Robert Morris Associates is the association of credit and risk management professionals. Its committee on securities lending was formed in 1983 to improve the skills and increase the knowledge of current issues of bankers involved in the lending of marketable securities.

The committee supports prudent risk management practices and the communication of these practices to securities lending clients.

The committee views the securities lending business as having both portfolio management and asset/liability management components and recommends that clients be familiar with the following issues associated with the investment of cash collateral.

Client communications. Investment guidelines for cash collateral should be formally documented and communicated to clients. Any modifications to these guidelines should be supplied to clients in a timely fashion. These guidelines should be laid out and communicated according to the standards established by the client with its investment managers for the investment of cash collateral.

Cash collateral portfolio holdings should be reported to clients periodically or upon request, with sufficient disclosure to ensure that a client has the appropriate information to understand the maturity structure, credit quality, interest rate sensitivity, and the asset composition of the portfolio.

Portfolio management of cash collateral. Responsibility for investment decisions should be clearly defined between the lender and the securities lending agent.

Measures of portfolio risk should include quantification of: liquidity; diversification and concentration limits; average life, duration, or other measures of sensitivity to interest rate movements; credit quality.

Clients should review and approve constraints on these measures consistent with their risk tolerance.

The approval process for the introduction of new investment vehicles and strategies to the cash collateral portfolios should be clearly defined.

Asset/liability management. The lending of securities in exchange for cash collateral generally results in an interest rate mismatch between the maturity of the investment securities purchased with the cash collateral and the maturity of the loan. Properly managed, this interest rate mismatch adds incremental income to the lending program. The securities lending agent should clearly articulate to lending clients the policies and procedures that govern and manage the extent of this interest rate exposure within the lending program.

Periodically or upon request lending agents should provide quantification of the net exposure resulting from the interest rate mismatch between the cash collateral investment portfolio (assets) and the securities loan rebate structure (liabilities) to lending clients.

Investment oversight and control. The lending agent should have an established and documented procedure for the periodic review of the investment guidelines instituted by the client.

Investment guidelines should be clearly communicated on a regular basis to the responsible cash collateral portfolio managers.

Individuals with responsibility for reviewing adherence by the portfolio managers to investment guidelines should be clearly named.

Any modifications to the investment guidelines should occur within the framework of a consistent process that ensures adequate oversight and control.

Credit approval policies and procedures. The lending client should be comfortable with the established credit review oversight of the portfolio manager and the individual assets purchased within the established guidelines.

Approval of borrowing counterparties, investment issuers, and trading counterparties should be conducted in accordance with well-defined credit approval policies and procedures.

Approved counterparty and issuer lists should allow for adequate diversity of counterparties, country risk, and issuers.

Risk ownership. The agreement between the securities lending agent and the lender should clearly define the ownership of risks related to the investment of cash collateral.

Mr. Toth, a senior vice president of Northern Trust Co., is also chairman of Robert Morris Associates' committee on securities lending. This article was written in conjunction with the other committee members.

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