The topic is a very controversial one given that while it is deemed essential by most beneficial owners involved in securities lending, there are concerns that future capital rules will increase the costs of agent lenders providing the service. Dodd-Frank section 165(e) will increase the amount of capital banks will have to put up to provide indemnification, a cost that could be passed onto beneficial owners.
Charles Rizzo, chief financial officer, John Hancock Investments, said the question of whether his firm can live without indemnification is “probably a non-starter”. “It is probably something we wouldn’t be willing to go without,” he added.
Rizzo said that one benefit of indemnification is that the programme risks at a fund level are “well-aligned” with the risks of lending agents, particularly relating to transactions with counterparties and volume of loans to particular borrowers.
“In that sense it serves as good mitigation process and control for funds that lend.”
Although Rizzo’s point of view tends to reflect that of most beneficial owners, Brian Yeazel, managing director, fixed income, Mason Street Advisors, questioned the value of indemnification.
“It’s important to show the board you’re doing something about risk but I wonder how much that indemnification is really worth at the end of the day.”
Yeazel said it is important to look at where risk lies in a lending programme, and he estimates that around 90-95% of risk is born from reinvestment of collateral. Programmes blown up in the past 20 to 30 years have been almost exclusively due to problems with collateral pools or cash reinvestment, he explained.
James Vance, vice president and treasurer, Western & Southern Financial Group – which runs an insurance programme, a mutual fund programme, and a pension fund programme – said indemnification is “extremely important and something our finance committee looks at”.
Christine Bosco, trader, Franklin Templeton, said although she acknowledges there is an argument that one can survive without indemnification, there are still some unanswered questions around the consequences of doing so.
“How would an unindemnified programme impact your recall process or even corporate action process? There are certain things outside default guarantee that also sit with indemnification that we would also want to consider before we consider an unindemnified programme.”