# The Swib Model

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[00:00:00.000] Welcome to another edition of Peer Connections, a podcast produced by the Global Peer Financing
[00:00:04.320] Association. My name is Chris Benesch. I'm a Managing Analyst at the State of Wisconsin
[00:00:08.140] Investment Board, also known as SWIB. Today, we're going to share a little bit about SWIB's
[00:00:12.200] model for securities finance and a bit about some of the more interesting things we're doing in this
[00:00:15.780] space. For those that aren't familiar, State of Wisconsin Investment Board manages the Wisconsin
[00:00:20.140] retirement system. We're a $110 billion U.S. pension fund serving more than 650,000 current
[00:00:25.660] and former Wisconsin employees. We represent people that work for state agencies, the university
[00:00:29.960] system, school districts, and many local governments here in the state of Wisconsin.
[00:00:33.860] We have a typical custodial securities lending arrangement, but we also have a couple of wrinkles
[00:00:37.780] in terms of how we think about leverage and securities finance and things like that. And
[00:00:41.740] we're going to get into more of that in a bit here. I'm joined today by two colleagues, Ping
[00:00:45.760] Wong and Mike Stamm. As for me, I've been with SWIB since 2007, working in a variety of roles.
[00:00:51.500] Currently, I oversee the synthetic beta replication as well as leverage implementation
[00:00:55.620] as part of the Asset and Risk Allocation team.
[00:00:58.000] I'd like to introduce Ping and Mike, let them introduce themselves,
[00:01:01.360] tell a little bit about their roles. So, Ping?
[00:01:03.580] Thanks, Chris. This is Ping Wang.
[00:01:05.560] I joined SWIB in 2016, and I'm an analyst with the Liquidity Inflation Rate Management team.
[00:01:13.160] Our team manages the front-end portfolios for SWIB and the state.
[00:01:17.380] I'm Mike Stamm. I'm the newest to SWIB.
[00:01:19.720] I joined here just in May as part of our new Financing and Collateral Management group.
[00:01:25.620] Previously, I helped build a similar treasury and portfolio finance group at a hedge fund.
[00:01:31.520] So this is a new experience for me.
[00:01:34.280] It's been really exciting starting here and learning this side of the market.
[00:01:38.160] Chris, how did you build this out and where did it start and how did it get to the point that we're at today?
[00:01:43.660] So when I started a little over 13 years ago here at Swib, you know, we had a fully functional securities lending program.
[00:01:51.180] Swib has been a lender for a very long time.
[00:01:53.320] It was a very vanilla program at the time, custodial lending program, in many ways, much
[00:01:57.680] like it is today.
[00:01:58.540] At that time, it was a quiet back office function, generated very little attention.
[00:02:02.340] Then in 2008, the global financial crisis came along and made things pretty interesting.
[00:02:06.420] I would say that SWIB came out of the crisis better than a lot of our peer funds, but we
[00:02:10.280] did learn some lessons along the way, and we try to carry those lessons through to today.
[00:02:14.100] Our program is very intrinsic value focused.
[00:02:16.640] We don't take a lot of risk with our cash reinvestment, but I think what we also learned
[00:02:20.660] through that process is thinking about securities lending, not as just a standalone one-off project
[00:02:27.460] within the fund, but as part of a holistic securities finance function. And that's
[00:02:31.320] something that we've tried to push forward in how we've grown and developed over the years.
[00:02:37.380] And obviously you guys certainly have a position in the market as a lender.
[00:02:41.820] How did your borrow program come to be? How did that get built?
[00:02:46.440] Yeah, so SWIB does operate as both a lender and a borrower of securities. We started discussing allowing our internal equity managers to short back in 2010. And we then launched that functionality in 2011. And it's grown over the years and it's currently used by several of our internal active teams to borrow securities, including equities.
