banks to lend their securities to borrowers. That is to say, brokers dealers. The presumption was that their custodian banks would get them the highest return for those assets.
But for several securities lending executives at an investment management firm, something just didn’t seem right.
“When we were trying to establish a securities lending program for portfolios managed by United Asset Management, we determined that securities lending should be treated as an investment management and trading discipline rather than an operational function as it was viewed at the time,” says Chris Jaynes, who was then senior vice president of that fund manager’s global securities lending unit and is now head of eSecLending, a startup in electronic services for securities lending.
According to Jaynes, many concepts common in the investment management industry were largely absent in the securities lending market. Those were best execution, performance measurement, competition, use of multiple managers and benchmarking. Plan sponsors—the owners of the assets—were simply taking the word of fund managers and custodian banks they were getting the best returns for their assets. Among the largest lending agents are State Street; JP Morgan, Northern Trust and Bank of New York Mellon.
“We discovered there was there was little information on just how well existing providers were performing,” recalls Jaynes who also served as vice president and compliance officer for UAM Trust Company, a subsidiary of United Asset Management.
Jaynes’ various roles at UAM Trust Company gave him a pretty good understanding of what plan sponsors really needed – and were lacking. While at UAM Trust Company, he was part of a group in charge of designing securities lending programs for plan sponsor clients. Jaynes’ and his colleagues’ answer: help create a new firm called eSec Lending that could provide plan sponsors with a lot more say in how their assets are lent than through traditional custodial programs.
eSecLending, which acts as an online securities lending agent and features a proprietary auction process in which the plan sponsor has the ultimate control over just who borrows its assets, what amount of assets and for how much.
Old Mutual, a London and Johannesburg insurance and asset management firm which purchased UAM in 2000 provided an undisclosed amount of seed money. The California Public Employees’ Retirement System (CalPERS), the largest pension plan in the U.S., agreed to become eSecLending’s first client that same year.
In 2006, private equity firm TA Associates and management bought the company from Old Mutual. By that point, eSecLending had already passed $200 billion in lendable assets and would pass the $400 billion mark the following year. As of today, it has auctioned more than $2 trillion of assets for 20 institutional investor clients. In addition to CalPERS, they include the Ohio Public Employees Retirement System, SEI Investments and Schroders Investment Management.
The reason for eSecLending’s durability goes far beyond the good fortune of having parents with deep pockets. eSecLending has made the auction-based model a viable alternative to the traditional custodian bank route to market.
The credit crisis has also helped boost the merits of eSecLending’s approach. Plan sponsors which suffered major financial losses in the cash collateral reinvestment pools during the crisis are becoming more focused on generating returns from lending the securities rather than just the reinvestment of cash collateral. With that, they are increasingly searching for separate, best-in-class providers for custody, securities lending and cash collateral management services, says Jaynes.
Custodian banks are no longer the ustodian banks are no longer the only option. Third-party lending agents such as eSecLending can enter the fray. Here is how its auction-based model works: the owner of the assets or plan sponsor agrees that eSecLending can post the book of assets it wants to lend on a secure website. An approved list of borrowers will be able to participate in the auction and each one will state the amount they wish to pay to borrow a certain segment of that client’s securities. None of the would-be borrowers know the identities of the others.
At the end of a designated period – typically a few hours – eSecLending will collect all of the proposed bids. It will then present them to the beneficial owner, which makes the ultimate decision. That decision will be based not only on the price that is offered but also the plan sponsor’s exposure to a particular dealer and its creditworthiness. Because of the blind nature of the auction process, if a borrower really wants to gain exclusive access to a segment of assets, they are often willing to offer a significant premium for that access.
A U.S. small cap portfolio could garner a bid of 30 basis points. With that bid, the borrower must pay that amount which gives it exclusive access to borrow those assets at any time during an agreed upon term. Within that term, the beneficial owner retains the right to recall securities from loan at any time and the borrower is contractually obligated to return the securities within the standard settlement cycle.
Just how much better is eSecLending’s auction-based model? Jaynes says that it typically outperforms traditional pooled approaches used by custodian banks. The improvement varies depending on the assets involved and the parameters of the securities lending program but Jaynes claims that clients can often see returns increase anywhere from 30 percent to 50 percent.
General collateral securities are the most liquid and cheapest to borrow. Specials are far less liquid so they attract a higher price tag when lending. Custodian banks primarily operate a pooled program in which clients with the most attractive supply of assets – the specials-- often subsidize the returns of clients with less attractive lendable assets or the general collateral ones.
“There is a practice inherent in traditional pooled programs whereby in order for a borrower to receive special securities it must commit to borrowing a certain amount in general collateral or less attractive securities,” Jaynes says. “This reduces the returns on specials as borrowers are not always able to offer their best price when required on a quid-pro-quo to also accept assets for which they have little or no demand.”
eSecLending’s clients don’t rely solely on its auction-based system to lend out their securities. They can also do this through exclusive arrangements with borrowers
The firm also offers “discretionary lending,” in which it actively trades the assets on a daily, best-efforts, non-pooled basis. Some of eSecLending’s clients utilize a multi-provider approach where they also hire their custodian bank as agent for certain portfolios. eSecLending depends on firms such as SunGard Data Systems, Pirum and EquiLend for middle- and back-office services including reconciling the books and records between the borrowers and the lending agents.
Jaynes isn’t concerned about the competition and is glad that technological advancements -- and market conditions -- have now leveled the playing field between custodian banks and other third-party lending agents. "We don't expect all plan sponsors will use an auction but most view the process as a relevant and proven alternative to traditional methods of lending," he says.