Asset consultant Watson Wyatt has recommended that its global clients suspend their securities lending programmes if they have any doubt about their arrangements with lending agents.
In a note to clients this week, the firm said that the risk reward trade off for securities lending had changed, and in some instances, may not even be worthwhile anymore.
Watson Wyatt cited events such as the demise of Lehman Brothers, government restrictions on short selling, and the underperformance of money-market funds in particular for putting pressure on the lending industry.
To identify the potential risks a lending agent might pose, the firm told its clients to research collateral types and amounts, reinvestment guidelines (in the event that cash collateral was taken), counterparty restrictions and any collateral indemnification provisions provided by the lending agent.
If any of these were perceived to carry too much risk, Watson Wyatt suggested that clients should suspend their securities lending programmes immediately, although for some funds with principal losses in their cash collateral or mark-to-market losses related to liquidity, this might incur an exiting cost, unless the lending agent had made a compensatory concession.
Some agents may restrict a wholesale withdrawal from their programs, Watson Wyatt warned.
For some funds, a gradual withdrawal might be more appropriate, but in this event Watson Wyatt recommended funds review their lending guidelines. The firm said it would be prudent to increase collateral requirements, review the list of borrowers, review the indemnification structure, and change the cash collateral reinvestment guidelines.
Funds with non-cash collateralised lending should be able to suspend lending immediately, Watson Wyatt said.
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