The Securities Lending Program performed well during 2015, earning over $85.4 million. The program has averaged over $100 million in earnings during the past five calendar years. Program earnings continue to be a steady source of incremental income, generating over $1.44 billion for CalSTRS since its inception in 1988, adding, on average, over four basis points annually to the total portfolio.
The Securities Lending markets experienced a slight decline in lendable assets over the past year after a trend of increases since the financial crisis in 2008. Program earnings decreased year over year by $6 million. The drop in earnings was attributable to several factors: lower demand to borrow individual securities with large return spreads “super specials”, an overall reduction of general collateral (non-special) trades, more restrictive dealer balance sheets given new and pending regulations and an overall decline in dividend related trades in the international equity market.
These headwinds were somewhat mitigated by a decrease in the overall supply of lendable assets which provided more opportunities for increased spread as well as cash collateral yields rising, which was the result of the Federal Reserve forecasting a normalization in rates. Staff is looking at the risk/reward opportunities of increasing the program’s exposure to non-cash collateral given its increased utilization in the marketplace.
The regulatory environment for Securities Lending continues to remain uncertain. Ongoing implementation and finalization of Dodd/Frank legislation, Volcker Rule, BASEL III and repo regulations could potentially limit the amount of activity that lending agents can engage with their counterparties as well as the type of lendable assets they are willing to borrow. Lending agents are experiencing increasing cost pressures to indemnify their lending clients as a result of these regulations. Fortunately, at this time these cost pressures are mainly impacting smaller plans and not large entities like CalSTRS. Central Counterparties (CCPs) are continuing to be viewed as a possible alternative to help reduce counterparty and indemnification risk exposures. Staff continues to evaluate the ramifications of these potential rule changes to the program.
The common theme throughout the Investment Branch Business Plans for this year has been to apply the core mission: “Path to the Future 2020 Vision.” The program sought to accomplish this by continuing to implement the Securities Lending Request for Proposal process to refresh our lending agents and create a lending agent pool. While Credit Suisse made the decision to exit the Securities Lending space during the year, staff continues to work on updating contracts and finalizing the allocation of available securities with its current lending agents and two new additional lending agents.
This annual report represents a review of CalSTRS’ Securities Lending Program for the calendar year ending December 31, 2015, along with any important updates subsequent to that period. Included is an overview of the program, the income earned compared to each of the previous years and an analysis of the performance of each of the cash collateral portfolios.
Glenn Hosokawa, CFA,
Director of Fixed Income
Chief Investment Officer
December 31, 2015