In May 2012, the Mutual Fund Directors Forum and eSecLending issued separate reports providing an overview of securities lending practices and offering guidance on the oversight and implementation of securities lending programs. The MFDF report focused on providing fund boards with guidance on evaluating proposals to implement securities lending programs and overseeing such programs. The eSecLending report focused on providing guidance to fund management for creating, monitoring and managing securities lending programs. The reports included the following guidance:
- Whether a fund can lend securities and the extent to which it may do so should be established in a board-approved securities lending policy. Such a policy may include the objectives of the securities lending program, criteria to determine appropriate borrowers, preferred routes to market (e.g., using a custodian, third party, principal exclusive or other type of model), securities lending restrictions, proxy voting guidelines on loaned securities, collateral guidelines and reinvestment guidelines.
- As part of determining whether to approve a securities lending program, boards should understand the costs and benefits of the program, any tax implications of the program, how collateral received in connection with loaned securities will be invested and what service providers fund management will use to implement the program.
- Boards should also understand the risks of securities lending, such as operational risks, counterparty risks, reinvestment risk, market risk and liquidity risk, among others, as well as the policies and procedures fund management has implemented to identify, monitor and mitigate such risks. Boards should initially approve the contracts with the service providers that will implement and manage the securities lending program.
- Boards should also review the performance and fees of the service providers on an ongoing basis and consider whether the fees remain appropriate in light of the services provided.
- Once a securities lending program is in place, the board, with the assistance of the fund’s chief compliance officer, should review the program on a regular basis. Fund management should regularly provide the board with reports about the securities lending program that include the performance of the program, as well as a review of compliance, risk management, operational information, collateral reinvestment, income earned and performance benchmarking. Fund management should provide the board with market color that discusses the strategies and interest for individual securities and asset classes to enhance the board’s understanding of what is driving the demand for the fund’s securities.
- Fund management should consider forming a working group comprised of management personnel responsible for monitoring the securities lending program and performing due diligence on the service providers.
- When deciding on a specific route to market and which lending agent to use, fund management should conduct proper due diligence, and ensure that the lending agent provides a comprehensive trading strategy for fund securities and that the lending agent understands the fund’s preferences for proxy voting and security restrictions. Fund management should conduct thorough due diligence of a lending agent’s collateral management process.
- Fund management should understand the lending agent’s operational processes around collateralization and what rights the fund will have to the collateral in the event of a borrower default.
The reports are available at the following websites: