Several news outlets have reported that BlackRock has stepped-up their indemnification offering to securities lending clients. The headlines might just as well have been “BlackRock becomes shadow bank.” We take a look at what the news is saying.
Indemnification is a hot topic in the sec lending world and the debate on how much capital it attracts is ongoing. Banks argue that since the deals are over-collateralized, that they don’t need extra capital; and if they did need capital is certainly isn’t much. Making indemnification expensive to the offering banks by increasing the capital needed could result in the business becoming altogether uneconomic; banks aren’t going to want to absorb the cost, beneficial owners don’t want to pay for it. Regulators are still mulling it over, but the optics of giving regulatory relief is tough. You can argue all you want that the problems in securities lending were entirely about cash reinvestment; indemnification wasn’t part of the issue (except for those clients who did not understand the fine print and perhaps thought their cash reinvest was indemnified). But indemnifications and the capital they attract are still on the regulators “to do” list.
From a January 15, 2013 article in indexuniverse.eu, “…But while offering insurance policies for securities lending clients suggests that capital is at risk, at present there’s no regulatory requirement for asset managers to put aside reserves when doing this, said one observer…” and “…In a public policy statement issued in May last year, the co-heads of BlackRock’s cash and securities lending businesses, Rich Hoerner and Simon Mendelson, stated that ‘indemnification does cover a real risk and therefore comes at a cost to provide which must necessarily be reflected in lending agent fees.'”
Looking at the most recent BlackRock 10-Q, it appears that when BlackRock bought Barclays Global Investors (BGI), Barclays continued to be responsible for the sec lending indemnifications. But on December 1, 2012 that stopped and it was now on BlackRock’s dime. As of September 31, 2012, BlackRock had $98.1 billion of securities on loan that were subject to indemnification, of which $58.1 billion were part of the BGI pool (and presumably Barclays risk). Saying that BlackRock has barreled into sec lending indemnification when in reality it is driven by the expiration of the Barclays wrap is a bit disingenuous. But it may be a distinction without a difference. If BlackRock absorbed all the indemnification risk when the Barclays deal expired, their indemnification portfolio more than doubled and that raises eyebrows.
From the 10-Q
“… The amount of securities on loan as of September 30, 2012 and December 31, 2011 and subject to indemnification was $98.1 billion and $60.4 billion, respectively. The Company held, as agent, cash and securities totaling $102.9 billion and $62.2 billion as collateral for indemnified securities on loan at September 30, 2012 and December 31, 2011, respectively. As part of the Barclays Global Investors (“BGI”) acquisition, Barclays is contractually obligated to continue providing counterparty default indemnification to certain BlackRock securities lending clients through December 1, 2012. As of September 30, 2012 and December 31, 2011, $58.1 billion and $57.9 billion, respectively, of the on loan balances of those BlackRock clients subject to indemnification were indemnified by Barclays. BlackRock intends to assume these indemnification obligations prior to or upon the expiration of Barclays’ indemnification obligation. As of September 30, 2012, the Company indemnified certain of its clients for loan balances of approximately $40.0 billion…”
The nastiest thing you can say to a financial institution these days is calling it a shadow bank. It is shorthand for unregulated, opaque, and susceptible. We hesitate to put BlackRock into that same category in general. The definition of shadow banking is providing maturity or credit mismatch products without regulation and while indemnification creates an exposure and securities lending is in the shadow banking world, that doesn’t mean that BlackRock as a whole should get the press treatment it has recently seen. The one thing for sure is that competitors in securities lending from the regulated world are going to be unhappy to see BlackRock on their turf without the same regulatory and capital requirements.
A link to the September BlackRock 10-Q is here.
A link to the article in indexuniverse.eu on BlackRock is here.