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CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER
INTERDEPARTMENTAL CORRESPONDENCE
Date: July 31 , 2012
To: Retirement Board Members
From:~sangeeta Bhatia, Retirement Plan Manager
Subject: Board Agenda Item NO.4: Discussion of Proposed Changes to the Account Structure of the Securities Lending Program; and Possible Action (August 8, 2012, Special Retirement Board Meeting)
Recommendation
That the Retirement Board adopt the proposed investment guidelines resulting from the change in the Securities Lending Program's current collateral pool commingled fund structure to a separately managed account structure.
Summary
In January 2005, the Retirement Board hired· Mellon Trust of California (Mellon) to provide Custody Banking Services. In 2007, Mellon merged with the Bank of New York to form one entity, the Bank of New York Mellon (BNY). The Retirement Plan participates in BNY's Securities Lending Program (SLP). The SLP has generated for the Plan annual net revenue of approximately $4.6 million from 2008 to 2011, and approximately $1.5 million year-to-date through May 31, 2012. Cash received by the Plan from borrowers as collateral for the securities on loan is currently invested in the Pooled Employee ASL ERISA Short Term Fund (ASL Pool).
As a result of the financial crisis, BNY changed to a more conservative investment strategy for the ASL Pool, based on Rule 2a-7 of the Investment Company Act of 1940. In January 2010, BNY provided its clients with four options, one of which was to remain in the ASL Pool. On January 13, 2010 (Resolution NO.1 0-51), the Retirement Board elected to remain in the ASL Pool and adopted the new, more conservative guidelines (attached).
On June 8, 2012, BI\JY notified Staff that the firm will phase out its cash collateral commingled investment funds, including the ASL Pool, in favor of a separately managed account (SMA) structure for its clients. The structural change is due to increasing demand for SMAs which allow clients the flexibility to manage risk according to their own customized investment guidelines. The new SMA structure will not result in any additional expense to the Plan.
Staff instructed Pension Consulting Alliance (PCA) to review the existing investment guidelines for the ASL Pool and evaluate its risk profile as it would apply to the Plan's SMA. After evaluating the ASL Pool investment guidelines, PCA is comfortable with its
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risk profile and recommends no changes. Therefore, PCA recommends, and Staff concurs, that the Retirement Board adopt the current ASL Pool investment guidelines for the Plan's new SMA.
The following documents are attached:
• Resolution No. 13-12 • Securities Lending Cash Collateral Investment Guidelines • Correspondence from PCA • Resolution No. 10-51 (approved 1-13-10)
wtt--SB:JW:SV:DN
4.2',
RESOLUTION NO. 13-12
RESOLUTION TO ADOPT SECURITIES LENDING INVESTMENT GUIDELINES
WHEREAS, In January 2005, the Retirement Board hired Mellon Trust of California (Mellon) to provide Custody Banking Services, and in 2007 Mellon merged with the Bank of I\lew York to form one entity, the Bank of New York Mellon (BNY); and
WHEREAS, the Plan, as directed by the Retirement Board, currently participates in BNY's Securities Lending Program (SLP); and
WHEREAS, the cash received by the Plan from borrowers as collateral for the securities on loan is currently invested in the Pooled Employee ASL ERISA Short Term Fund (ASL Pool); and
WHEREAS, as a result of the financial crisis, BI\lY changed to a more conservative investment strategy for the ASL Pool based on Rule 2a-7 of the Investment Company Act of 1940; and
WHEREAS, Rule 2a-7 compliant investments have higher credit quality and shorter maturity dates than the ASL Pool's previous investment guidelines; thus making them more conservative; and .
WHEREAS, on January 13, 2010, the Retirement Board elected to remain in the ASL Pool and adopted the new, more conservative investment guidelines currently used by BNY to manage risk and liquidity within the ASL Pool; and
WHEREAS, On June 8, 2012, BNY notified Staff that the firm will phase out its cash collateral commingled investment funds, including the ASL Pool, in favor of a separately managed account (SMA) structure for its clients; and
WHEREAS, the structural change is due to increasing demand for SMAs which allow clients the flexibility to manage risk according to their own customized investment guidelines; and
WHEREAS, the new SMA structure will not result in any additional expense to the Plan; and
WHEREAS, Staff instructed Pension .Consulting Alliance (PCA) to review the existing investment guidelines for the ASL Pool and evaluate its risk profile as it would apply to the Plan's SMA; and
WHEREAS, after evaluating the ASL Pool investment guidelines, PCA is comfortable with its risk profile and recommends no changes to the investment guidelines; and
WHEREAS, PCA recommends, and Staff concurs, that the Retirement Board adopt the current ASL Pool investment guidelines for the Plan's new SMA.
