Misguided conclusions: Moody's, AIG and risk in securities lending

Misunderstandings of securities lending extend far and wide in the financial arena. This week’s gaffe award goes to Moody’s Investor Services, who announced this week that AIG’s return to securities lending would be negative for bondholders. What Moody’s is skimming past is that securities lending has little to do with potential risk for bondholders. Rather, it is the cash collateral that really matters.

While Moody’s analyst Laura Bazer highlighted cash collateral worries in her research note as quoted by Bloomberg News, concerns about securities lending get mixed up so profoundly with cash collateral reinvestments that it will take a bullhorn to get the message across: securities lending actually works pretty well and provides some significant benefits to financial markets. If you are worried about the big risk, then look at what happens with the cash collateral.

Put another way, let’s change the topic of conversation away from securities lending to cash collateral reinvestments. That would clear up substantial conceptual, lexical and practical errors and confusions, and place the concerns and potential remedies squarely where they ought to be.

According to Bloomberg:

“SunAmerica’s own securities lending mishap during the AIG financial crisis showed what can happen in a stress situation when things go awry,” Laura Bazer, a Moody’s analyst, said in a note. “The company faced a potential liquidity crisis when the value of its subprime and structured securities lending collateral investments plummeted.”

All true. Bazer did miss the fact that the new AIG securities lending program’s cash collateral will be managed by a third party. I personally would like to know what those holdings are, but a safe bet suggests they fall within 2a-7 money market guidelines.

The response to Bazer’s worry, as well as the concerns of investors worldwide on securities lending, is simple: disclosure on what is held in collateral pools. We at Finadium do this disclosure work for investors, but even without us, generating a readily available list of collateral investments and posting it on a website is not that hard. Check out the many derivative-backed ETF providers in Europe who have managed to figure out a way to provide data to investors on at least a monthly basis.

If AIG wants to reduce the concerns of the Moody’s and others in the world with uncertain understandings of the securities lending market, publicizing collateral holdings would be a cost effective step. And Moody’s, please, let’s get straight where the concerns really lie.

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