May 2010
Realizing value in asset servicing
Memories of the credit crisis will not fade quickly. Events in 2008 shook the financial system to its core and have raised fundamental questions about the ability of market participants to quantify, predict, and control risk.
Pension funds are now repositioning themselves to reduce risk and volatility and sponsors are seeking to insulate themselves from market shocks in the future. Asset servicing providers (commonly known as custodians) are well-positioned to assist pension funds in this process, by offering:
- Greater insight into a fund’s investment performance and risk
- Services to monitor investment mandate compliance
- Transparency and return enhancement opportunities n securities lending
De-risking Plans
Pension funds are also repositioning themselves or the future by taking another look at their long-term investment strategies. Shifts in asset allocation will bring some important asset servicing implications.
For instance, if a fund changes investment managers, pension funds can reduce trading costs and operational risk by using a transition management service. Certain transition managers can also help funds when they need to liquidate pools of distressed securities or achieve synthetic exposure to a market when an outright sale is impractical.
Pension funds will also make greater use of derivatives and alternative investments as they manage volatility and seek non-correlated market returns. Asset servicing providers are developing new capabilities that can help them control counter-party and other operational risks in derivative transactions.
Unfortunately, the demand for stronger governance is driving up administrative complexity at a time when pension funds face intense cost sensitivity. After all, pension fund executives are making crucial investment decisions and need to reduce their administrative workload.
Asset servicing providers are in a good position to help pension funds owing to their sustained focus on operational excellence, processing scale, and continuous investment in best-in-class systems. There is much discussion about impending regulatory change in the wake of the credit crisis and this will also increase workloads for pension funds.
Pension funds can assess their provider’s ability to respond to regulatory change by investigating how they are responding to changes such as IFRS. Asset servicing providers are stepping up to support pension funds as they seek a new balance of risk and return. The industry is increasingly supporting entry into new asset classes, controlling administrative costs, optimizing returns, and providing insightful analysis.
As they seek to enhance returns, funds need providers that can help them administer and monitor all asset classes including alternatives. They must also actively monitor and maximize their available cash resources by looking for real-time cash reporting or other tools that help them manage cash.
They are also looking to protect themselves against currency risks by hiring overlay managers or by entrusting the administration of these programs to their asset servicing provider.
Securities Lending Turns Corner
In 2008, there was uncertainty and loss throughout the securities and investment industry. At the time, securities lending garnered some negative attention through the temporary (and possibly misdiagnosed) restrictions on short selling and the Lehman Brothers bankruptcy that triggered the industry’s first borrower default.
By contrast, 2009 brought a growing sense of confidence in securities lending. It had proven itself to be a professional, secure, and well-managed industry which is dedicated to enhancing transparency for sponsors. There were two key developments:
- The industry formed the Canadian Securities Lending Association (CASLA) to advocate for industry participants including pension funds. CASLA’s mission is to enhance transparency, promote awareness of the benefits of securities lending, ensure a secure and efficient marketplace, and promote greater cooperation between market participants and regulators.
- In its December 2009 Financial System Review, the Bank of Canada identified securities lending as a small but important “core funding market.” As such, it provides “essential funding liquidity to financial institutions and market-makers, the key providers of liquidity to the financial system.”
Shining A Light
Transparency in securities lending is crucial as pension sponsors manage enterprise- wide risk. They must have open communication with their agent lenders to fully understand how the program is managed for value creation and risk reduction.
We predict that the use of cash collateral will grow in Canada in coming years as sponsors seek greater returns. Although cash collateral is relatively new to many Canadian plans, it is the most popular form of collateral used around the world.
Cash collateral provides sponsors with opportunities to earn incremental income, beyond the intrinsic value of each loan, through reinvestment of cash collateral. Pension funds should look for conservatively managed programs, with strong risk management practices and a strong performance track-record throughout the credit crisis.
Pension funds are working very closely with their corporate parents, investment managers, and consultants to help them solve long-term strategic issues and to deliver against the growing liabilities of an aging workforce. Asset servicing providers are valuable partners that are helping pension funds to reduce the noise generated by greater administration, control operational risk and cost, and meet their long-term growth objectives.
By David S. Linds, senior vice president, business development and client relationship management
* Reprinted with permission from Benefits & Pensions Monitor, February edition
* * *
Trade Talk® is provided for general information purposes only and CIBC Mellon Global Securities Services Company, CIBC Mellon Trust Company, CIBC, The Bank of New York Mellon Corporation and their affiliates make no representations or warranties as to its accuracy or completeness. Readers should be aware the content of this publication should not be regarded as legal, tax, accounting, investment, financial or other professional advice nor is it intended for such use.
To print the entire newsletter, download PDF version.