4.3
NOW, THEREFORE, BE IT RESOLVED, the Retirement Plan Manager is hereby authorized to incorporate the Securities Lending Investment Guidelines for the SMA into the Plan's Investment Policy.
I HEREBY CERTIFY, the foregoing is a full, true, and correct copy of a Resolution adopted by the Retirement Board of Administration, [created by Section 1102 (b) of the Los Angeles City Charter], at its speCial meeting held on August 8, 2012.
Sangeeta Bhatia Retirement Plan Manager
4.4'
SECURITIES LENDING CASH COLLATERAL INVESTlVIENT GUIDELINES
In accordance with the Agreement between the Lender and Bank, Cash Collateral received by the Bank on behalf of the Lender shall be held and maintained in a separately managed Cash Collateral Account established and maintained by the Bailk for the Lender (the "Cash Collateral Account"), the assets of which shall be invested and reinvested in one or more of the Approved Investments below.
While the Cash Collateral Account will be operated on a cost basis, there is no guarantee that there will not be differences from time to time between the cost and the underlying fair market value of the assets held in the Cash Collateral Account. The cost or book value of the investment assets held in the Cash Collateral Account and their fair market value may differ from time to time. This difference may result in a loss, which is the responsibility of the Lender.
All Approved Investment, Credit Quality, Concentration and Liquidity guidelines set forth herein shall be applicable only at time of purchase (i.e., trade date).
Approved Investments may have fixed or floating interest rate provisions. Floating rate notes will reset no less frequently than quarterly.
Bank and/or Bank Affiliates may provide services with respect to Approved Investments, and may receive compensation with respect to these services. Lender consents to the retention by Bank and Bank Affiliates of such compensation.
A. APPROVED INVESTMENTS
] . Instruments
• Obligations of the U.S. Treasury as well as agencies and instrumentalities and establishments of the U.S. Government ("U.S. Government Securities").
• Repurchase transactions (including tri-party repurchase transactions) collateralized at 102% or greater at time of purchase and marked to market on each business day. Collateral will consist of one or more Approved Investments described herein without limitation on maturity, as well as equity securities.
• Obligations issued by the central government of any OECD country and any of their respective agencies, instrumentalities or establishments ("OECD Obligations").
CORE Guidelines (6)
4.5
• Obligations issued by 'supranational organizations', including but not limited to African Development Bank, Asian Development Bank, Council of Europe, Eurofima, European Bank for Reconstruction and Development, European Investment Bank, Inter-American Development Bank, International Bank for Reconstruction and Development (World Bank), International Finance Corp~ration, and Nordic Investment Bank.
• Commercial paper, notes, bonds and other debt obligations (including funding agreements and guaranteed investment contracts), whether or not registered under the Securities Act of 1933, as amended.
• Certificates of deposit, time deposits and other bank obligations.
• Asset-backed securities, including asset-backed commercial paper.
• Shares of money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940, including affiliated funds of the Bank. (These shares shall be deemed to have a final maturity of one business day for the purposes of the Maturity Guidelines in paragraph D.)
• Units of unregistered, collective investment vehicles sponsored or advised by the Bank or a Bank Affiliate. (These units shall be deemed to have a final maturity of one business day for the purposes of the Maturity Guidelines in paragraph D.)
2. Currency
• Shall be limited to the same currency in which the Cash Col~ateral being invested is denominated.
B. CREDIT QUALITY
• Repurchase transaction counterparties must have executed a written repurchase agreement and they, or their parent company, must have a short term rating of at least A-2, P-2 or F2 or equivalent by at least one nationally recognized statistical rating organization ("NRSRO").
• Obligations issued by 'supranational organizations' must be rated AAA or equivalent by at least one NRSRO.
