Indemnification can no longer be ignored, the conversation continues

Hi, friends. Welcome back to another episode of Peer Connections, the podcast series brought to you by the Global Peer Financing Association, also known as GPFA. These podcasts offer our GPFA members and global beneficial owner friends a forum for information sharing and discussion on topics most important to them. And we hope you, our listeners, appreciate the insights, best practices, and transparency offered from our members and industry friends about securities, finance, or related investment areas. Now let's get into the episode. Welcome back to the Peer Connections Podcast, part of the GPFA. We're here today to discuss an extension of the discussion that was started a few weeks back on indemnification. My name is Chris Benesch. I'm a Portfolio Manager here at the State of Wisconsin Investment Board. And joining me today are Matt Burnett from Norges Bank and Jerry May from Ohio PERS. Matt and Jerry, do you guys want to take a minute to introduce yourselves? Sure. Hi, I'm Matt Burnett, Global Head of Financing. We run an unindemnified securities lending program through an agent lender. Hi, I'm Jerry May. I am a Senior Portfolio Manager at Ohio PERS. Our program is run through an agent lender and we do have indemnification. We're involved with not only the lending portion of the program, but we also manage all of the cash collateral as well. Thanks guys. And thanks for joining us today. So this discussion was really prompted in part by a white paper that was released by Mark Faulkner earlier last year called Something Better Changed. Securities lending indemnification is unsustainable in its current form. It's triggered some interesting discussion, I think, amongst beneficial owners, particularly as we saw in the last podcast between Mark and Matt. And I think what we wanted to do was continue to extend that discussion, bring in a few more voices and viewpoints. So thanks for being here today. Maybe by way of introduction, I just wanted to touch briefly on what we mean by indemnification in this context. So in a securities lending transaction, I think as many of you know, there is a situation that may occur where a borrower may fail to return the securities that they have borrowed. And if that were to happen and the collateral that's being held is insufficient, oftentimes the agent will step up and indemnify that transaction and make the lender whole. And that's what we're really talking about here when we talk about indemnification and what might be changing in the industry. In the last podcast, Matt, you talked a lot about your view and your relationship to indemnification. And maybe just by way of recapping a little bit, you could share a little bit more, Matt, about how you guys view indemnification, how you use it today. Yeah, sure. Thanks, Chris. So I'll try not to repeat myself too much here and try to touch on a few different points. But one thing is I think there's some principles that we thought about along the way. And when I say along the way, this is a process that takes time to go from an indemnified program to being comfortable to managing risk yourself. The first is that the agent lenders indemnification or their balance sheet may get in the way of your own strategy. So an agent lender has to find trades and risk that works for all of their clients, not just you yourself. So that's something to consider and something we considered. And it's also worth thinking about what is indemnification actually worth? So when we took this conversation, it was more of most of the agents are banks and most of your counterparties are banks. So the credit quality of your agent lender and their ability to indemnify you is probably pretty highly correlated with the borrowers they're looking to indemnify. So one of the things is if you are indemnified, it may be worth assessing your agent's ability to cover that indemnification. How much are they indemnifying? I think is a fair question. What types of trades are they indemnifying outside of you? So beyond putting in analytics, databases, trading competency, et cetera, there's a few things that sort of have to scope how you think about risk rather than just how do you transact when that default does happen. One of our core principles was we didn't want to outsource risk management. And that carries forward to this day when we think about things like CCPs, et cetera, but we'll save that conversation for another time. But critically, even if there are very few defaults in this industry, there's still a lot of decisions that you have to make.