Asset manager BlackRock has said that it is providing an increasing number of indemnifications to securities lending clients to cover the risk of borrower default. The move is likely to raise the costs of the firm’s lending programme, while also raising questions over whether asset managers should have to hold more capital.
In a typical securities lending transaction the lender of securities takes collateral from the borrower, with the collateral exceeding the value of the loaned securities by a set margin.
Despite the “secured” nature of the loan, a loss under a securities lending programme could happen if a borrower defaulted and the value of the collateral failed to cover the value of the loaned securities. This could occur, for example, following a borrower default and as a result of market movements affecting both the value of the collateral and the value of the assets originally loaned out. Without an indemnity, an investor in the fund lending the securities would bear the loss.
As at the date of its latest 10-Q statement, September 30 2012, BlackRock says it was indemnifying certain securities lending clients against potential losses from borrower default, covering total loan balances of $40 billion. A 10-Q is a mandatory quarterly report filed by US-listed companies to the country’s securities regulator, the Securities and Exchange Commission (SEC).
BlackRock acts as the lending agent for its securities lending clients, while the asset manager’s parent company, BlackRock Inc., is also the firm offering the indemnity to clients.
In a presentation issued to European professional investors in May last year, the firm made it clear that it indemnifies certain securities lending clients only against borrower default, not against possible losses incurred as a result of the reinvestment of cash collateral.
According to a report published by consultancy Finadium in 2011, most of the losses incurred by securities lending clients in the 2007-09 financial crisis occurred as a result of mistakes made by those investing cash collateral, rather than as a result of any shortfall in the value of collateral held against loans.
BlackRock said in its September 10-Q that it’s likely to increase the scope of its securities lending indemnity programme.
After the firm bought Barclays’ fund management business, BGI, in 2009, Barclays agreed to indemnify certain of BlackRock’s securities lending clients for a transitional period, which has just ended. As a result, BlackRock will be indemnifying a number of clients itself in future.
But the firm is now also offering indemnities to new categories of clients as a matter of course. BlackRock confirmed to IndexUniverse.eu that it is now indemnifying all its European ETF clients against potential securities lending losses, for example.
The firm declined to comment on the current value of securities loan balances under indemnification, saying that it only publishes such information quarterly and with a lag.