Fidelity drops Goldman, brings securities lending in-house

As fees on index funds fall, revenue from businesses like stock lending becomes more important to asset managers

May 14, 2019 @ 12:14 pm

By Bloomberg News

Fidelity Investments is cutting out its middleman — Goldman Sachs — when dealing with Wall Street short sellers.

The money manager is bringing its stock-lending business in-house, according to a March 29 regulatory filing, instead of paying Goldman Sachs to run it. According to filings, the bank received about 10% of the revenues generated by Fidelity's lending, primarily to firms that borrow stocks to bet against them.

Fidelity, which managed $2.7 trillion of assets in March, plans to use some of the savings from the switch to boost returns in the funds that lend securities, particularly index trackers that hold thousands of different stocks. The move comes as Fidelity and its rivals compete to cut fees on index funds, luring assets that can be used for more profitable businesses like securities lending, industry analysts say.

"The lower fees go, the more important securities lending revenue becomes," said Stephen Biggar, an Argus Research analyst who tracks financial services companies.

Securities finance is a big business, producing more than $9.9 billion of revenue globally for lenders last year, according to EquiLend, a securities-finance trading and clearing service owned by global financial firms.

Boosting returns

Securities lending plays an essential role on Wall Street. Fund managers, pension plans and insurers — some of the largest players in the market — make their stocks and bonds available to those who want to sell short, avoid a settlement failure or capture an arbitrage opportunity. Hedge funds are a major source of demand.

The borrowers put up cash collateral, which typically exceeds the value of the securities, that lenders reinvest for the life of the loan. The investment gains can go both to the fund that lends the securities, lifting its return, and to the management firm, boosting its revenue, according to a December report by Morningstar Inc.

Fidelity's stock funds mostly invest the cash collateral in a dedicated money market fund, making it a rough yardstick for their total securities lending. At the end of February, the Fidelity Securities Lending Cash Central Fund had net assets of about $18.8 billion.

Fidelity's goal in taking over securities lending is to provide "an even greater benefit" to shareholders, according to a statement from spokeswoman Nicole Abbott. The funds will collect at least 90.1% of the revenue from their lending, compared with the 90% they got when Goldman was the broker, according to Fidelity.

(More: Fidelity launches fund focused on female leadership)

Vanguard, BlackRock

Vanguard Group and BlackRock Inc., the other titans of index funds, already run their own lending operations. Vanguard gives almost all the revenue — 98% — to shareholders, according to Morningstar. At BlackRock, the figure is about 69%. Spokesmen at Vanguard and BlackRock declined to comment.

Investors in the Fidelity Extended Market Index Fund benefited from its lending, which included shares of Tesla Inc., a popular short. The total loans equaled about 14% of the fund's $23 billion of net assets at the end of February, according to a filing. It earned about $27.6 million of lending revenue during its last fiscal year, more than double its expenses.

A representative for Goldman Sachs Bank USA, one of the biggest securities lending agents for mutual funds and insurers, declined to comment. The bank arranges and administers securities loans for mutual funds run by Putnam Investments, Russell Investments and Charles Schwab Corp., among others, according to the most recent filings.

Firms sometimes pay a high price to borrow securities. In addition to putting up collateral, they are charged an interest rate when borrowing stocks in high demand by short sellers.

(More: Fidelity to start trading bitcoin)

Priciest short

Tilray Inc., a Canadian developer of cannabis-based drugs that went public in July at $17 a share, was the most expensive stock to borrow last year, according to IHS Markit. When the shares soared above $200 in late September, firms borrowing the stock paid a daily interest rate of almost 1% on the loan, or more than 300% on an annual basis, said Sam Pierson, IHS Markit's director of securities finance.

Fidelity's brokerage will use automated third-party software to allocate loans to a pre-approved list of borrowers provided by the mutual fund giant, according to the March filing. It also purchased insurance to mitigate risks posed by borrower defaults.

"Only the largest fund complexes typically can support" their own securities lending business, said William Pridmore, a consultant to institutional investors. "It really does take an infrastructure."

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