[00:03:07.240] The way that we set ours up is we partnered with our custodian to build out a prime broker-like
[00:03:13.100] function. Some call it enhanced custody, we call it borrow plus, but it has different names. But
[00:03:17.980] essentially the custodian facilitates that prime broker-like functionality and allow us to do a
[00:03:23.060] couple of things. We can borrow from ourselves. So we have a lot of passive assets that we manage
[00:03:28.360] internally here. And so if an active equity manager, internal equity manager wants to short
[00:03:33.440] of security that we hold in our index fund. We're able to transfer that over and kind of do what we
[00:03:37.900] call a self-borrow. But then we also have the functionality within the custodian managed
[00:03:43.060] service to borrow externally. So the custodian sources borrows on our behalf, collateralize those
[00:03:48.620] and are able to execute those shorts. What we really like about the self-borrow program is,
[00:03:55.660] you know, first of all, it overall lowers our cost to borrow. We're not beholden to prime brokerage
[00:04:00.120] like fees. And it also reduces our collateral needs because if we're borrowing from ourselves,
[00:04:04.720] we don't need to collateralize those trades. And it becomes essentially an accounting entry.
[00:04:08.760] And that overall reduces counterparty risks. You mentioned your role as managing the leverage
[00:04:14.340] programs for SWIB. That's not like obviously me from a hedge fund background. That's a big part
[00:04:19.320] of what we did, but that's not something I think of as directly part of a pension role. How do you
[00:04:24.120] think of leverage and how do you implement it for SWIB? Yeah, so we use leverage in a couple
[00:04:29.420] different ways. One, we have a levered policy allocation. So when we look at our total asset
[00:04:34.240] allocation, it adds up to more than 100%. And we utilize that to still achieve our target policy
[00:04:40.840] returns that we need to be able to support the benefit payments that are expected of our
[00:04:45.120] beneficiaries. But it also helps to reduce the risk because we're able to lever lower volatility
[00:04:49.580] assets to achieve the same returns that we would otherwise. The other way that we think about
[00:04:54.140] leverage is in the context of our hedge fund allocation. We run a portable alpha strategy
[00:04:58.800] where we port our hedge fund portfolio over a synthetic beta that's created through the use
[00:05:04.800] of leverage. And that synthetic beta provides kind of a market return, and we layer the alpha return
[00:05:09.980] on top of that. In both cases, we're using synthetic instruments to get the beta exposures
[00:05:15.380] that we need without committing capital. And for that, we use swaps, we use futures. And the
[00:05:19.920] capitalization requirements are sort of part of the overall calculation of how much capital we
[00:05:24.940] need to set aside for those things, but it's much lower than if we were buying fully paid assets.
[00:05:28.300] What that means, though, is we need to really understand what our liquidity profile is.
[00:05:32.820] We need to understand what our collateral needs are, not just on kind of standalone
[00:05:36.420] strategies, but across the whole trust fund.
[00:05:38.340] And that's something we've been working towards building out over the years.
[00:05:41.640] The other way that we generate leverage is through repo.
[00:05:44.140] And so we'll pledge assets in order to raise cash for other uses.
[00:05:47.760] And there's where we really have a mix of traditional and non-traditional counterparties
[00:05:51.200] that's been really beneficial for us.
[00:05:53.660] How does that part of our leverage function work?
[00:05:57.240] Okay, what ways do we interact with our peers currently?
[00:06:00.620] Yeah, so peers have been a great source of non-traditional repo counterparties for SWIB.
[00:06:04.880] We started looking at this way back in like 2015, 2016.
[00:06:10.220] The repo markets were getting more challenging to find counterparties to find bank balance
[00:06:14.240] sheet in order for us to raise cash to generate the leverage that we needed.
[00:06:17.840] So we started looking at other sort of non-traditional counterparties and looking for folks that
[00:06:23.200] had complementary needs and discovered that amongst some of our peer funds.
[00:06:27.240] And that was really kind of the impetus to get involved with the Peer Financing Association early on, met some other like-minded peer funds that kind of helped us think through the process and, you know, figure out some of the issues around counterparty underwriting and legal negotiations and operational issues and all the things that we've relied on each other for over the last few years as we've been building this association.
[00:06:48.680] And to the point now where we have a really good roster of peers and traditional counterparties and other routes to market that we utilize as we implement our repo strategy.
[00:06:58.820] And I think where this brings us to is kind of where we are today.
