From the November 2009 issue of Treasury & Risk magazine

Plan Sponsors Revisit Risks Involved in Securities Lending

Companies that sponsor retirement plans haven't abandoned securities lending on a wholesale basis in the wake of last fall's problems, but many are taking measures to rein in the risks involved.

Securities lending has traditionally been regarded as a safe way to offset some of a pension plan's costs or bolster its returns. After all, when a portfolio lends out securities, usually to a party that is shorting the stock, it receives cash collateral in return. But last fall, as the markets became increasingly illiquid, some companies suffered losses on the investments in which they had placed their collateral, a development that aroused skittishness about the whole practice of securities lending.

Collateral reinvestment losses were the top concern cited by 72 plan sponsors and funds surveyed by investment consulting firm Callan Associates earlier this year. The survey found that nearly 80% of those surveyed were interested in greater disclosure about their lending program's structure and risks, and many were reviewing their programs' investment policies.

Despite the extent of their concerns, only about 25% said they might terminate securities lending altogether. Of the respondents who sponsored defined-benefit plans, 64% said they were considering moving from funds that lend securities to funds that don't lend.

"Non-lending funds are growing very rapidly," says Virgilio Abesamis, a senior vice president who heads Callan's master trust, global custody and securities lending group. "There is a mad dash by mutual fund complexes, index funds, commingled fund providers to offer non-lending equivalents to their fund offerings."

One way plan sponsors can avoid reinvestment risk is to put the collateral into very safe investments, like money market funds. But Abesamis notes that if U.S. interest rates begin to rise rapidly from their current low levels, even money funds will not be immune to losses.

He suggests another way to avoid collateral reinvestment risk: adopting an intrinsic value approach, in which the plan sponsor lends out only the most sought-after securities. Since they earn more from lending out securities that are in higher demand, they can afford to forego the return from investing the collateral, and the risks involved in that. "In an intrinsic-value world, you're seeking just to lend the hot stocks," Abesamis says. "The economics are there."


Rates Inch Lower for Companies

The average rate at which corporations are taxed by countries around the world inched just a bit lower this year, suggesting the decade-long downtrend in corporate rates may be petering out.

Global corporate tax rates averaged 25.5% in 2009, little changed from 25.8% in 2008, according to a survey by KPMG. In 1999, when corporate rates started to fall, the average stood at 32.7%.

KPMG predicts countries will increasingly turn to indirect taxes, which are those levied on products and services, like a value-added tax (VAT), to raise the revenue they need. In recent years, the average global indirect tax rate has hovered in a narrow range between 15% and 16%.

That raises the question of whether the United States, the only Group of 20 nation that doesn't impose a VAT, will join the crowd. In recent months the massive federal budget deficit has led to speculation that Congress might break with tradition and inaugurate a U.S. VAT.


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