• OECD Obligations, bank obligations, commercial paper (including assetbacked commercial paper), notes, bonds and other debt obligations must be rated at least A-I, P-I or FI or equivalent by an NRSRO. Obligations rated by more than one NRSRO must be rated A-I, P-I or FI or
CORE Guidelines (6) 4.6'
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equivalent by at least two NRSROs. Obligations without a short tenn rating must have a long tenn rating of at least A, A2 or A or equivalent by an NRSRO. Obligations that have a long tenn rating from more than one NRSRO (but no short tenn rating) must be rated A, A2 or A or equivalent by at least two NRSROs. Obligations that are not rated will be Approved Investments if the issuer of the obligation meets the above rating criteria.
• Asset-backed securities (other than asset-backed commercial paper) must be rated AAA, Aaa or AAA by at least one of the following NRSROs: Standard & Poor's, Moody's or Fitch. Asset-backed securities (other than asset-backed commercial paper) rated by more than one of the foregoing NRSROs must be rated AAA, Aaa or AAA by at least two of: Standard & Poor's, Moody's and Fitch. Asset-backed securities (other than assetbacked commercial paper) that have only short term ratings must be rated A-I+, P-I or FI+ by a NRSRO. Asset-backed securities (other than assetbacked commercial paper) that have only a short tenn rating from more than one NRSRO must be rated A-I +, P-I or FI+ by at least two NRSROs.
• Registered money market funds must be rated in the highest category available to such funds by one NRSRO.
• Collective investment vehicles sponsored or advised by the Bank or a Bank Affiliate do not require a rating by a NRSRO.
• U.S. Government Securities do not require a rating by a NRSRO.
CONCENTRATION GUIDELINES
• Excluding U.S. Government Securities, repurchase agreements, shares of money market funds and collective investment vehicles, concentration of any Approved Investment in the Cash Collateral Account will not exceed 5% per issuer.
• A maximum of 25% of the Cash Collateral in the Cash Collateral Account may be invested in repurchase transactions with a single counterparty.
D. MATURITY GUIDELINES
• Approved Investments will have a maximum final maturity of 397 days, except U.S. Government Securities, which shall have a final maturity not exceeding 762 days.
CORE Guidelines (6) -4.7
• The weighted average maturity of Approved Investments in the Cash Collateral Account (based on the shorter of final maturity or days to reset for floating rate obligations) shall not exceed 60 days.
• The weighted average life of Approved Investments in the Cash Collateral Account based on final maturity shall not exceed 120 days.
E. LIQUIDITY GUIDELINES
• All Approved Investments shall be deemed to be liquid at time of purchase, with the exception of time deposits and repurchase agreements having a final maturity greater than 7 days, which shall be deemed to be illiquid for purposes hereof.
• "llliquid" Approved Investments shall not exceed 5% of the total amount of Approved Investments in the Cash Collateral Account.
• No Approved Investment having a final maturity longer than one business day shall be made if, immediately after such investment, the total amount of Approved Investments in the Cash Collateral Account would have less than 10% of total assets maturing in one business day.
• No Approved Investments other than Weekly Liquid Assets (as defined below) shall be made if, immediately after such investment, the Cash Collateral Account would have less than 30% of total assets invested in Weekly Liquid Assets. Weekly Liquid Assets are defined as cash, direct obligations of the U.S. Government (i.e., bills, bonds and notes), U.S. government agency discount notes with a remaining maturity of 60 days or less, and any other Approved Investments that will mature in, or have an unconditional put option of, five business days or less.
CORE Guidelines (6) 4.8
Date: August 8, 2012
To: Water & Power Employees' Retirement Plan (WPERP)
From: Pension Consulting Alliance, Inc. (PCA) cc: Neil Rue, CFA - PCA Kay Ceserani - PCA
~ David Sancewich - PCA Colin Bebee - PCA
RE: BNY Mellon Securities Lending - Separate Account Structure
Recommendation
Due to changes in the demand for securities lending vehicles at BNY Mellon, WPERP's custodian, BNY Mellon, is transitioning their current commingled fund clients to separately managed account structl,Jres. These changes allow WPERP to customize securities lending guidelines to each Plan's specifications. At this time, PCA recommends that WPERP continue its participation in the securities lending program and that WPERP respond to BNY Mellon's request, dated June 8, 2012, to convert from a commingled fund account structure to a separately managed account structure. PCA also recommends that WPERP accept the stated investment guidelines which are identical to the current commingled fund, and incorporate them into to WPERP's Statement of Investment Objectives, Goals, and Guidelines. The new separate account structure provides WPERP the ability to make adjustments to these guidelines at any time.