[00:07:03.020] And so, you know, Ping, if I can turn things to you for a minute and maybe ask, talked a little bit about some of the leverage and borrowing activities that we've evolved into.
[00:07:11.280] Can you maybe talk a little bit about how our view into securities lending informs some of the other activities within the trust fund?
[00:07:18.100] Yes, Chris. Thanks for the question. So, I mean, knowing our own lending activities is beneficial for us. It certainly gives us a window into what we should be paying on the borrow side. And as you can imagine, the quality of the inputs improving, the feedback loop becomes better on both borrowing and lending. So that allows us to make better decisions.
[00:07:42.320] And second, the relationships built up with the external managers can and has led to mutually beneficial exclusive lending arrangements.
[00:07:52.700] Now, finally, having this good visibility in the lending activities, as I've mentioned, can result in bond decisions.
[00:08:00.500] For instance, when we're looking at the instruments to execute our investment strategies, we might choose to hold an ETF to get an exposure to different asset class rather than futures contracts because the income from lending that ETF can result in a better overall economics.
[00:08:21.320] That's a really important point, Peng, and I think it's something that both the active and the passive teams take into consideration when they're looking at different ways to implement their strategies.
[00:08:29.480] In addition to, I talked a little bit before about peer interactions and Ping, you sit in our internal cash management team.
[00:08:37.700] And one of the things that we've done over the last few years is the trust fund has interacted with your team on a cash basis.
[00:08:44.580] So we have needs to borrow cash.
[00:08:46.640] The cash team has needs to invest cash.
[00:08:48.260] And so we figured out a way to essentially borrow cash from ourselves through the same repo mechanics we use interacting with some of our peer organizations.
[00:08:56.140] What has that meant for you and the rest of the cash team
[00:08:58.880] in terms of counterparty and balance stability?
[00:09:02.200] Yeah, no, this is a win-win situation.
[00:09:04.260] I mean, even internally, it's a win-win for both divisions.
[00:09:08.020] So there is for us, there's an extra source of diversity
[00:09:11.420] that we can add to the portfolio.
[00:09:13.940] And I think everyone here can agree
[00:09:16.380] is that SWIFT is a very good counterparty.
[00:09:19.340] So, you know, doing repo,
[00:09:21.600] the core fund is a pretty good decision from our end.
[00:09:25.100] And then I've imagined having the ability to utilize the internal portfolios to fulfill the leverage requirements can increase the efficiency of not just the business, but also in the operations.
[00:09:41.060] Essentially, we can make more money without cutting the middleman some portion of the profit.
[00:09:47.120] So it's a win-win situation.
[00:09:49.640] And Ping, over the last four or five years, since you've been involved with the securities
[00:09:53.060] lending program, what are some of the changes that you've seen in the market?
[00:09:56.560] Yeah, good question.
[00:09:57.520] So certainly, I think the securities financing has become more tailor-made.
[00:10:02.680] As we've mentioned, we do have some customized arrangements with certain counterparties
[00:10:07.520] like custodians.
[00:10:09.360] Second point is that there's a BASL-3 implementation.
[00:10:13.840] So the introduction of the counterparty risk model and operation risk model in Basel III has resulted in a high level of capital buff in the financial system.
[00:10:25.680] This certainly helps reduce the profitability of the left tail events.
[00:10:30.280] And related to COVID, have you seen any impacts from that in the securities finance space?
[00:10:34.760] So when we were looking at the earnings this year and when we compared earnings to past years, we actually did not see an increase in the overall earnings during this March or April, despite the market condition.
[00:10:50.620] That was somewhat surprising to me personally.
[00:10:53.580] Now, there are many reasons that could have contributed to that, such as limitation in the bank balance sheets, lack of liquidity in the overall financial system during the early days of COVID.
[00:11:06.740] These reasons might have limited the overall opportunity sets.
[00:11:10.820] However, we did see a high level of utilization in certain ETFs, probably because it's easier to express an investment view through ETF rather than through individual securities, which is more efficient for followers.
[00:11:26.860] And then one final observation is that the overall balance sheet of banks is resilient. Most banks have been able to generate sufficient profits to cover provisions for loan losses during the pandemic.
