Pension funds play a vital role in the financial markets, both in terms of liquidity, and providing stability. The maturing nature of pensions is a factor that could well impact aspects of the securities finance industry in the years and decades to come.
For Jerry May, senior portfolio manager at Ohio Public Employees Retirement System (OPERS), pensions serve well in the roles for which they have been created 鈥� those roles 鈥減rovide coincident benefits to the securities finance industry鈥�.
Pension funds accumulate capital to be paid out as a pension for employees when they retire. Typically, these funds aggregate large sums of money to be invested into the capital markets, such as stock and bond markets, to generate returns. These entities typically hold high quality assets over a long-term basis.
鈥淲e are long-term investors, and that perspective is important in what has become a short-term focused environment. As long-term investors, we have a stable distribution of assets that we hold, providing a natural partner for prime brokers and others who seek that type of supply,鈥� says May.
Pension funds tend to be very high-quality counterparties from a risk perspective. According to May, most pensions do not have to deal with balance sheet restrictions that banks and brokers must manage. 鈥淎s each of these is considered, it becomes apparent why pension funds are important participants in this industry.鈥�
Enhancing performance
OPERS has been developing its securities lending programme over the past two decades, to facilitate the financing of assets and to invest in short-term markets.
Promoting itself as the largest pension fund in the state of Ohio, the entity was established to provide retirement, disability, and survivor benefits to Ohio's public employees. Its securities lending programme looks to incorporate best practices from many facets of the industry and apply them to its functional internal framework.
May joined the pension fund two decades ago to manage cash and securities lending, with responsibilities transitioning from the daily oversight of investing and lending to overseeing the team that is now doing this on a daily basis.
鈥淥ur team is accountable for the success we鈥檝e seen over the last 20 years of activity here at OPERS. We continue to think of new ways to do things and to look for paths that may be outside the traditional structure of securities lending and cash management,鈥� says May.
When he joined the pension fund, May recalls how the lending programme was diversified across a number of agent and custodial providers and had been put together in 鈥渁 piecemeal fashion鈥� over the preceding years. May鈥檚 first goal was to enhance the performance of the lending programme and to ascertain whether any efficiencies could be achieved through consolidation.
In the first step of this development journey, OPERS began to manage cash in-house. Using internal OPERS cash, the pension fund eventually incorporated cash collateral from securities lending. eSecLending was subsequently hired as a new lending agent to manage the lending of OPERS鈥檚 US equity assets, and to maximise the returns through an auction programme.
For May, the concept of competition was the foundation of improving the performance of the lending programme. Along the way, OPERS began hiring human resources to support the cash and lending changes that were taking place.
Yet again engaging in a partnership with eSecLending, OPERS鈥檚 next major change involved the securities lending trading of its own US Treasuries and mortgage-backed securities (MBS), which was supported by eSecLending鈥檚 middle and back office capabilities.
With OPERS acting as the trading desk and eSecLending providing the legal and operations functions, May says the set up provided a 鈥渇oundational hallmark鈥� of the securities lending programme 鈥� managing the asset-and-liability aspects of the programme in an 鈥渙ptimal manner鈥�.
Benefiting the beneficial owner
鈥淲here the past saw securities lending as a way to pay expenses, today鈥檚 more sophisticated beneficial owners are realising the potential and importance of having an effective securities finance programme married to advanced cash management options and collateral management tools,鈥� states May.
Securities lending programmes can be a low-risk way for beneficial owners to generate additional income to their plans. The risk tolerance of the individual plan would determine how much profit that might be, as well as the risk taken to generate it.
This view is perhaps enough for many beneficial owners who engage in securities lending.
May interjects: 鈥淚 do believe that sophisticated plans with resources that can be allocated to securities finance and cash management are viewing the potential for their programmes to be more than that. That鈥檚 one of the main ways that I鈥檝e seen the beneficial owner community advance over the last several years.鈥�
As the securities lending landscape continues to evolve, there are now ways to incorporate derivatives into securities lending trading. Doing so in a competent manner can boost returns and mitigate risk, May explains. In addition, there are aspects of optimising the management of collateral that can now be included in securities finance considerations. OPERS says enhancing cash management to efficiently establish and manage an asset/liability model is another way that several plans are now contemplating.
Exploring opportunities in non-traditional counterparties is an avenue that participants are taking note of. May pinpoints that some industry players are advancing a transformation in their approach to leverage by incorporating securities lending in that discussion. While others are asking how securities lending, collateral management and cash investing can become integral parts of an effective risk-management effort.
Significance of securities lending
Reviewing the key trends in the securities lending sector over the past year, May names regulatory changes as 鈥渙ne of the most significant concerns鈥� to many investors and beneficial owners.
He continues: 鈥淏alancing the oversight necessary for well-functioning markets with a proper degree of having free markets is a very important, yet difficult, line that regulators are walking. Watching how those developments take place, and the potential impacts that may occur on plans like ours, has certainly been growing in consequence.鈥�
These regulatory developments continue to make efficient balance sheet management for banks and brokers a pivotal issue, agrees May.
In terms of trends, there also remains interest from investors in the potential for peer-to-peer interactions, including education, trading, and resource management practices.
Aside from his role at OPERS, May is also a board member at the Global Peer Financing Association (GPFA), a non-profit industry association with over 35 global asset owners. The association was started around a common opportunity in the market, which was to promote the education and adoption of peer-to-peer (P2P) trading in the marketplace.
GPFA brings together members with the goal of encouraging the development of a more effective and transparent marketplace for securities financing activities, liquidity management and collateral management. It was officially incorporated as a business association in 2020 by four pension plans 鈥� California Public Employees' Retirement System (CalPERS), Healthcare of Ontario Pension Plan (HOOPP), OPERS, and State of Wisconsin Investment Board (SWIB).
As P2P lending continues to develop and grow in importance for the industry, May says this practice should not and will not take the place of traditional lending counterparties. However, he highlights the significance of P2P lending as an avenue for diversification and risk mitigation for which 鈥渕ore beneficial owners are becoming aware鈥�.
As trading strategies for beneficial owners become more complex 鈥� such as long-short strategies, hedging and derivatives trading 鈥� being able to source assets is becoming more important. Moreover, as it becomes increasingly difficult to outperform or positively differentiate oneself from a benchmark index on a consistent basis, having a stable source of alpha that produces every year is a key consideration.
鈥淭hese concepts point to the significance of securities finance and cash management. Having a diversified source for these strategies becomes paramount to managing risk in a prudent manner,鈥� May explains.
He also believes that while the beneficial owner community 鈥渕ay be slow in espousing change鈥�, it is not one that is incapable of adjustment. OPERS says it sees a number of plans move down the pathways described to arrive at places that have not traditionally been occupied by their organisations. This 鈥渟low pacing鈥� is simply another way for plans to control risk while expanding capabilities.
Resource allocation is a key metric in how rapidly plans can move along that continuum. May suspects it will continue to do so with quickening speed, as innovators among that community prove the concepts that others then adopt.
Over the next year, OPERS will continue to review developments in the regulatory environment, monitor the economic markets and their impacts on the portfolios, and seek partnerships and counsel from others who may be able to help drive the pension fund toward optimal ways of managing the risk and return in its programme.
In conclusion, May says: 鈥淚 know it sounds trite, but our team is focused on doing the best we can for our pensioners each day. When we take our eyes off that goal there is a danger that we confuse the reason why we are here. Having this noble mission, to help pensioners, keeps us grounded and hungry to do the best we can. Innovation and performance spring from that foundation.鈥�
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Image: Jerry May 