Background and Discussion
WPERP currently participates in the BNY Mellon securities lending program through a pooled vehicle, the Pooled Employee ASL ERISA Short Term Fund (ASL Pool). On June 8,2012, BNY Mellon notified WPERP of changes in the operations of the ASL Pool to reflect changing market demands for separately managed accounts.
In an effort to meet various participants' needs and to ensure all participants are treated fairly and equitably through the transition period, BNY Mellon is shifting the commingled fund's focus into overnight investments to insure efficient migration to each client's new vehicle structure. Cash/Overnight Assets include cash and any assets held by the ASL Pool which have a maturity of one business day or less.
BNY Mellon has constructed investment guidelines for the new separately managed vehicle that are identical to the current commingled fund policy guidelines. Credit quality, maturity, liquidity,
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, .~----------and other factors such as issuer diversification will not change. (The new policy guidelines are listed at the end of this memo.) It is also important to note that the current fee arrangement that WPERP has with BNY Mellon will not change and that BNY Mellon has insured WPERP that there will be no additional costs associated with this change in account structure.
The management strategy of the current ASL Pool transitioned to investment guidelines generally consistent with Rule 2a-7 of the Investment Company Act of 1940 in the early part of June 2009.
The following table summarizes the current Rule 2a-7 guidelines.
-
Asset Class Current ASL Guideline
(Rule 2a-7)
Credit/Quality Maturity
100% minimum 397 days collateralization (usu. "AM" or better)
397 days 762 days
A1 / P1 or F1 397 days (maturity) A1 / P1 or F1 397 days (maturitv) A1 / P1 or F1 397 days A1 / P1 or F1 397 days
A1 / P1 or F1 397 days A1 / P1 or F1 397 davs A1 / P1 or FI 397 days Eligible
5% of Portfolio None 90 days
Repo
US GovtlAgency Fixed Floating
Asset Backed Securities Fixed Floatina
Floatina Note Rates Commercial Paper COfTO's (Foreign or Domestic)
Fixed Floating
Gtd. Investment Contracts Money Market Funds General
Issuer Concentration Liquidity Target Weiahted Averaae Maturity
4.10
Current Commingled Fund and Suggested Separate Account Policy Language
SECURITIES LENDING CASH COLLATERAL INVESTMENT GUIDELINES
In accordance with the Agreement between the Lender and Bank, Cash Collateral received by the Bank on behalf of the Lender shall be held and maintained in a separately managed Cash Collateral Account established and maintained by the Bank for the Lender (the "Cash Collateral Account"), the assets of which shall be invested and reinvested in one or more of the Approved Investments below.
While the Cash Collateral Account will be operated on a cost basis, there is no guarantee that there will not be differences from time to time between the cost and the underlying fair market value of the assets held in the Cash Collateral Account. The cost or book value of the investment assets held in the Cash Collateral Account and their fair market value may differ from time to time. This difference may result in a loss, which is the responsibility of the Lender.
All Approved Investment, Credit Quality, Concentration and Liquidity guidelines set forth herein shall be applicable only at time of purchase (Le., trade date).
Approved Investments may have fixed or floating interest rate provisions. Floating rate notes will reset no less frequently than quarterly.
Bank and/or Bank Affiliates may provide services with respect to Approved Investments, and may receive compensation with respect to these services. Lender consents to the retention by Bank and Bank Affiliates of such compensation.
A. APPROVED INVESTMENTS
1. Instruments
• Obligations of the U.S. Treasury as well as agencies and instrumentalities and establishments of the U.S. Government ("U.S. Government Securities").
• Repurchase transactions (including tri-party repurchase transactions) collateralized at 102% or greater at time of purchase and marked to market on each business day. Collateral will consist of one or more Approved Investments described herein without limitation on maturity, as well as equity securities.
• Obligations issued by the central government of any OECD country and any of their respective agencies, instrumentalities or establishments ("OECD Obligations").
• Obligations issued by 'supranational organizations', including but not limited to African Development Bank, Asian Development Bank, Council of Europe, Eurofima, European Bank for Reconstruction and Development, European Investment Bank, Inter-American Development Bank, International Bank for
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Reconstruction and Development (World Bank),' International Finance Corporation, and Nordic Investment Bank.
• Commercial paper, notes, bonds and other debt obligations (including funding agreements and guaranteed investment contracts), whether or not registered under the Securities Act of 1933, as amended.
