Securities lending initiative by iShares in new quarterly filing

Greater insight into an opaque business

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IShares is to expand the reporting of its securities lending business, allowing investors an insight into a vital activity in global capital markets that remains largely unreported.

The world’s largest ETF manager is to provide regular quarterly updates that will illustrate the key risk parameters for its securities lending activities.

It will also provide some details about the revenues that its exchange traded funds generate from market participants who want to bet that an asset will fall in price.

Securities lending activity has remained extremely opaque even though the market is vast.

A pool of more than $11,000bn of assets is available for securities lending globally with over $1,900bn of assets out on loan every day, according to Data Explorers, the specialist provider of securities financing data.

Asset managers, such as iShares, use securities lending to generate extra revenues by lending out equities or other securities to other institutions who can then use them for hedging or for short-selling.

“Securities lending and short-selling are vital components of well functioning capital markets,” said Stefan Kaiser, director at iShares “It improves liquidity, allows investors to express negative views, helps to prevent asset bubbles and is an important risk-hedging tool.”

The new report shows how revenues from securities lending by iShares are split, with 60 per cent being paid directly to the ETF and 40 per cent being taken by BlackRock, the owner of iShares.

Up to 95 per cent of the net asset value of an ETF can be lent out but iShares’ average loan levels are significantly lower.

So the iShares EURO STOXX 50 ETF (one of the largest in Europe with assets of $5bn at the end of 2010) had an average of 11 per cent and a maximum of 50 per cent of its assets out on loan in the year to September 30.

That lending activity helped the iShares EURO STOXX 50 ETF earn revenues of 28 basis points over that period.

In monetary terms, this ETF generated around $14m in revenue from securities lending.

The new report shows that only 14 iShares ETFs earned meaningful amounts from stock lending, of 15 basis points or more, in the year to September 30.

The biggest earning fund was iShares MSCI Turkey, which generated 93 basis points from securities lending. It had an average of 37 per cent of its assets out on loan, rising to a maximum of 82 per cent, in the year to September 30.

Securities lending activity has attracted greater scrutiny since the financial crisis as the implosion of Lehman Brothers in 2008 led to heightened concerns about counterparty risk.

One of the key risks with securities lending is that a borrower (counterparty) could default on its commitment to return borrowed securities and the value of any collateral might fail to cover the cost of repurchasing the assets lent out.

In order to mitigate this risk, BlackRock has a risk & quantitative analysis (RQA) group that operates independently of the securities lending business.

The job of the RQA group is to select creditworthy borrowers and to determine collateral parameters (how much to ask for as security and to decide how it should be made up from stocks, bonds and other instruments).

Collateral values range between 102.5 per cent and 112 per cent of the value of the loan and both are marked to market daily.

The RQA groups reviews levels of over collateralisation regularly and can increase collateral requirements if markets become more volatile.

The biggest borrowers of assets from iShares are the big investment banks such as Barclays, Citigroup, Credit Suisse, Deutsche Bank and Goldman Sachs.

However, they are not necessarily the end users of the borrowed securities as the investment banks may also lend on these assets to their own clients such as hedge funds.

The new report from iShares could lead to more pressure on swap-based ETF providers to disclose how they benefit from securities lending.

Currently swap-based ETF providers reveal no details as securities lending is carried out by their parent investment bank.

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