[00:11:40.200] and trading has been a bright spot to many banks.
[00:11:43.800] This gives us confidence as we progress to the future of securities financing.
[00:11:48.820] Now, speaking of future, Mike holds the key to the future of our securities financing.
[00:11:53.980] But first, Mike, let me ask you this.
[00:11:56.560] Coming from a hedge fund, what struck you about how we're structured?
[00:12:01.540] You know, it's been really interesting.
[00:12:03.020] I think there's a temptation to just kind of think all treasury is the same, right?
[00:12:07.000] It's assets, liabilities.
[00:12:07.880] But actually, it's been really interesting for me to come in here and just see all of the different tools and opportunities you have at your disposal when you're kind of a really big fund and a really big credit, a really good credit in the market, right?
[00:12:24.540] you don't really need to like people to do business with you the same way you do when
[00:12:28.460] you're a hedge fund you actually can dictate terms more you have more stable assets and all of these
[00:12:34.400] things just become real advantages i didn't even know existed when i was on the other side of the
[00:12:40.500] trade when you're at a hedge fund you're so beholden to maintaining your leverage you really
[00:12:45.800] don't get to think of these next opportunities the same way we do here so it's been really
[00:12:50.060] interesting to explore those and learn from you guys.
[00:12:53.300] I think we're learning from each other, but thanks for the compliment.
[00:12:57.360] No, it's been really good. You've seen already kind of how you and I have had that dialogue
[00:13:03.740] about kind of the cash side versus the borrow and lending side. You really get to kind of see
[00:13:09.980] how the market comes together between all the different sides, that holistic look.
[00:13:14.700] Yeah, absolutely. So as we continue to evolve our securities finance platform, what opportunities do you see?
[00:13:23.300] Well, I see there are ways to kind of move our program out of the individual portfolios into a more top of house, holistic perspective where we can look across all of portfolios, see positions at the largest level and kind of use our scale as an asset to bigger chunks or kind of participate in the market in a bigger way.
[00:13:47.280] There are ways where moving up in that way, we can probably reduce some of our collateral
[00:13:52.900] needs, right?
[00:13:53.820] We can kind of show our lending partners a more diversified portfolio and lower our margin
[00:13:59.880] need.
[00:14:00.500] We can also start looking into various peer relationships and other ways to find new avenues
[00:14:08.440] to lend in tomorrow.
[00:14:10.100] So much of banking is by having multiple different types of interactions, right?
[00:14:14.440] And then you find the right interaction for that moment, right?
[00:14:17.120] You find the person who kind of fits best in the relationship that fits best.
[00:14:21.440] And I think by historically in markets, asset managers haven't had that diversity, but through things like peer networks and, for instance, prime brokers and other types of arrangements, we can kind of use that price discovery and that diversity to find more opportunities.
[00:14:37.680] Yes, so totally agree with the expanding the network and increasing opportunity set there.
[00:14:43.920] So how has your involvement today in the peer association shown what might be possible?
[00:14:52.000] You know, it's been just as it is talking to you and Chris, it's been just really educational for me to speak to the other members to learn how they think of these things.
[00:15:02.180] There are so many ways to skin a cat in treasury portfolio finance and all of these various peers have thought of it slightly different.
[00:15:09.880] And it's really interesting to just kind of look across everybody and, to be honest, kind of steal ideas from the other people in the association.
[00:15:17.340] So it's kind of shown what's out there and what's possible and what we could do as a group trading with each other.
[00:15:23.540] Well, we've certainly come a long way just in the last 10 years.
[00:15:27.020] And I think, as we've discussed, there's a lot of opportunities to grow.
[00:15:30.480] Thank you, Mike and Peng, for joining me on this episode today.
[00:15:33.940] Thanks for joining us.
[00:15:35.100] To all you listening on this episode of Peer Connections, hopefully you found it informative.
[00:15:38.520] If you have other topics that you're interested in, please get in touch with us via our website,
[00:15:43.040] globalpeerfinancingassociation.org or via LinkedIn.
[00:15:46.020] You can subscribe to these episodes wherever you find your podcasts.
[00:15:49.560] Thank you.