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A Company That Puts The Client First

July 01, 2012 | Comments: 0 | Views: 149

A few years back securities lending programs made big news in the wake of the credit crisis of 2008. Lending of securities occurs between a lender and a broker-dealer in exchange for cash collateral that can be reinvested to earn income for the lender. The lender also will charge a fixed fee for the lending of the securities. The lending of these securities helps facilitate the practice of "short selling". Short selling occurs when the broker-dealer borrows securities and sells them with the belief that they will be able to buy them back at a lower price.

There are two strategies that securities lending can take; a volume-oriented strategy, or a value- lending strategy. The volume-oriented strategy involves lending out large percentages of easily acquired securities, and investing the collateral in aggressive investment vehicles in order to boost revenues. The aggressive investing is an attempt to make up for the increased rebate rate that is offered to the borrowers. Easy to find securities have higher rebate rates than those securities that are harder to locate because of their lesser demand. The value-lending approach looks to only to lend out those securities that are in higher demand. They can negotiate a lower rebate rate and take a safer investing approach with the cash collateral.

Securities lending was impacted by the credit crisis because the broker-dealers were defaulting on their security loans. When the lenders tried to buy back the securities to make up for these defaults, they did not have enough collateral because in many cases it had been aggressively invested in asset-backed securities, subprime mortgages, and other less-creditworthy securities. These types of investments were hit hard during the economic downturn. The more responsible approach was taken by the Vanguard Group; one of the country's largest mutual fund companies.

Vanguard takes the value-lending approach by lending out many hard-to-borrow securities in an attempt to take advantage of the "scarcity premium". Lending only scarce securities allows Vanguard to see higher returns per dollar of assets lent, and set low-to-negative rebate rates which leads to larger lending revenues. Vanguard also implements risk controls that ensure a successful securities lending program. First, they only lend to a limited number of preapproved broker-dealers that are continuously evaluated by an independent internal credit team. This practice ensures that Vanguard only deals with responsible broker dealers. Second, Vanguard reviews the value of the securities they have lent out so they can maintain the 102% to 105% collateral rates that they charge to borrowers. Vanguard will collect additional collateral if the value of the securities increases in order to maintain the 102% to 105% rate. Third, Vanguard invests its cash collateral in conservative money market investments that earn consistent returns. Furthermore, Vanguard sticks to strict self-guidelines on the total dollar amount that is loaned out to each borrower.

What most sticks out about Vanguards securities lending program is that it works on a zero profit basis. The revenues that are made are put right back into the funds that held the securities after subtracting out the programs costs, agent fees, and any broker rebates. In fact, less than one-half of 1% of the revenue generated from Vanguard's securities lending program is used to pay for the expenses. Other lenders retain up to as much as 50% of their revenue. Vanguard has prided itself on always putting the interest of the shareholder first. By simply covering their fixed and variable costs for the securities lending program, they return all the profits to their shareholders in the form of larger returns. A company that puts its customer first is a hopeful thought coming out of an economic downturn which was basically defined by greed.

Other lenders will have to implement more responsible lending programs if they wish to participate. The Dodd-Frank Act of 2010 called for the SEC to institute new rules on securities lending by July 21, 2012. These rules are designed to allow for more information to be made available to brokers, dealers, and investors regarding the lending of securities. The Financial Industry Regulatory Authority (FINRA) is also considering rules that will better prepare those participating securities lending programs for the risks associated with this type of practice. Let's hope our economy has learned from its prior mistakes and we all become more responsible investors.

Source: EzineArticles
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