Some pension funds ended their securities lending programmes due to increased risk aversion in the post-crisis period. While some globally have resumed their programmes, especially in the US, Lee is sceptical about UK schemes returning to the market.
“I have not heard many schemes say that they are now comfortable and would like to go back to the market,” he said.
Some pension funds are concerned that some of the risks associated with their programmes were not fully apparent to them ahead of the credit crisis and there is no clear way of managing some of these risks, according to Lee.
Lee said that if the securities lending industry wants to encourage pension funds to return, it needs to do a better job of convincing them that risks are effectively managed and that compensation is sufficient to justify sacrificing the liquidity.
“A lot of pension funds came to the conclusion that the money they were being paid to give up their liquidity was not sufficient to justify it.”
The NAPF does not have a standard policy with regards to securities lending but the association continues to support its members in this area.
Another challenge to involvement in securities lending is the increasing amount of illiquid assets that pension funds hold in their portfolios, including investment in infrastructure.
"One option might be for the NAPF to work with government and asset managers to create liquid vehicles that allow funds to invest in tradable securities that ultimately represent illiquid underlying assets," Lee said.
"Alternatively, the NAPF could work with regulators and the government to relax some of the constraints to enable more direct investment in illiquid assets.”
The trend towards illiquid assets is a response to the desire of pension funds to match their assets to their liabilities, which are promises to pay scheme members pensions often extending into the distant future.
Lee said: “This means a shift away from traditional asset classes, particularly a shift away from equities. In some ways, therefore, securities lending becomes a bit less relevant.”
Pension funds typically lend equities whereas fixed income lending is comparatively smaller, although this area is growing.
Another factor limiting pension schemes’ involvement is a requirement for over-the-counter (OTC) derivatives to be centrally cleared, in the European Market Infrastructure Regulation (Emir).
Pension funds use derivatives to mitigate risks such as inflation and their members’ longevity. Such contracts must be collateralised with assets such as UK government gilts and, said Lee, the new obligation is significant and expensive.
As these assets are tied up collateralising derivatives, they are unavailable to be used in securities lending. Collateral held at CCPs cannot be used in other financial transactions.
“It is another way in which assets are locked up and which takes away liquidity from pension funds,” said Lee.