For completeness there is the full transcript of the email below I'll attach the doc's if I can (edit - only the notice was able to be attached - you'll have to wait and get their new investment statement online)
My summary of the situation
They will be authorized to lend up to %50 of the funds shares to NZCL a clearing house operator launched by NZX and then later to bilateral parties (described as NZX Market Participants)
Only NZ funds are operating at this stage also due to some initial complication. But the regulations allow the OZ funds to lend.
Options strategy are not part of the proposal
Smartshares and others will clip the ticket though it will still probably be cash positive for the fund to paticipate in the lending.
The risks would appear to be purely third party and operational rather than financial. So theoretically all market risk is assumed by others.
My take on it is that they smartShares are acting prudently enough in the pursuit of maximizing the gain from holding stock but whether its worth the very small risk in having the funds assets exposed to third party risk for the presumably quite small gains it will create after all the conductors have a clip is debateable.
I wonder if when you're buying quality (and these top 10 and top 50 companies will mostly be quality) its best not introduce to much of this unlikely but potentially nasty risk into the equation.
In the worst case scenario a fund could lose 50% from counterparty failure. Thats more likely in some ways than 50% of the companies in the funds pool going belly up I think. (Tho not as likely as share prices falling 50% at some stage).
Its a bit of an unquantifiable risk imo, probably infintesimal but maybe not.
peat
Many thanks for your note. We are pleased that potential investors take the time to read our documentation properly. It’s important for all investors to understand the nature of the products they are investing in fully and we encourage people to ask questions where aspects appear unclear.
In relation to securities lending the amendments to the Trust Deeds contemplate two types of permissible lending:
1. Lending through a central clearing house; and
2. Lending to NZX market participants bilaterally
It is important to note that at this stage the nature of the Funds’ agreements with the Trustees and the Securities Commission means that they are only conducting lending through the clearing house and will not in the immediate future be lending to individual participants bilaterally.
What does lending through a central clearing house mean? NZX has launched a central counterparty clearing and settlement system which has become the central counterparty for the settlement of trades of financial products on NZX’s market. At the beginning of each day the settlement system creates a lending pool of identified securities, which the Funds are now contributing to, and participants in the system can request to borrow stocks to help them meet their settlement obligations. Immediately after creation the lending transactions are novated and replaced with individual contracts with the Clearing House Operator (CHO) i.e. CHO acts as a central counterparty to both sides.
The net effect of this is that the funds are effectively lending to CHO rather that the underlying market participant and all settlement obligations reside with CHO. Therefore all borrower and settlement risk is replaced with the risk associated with the possible failure of the central counter party system. As I am sure you will be aware the clearing and settlement system was recently brought into existence by the passing of the relevant legislation by the Government and risk of failure of the system is mitigated by ongoing prudential oversight arrangements by the Reserve Bank.
Those participants borrowing stock will pay a fee to the lender calculated by reference to an interest rate which will be based on the value of the Official Cash Rate. The additional income receivable from securities lending will be accumulated daily into the value of the Fund and therefore represented in its daily NTA. It will then be distributed as per all other income in the Funds’ half yearly dividend payments. The Manager will be entitled to receive fees for administering the lending programme however those fees will be based on a proportion of revenue received to ensure that the programme is always revenue positive for investors.
As you will be able to see the terms under which the Funds are able to lend have been agreed in a highly prescriptive form so as to provide comfort to Trustees, the Securities Commission and, most importantly, investors that all precautions have been put in place to ensure risks are mitigated as far as possible. The Funds will not be in a position to lend other than as prescribed and nor would they wish to do so. They certainly would not want to be in a position to engage in some sort of option writing strategy where risk is retained. We do not believe in financial “whizz tricks” either and have recently updated our offer documentation specifically to explain the nature of the lending permissible and define the risks involved (see attached). This document has just being rolled over and as such we do not have a designed copy however it will be available soon. We also recently made the attached announcement to the NZX Market Announcement Platform and a letter is being sent to all unitholders explaining stock lending in greater detail.
I hope this goes along way to answering your query (along with the updated offer documentation and the market announcement attached) however we appreciate there is quite a lot to take in so please feel free to follow up if there are aspects that still remain unclear.
Thanks and regards
James F
On 21 September 2010 16:09, NZX Smartshares <smartshares@nzx.com> wrote:
Hi peat
Thank you for you email regarding the changes to the Trust Deed. We are putting some information together for you regarding this and will get back to you shortly. We take questions about such matters extremely seriously as we want to assure our investors that every step has been taken to protect their assets. Therefore we would like to provide you with a thorough explanation of securities lending and how it will affect the fund. I will look to send you and email tomorrow.
Please let me know if you have any questions in the mean time.
Regards
James
On 20 September 2010 18:01, peat wrote:
Hi
Your investment statement for the various smartShare funds advises about a change to the Trust deed allowing the shares to be lent
I quote "The Manager intends, subject to amending the Trust Deed, to implement a securities lending programme in the next 12 months. Please refer to page 41 for further information on securities lending."
That statement is included for all the specific funds. It then goes on to advise on pg 41 about the risks of lending the shares such as third party risk, operational risk etc.
The ramifications of what this means are unclear or at least open to interpretation and thus could lead to harmful speculation regarding the safety of investing in smartShares. Also it is never made clear how exactly the unitholders will benefit from this lending.
I can understand how lending stock will generate revenue if none of the (presumably speculative ) borrowers risk is taken on board by smartShares, but I wonder whether the Trust Deed Amendments are also allowing smartShares itself to participate in some sort of option writing strategy where the risk is retained.
I guess it makes unitholders nervous to think that financial whizz-tricks are being performed with the shares that their investment funds have effectively purchased and I’m putting forward the idea that even the suggestion of this undefined added risk could intimidate investors and thus reduce your custom.
Perhaps you would care to elaborate on your intentions.
Regards
peat
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Originally Posted by peat
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