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Achieving extra return with specials: How does that work?

In securities lending terms, there is often talk of so-called 'specials', also known as hard-to-borrow securities. These specials enable the lender to achieve a higher than average return on these securities.
In this short article we look at what makes these securities 'special' and how you can enjoy the benefits of this extra return within your investment portfolio?

14 May 2019

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Specials explained

Specials are securities for which there is a great demand to borrow. This high demand results in a limited availability in relation to the borrowing requirement, creating upward pressure on the price with which these securities can be borrowed. In other words, demand exceeds supply. This is interesting for the lender because lending these leads to a higher remuneration without changing the risk profile. Changes in legislation or takeovers are examples which could lead to a higher remuneration for lenders.  

From equity specials to fixed-income securities and ETFs

Traditionally, it was mainly about shares when referencing specials. In recent years, changing legislation and regulations have increasingly focused on fixed-income securities, both government and corporate bonds, as well as Exchange Traded Funds (ETFs). The phased implementation of Basel III in particular has triggered this trend since 2013.

Among other things, Basel III oversees the liquidity coverage ratio (LCR). The aim of the LCR is to improve the short-term resilience of banks by ensuring that they have sufficient high-quality liquid assets (HQLA). These assets must be easily and directly convertible into cash. As a result, banks are better able to absorb shocks caused by financial and economic stress situations, which benefits the overall stability of the financial system. The majority of these highly-liquid fixed-income securities are held by pension funds and insurance companies, often forming part of the matching portfolio. As a result, these institutional parties are reluctant to sell these securities in large numbers. However, lending is often possible.

What does this mean for your situation?

One of the main reasons for the long-term maintenance of high-quality fixed interest-bearing securities is the certainty it provides with regard to the return that can be achieved at some point in the future. Particularly in the matching portfolio, the confidence that future obligations towards customers/participants can be met is shown by the confidence that this will be the case. The disadvantage, particularly in the current economic climate, however, is that a negative return is often achieved on high-quality (government) bonds when this is adjusted for inflation. Return is therefore exchanged for certainty.

Lending out these securities will therefore always result in an improvement in the return without significantly changing the risk profile. After all, for each lent position you receive non-cash collateral, whereby KAS BANK continuously monitors that the value of this collateral is always higher than the value of the lent securities, which mitigates the risk for you.

Would you like to know how you can make specials work to your advantage?

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Mitchel Steur


Mitchel Steur

Director Pensions & Insurers
+31 (0)20 557 5482