• Certificates of deposit, time deposits and other bank obligations.
• Asset-backed securities, including asset-backed commercial paper.
• Shares of money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940, including affiliated funds of the Bank. (These shares shall be deemed to have a final maturity of one business day for the purposes of the Maturity Guidelines in paragraph D.)
• Units of unregistered, collective investment vehicles sponsored or advised by the Bank or a Bank Affiliate. (These units shall be deemed to have a final maturity of one business day for the purposes of the Maturity Guidelines in paragraph D.)
2. Currency
• Shall be limited to the same currency in which the Cash Collateral being invested is denominated.
B. CREDIT QUALITY
• Repurchase transaction counterparties must have executed a written repurchase agreement and they, or their parent company, must have a short term rating of at least A-2, P-2 or F2 or equivalent by at least one nationally recognized statistical rating organization ("NRSRO").
• Obligations issued by 'supranational organizations' must be rated AAA or equivalent by at least one NRSRO.
• OECD Obligations, bank obligations, commercial paper (including asset-backed commercial paper), notes, bonds and other debt obligations must be rated at least A-1, P-1 or F1 or equivalent by an NRSRO. Obligations rated by more than one NRSRO must be rated A-1, P-1 or F1 or equivalent by at least two NRSROs. Obligations without a short term rating must have a long term rating of at least A, A2 or A or equivalent by an NRSRO. Obligations that have a long term rating from more than one NRSRO (but no short term rating) must be rated A, A2 or A or equivalent by at least two f\lRSROs. Obligations that are not rated will be Approved Investments if the issuer of the obligation meets the above rating criteria.
• Asset-backed securities (other than asset-backed commercial paper) must be rated AM, Aaa or AM by at least one of the following NRSROs: Standard &
4.12
Poor's, Moody's or Fitch. Asset-backed securities (other than asset-backed commercial paper) rated by more than one of the foregoing I\IRSROs must be rated AAA, Aaa or AAA by at least two of: Standard & Poor's, Moody's and Fitch. Asset-backed securities (other than asset-backed commercial paper) that have only short term ratings must be rated A-1+, P-1 or F1+ by a NRSRO. Assetbacked securities (other than asset-backed commercial paper) that have only a short term rating from more than one NRSRO must be rated A-1+, P-1 or F1+ by at least two NRSROs.
• Registered money market funds must be rated in the highest category available to such funds by one NRSRO.
• Collective investment vehicles sponsored or advised by the Bank or a Bank Affiliate do not require a rating by a NRSRO.
• U.S. Government Securities do not require a rating by a NRSRO.
C. CONCENTRATION GUIDELINES
• Excluding U.S. Government Securities, repurchase agreements, shares of money market funds and collective investment vehicles, concentration of any Approved Investment in the Cash Collateral Account will not exceed 5% per issuer.
• A maximum of 25% of the Cash Collateral in the Cash Collateral Account may be invested in repurchase transactions with a single counterparty.
D. MATURITY GUIDELINES
• Approved Investments will have a maximum final maturity of 397 days, except U.S. Government Securities, which shall have a final maturity not exceeding 762 days.
• The weighted average maturity of Approved Investments in the Cash Collateral Account (based on the shorter of final maturity or days to reset for floating rate obligations) shall not exceed 60 days.
• The weighted average life of Approved Investments in the Cash Collateral Account based on final maturity shall not exceed 120 days.
E. LIQUIDITY GUIDELINES
• All Approved .Investments shall be deemed to be liquid at time of purchase, with the exception of time deposits and repurchase agreements having a final maturity greater than 7 days, which shall be deemed to be illiquid for purposes hereof.
4.13
• "Illiquid" Approved Investments shall not exceed 5% of the total amount of Approved Investments in the Cash Collateral Account.
• No Approved Investment having a final maturity longer than one business day shall be made if, immediately after such investment, the total amount of Approved Investments in the Cash Collateral Account would have less than 10% of total assets maturing in one business day.
• No Approved Investments other than Weekly Liquid Assets (as defined below) shall be made if, immediately after such investment, the Cash Collateral Account would have less than 30% of total assets invested in Weekly Liquid Assets. Weekly Liquid Assets are defined as cash, direct obligations of the U.S. Government (Le., bills, bonds and notes), U.S. government agency discount notes with a remaining maturity of 60 days or less, and any other Approved Investments that will mature in, or have an unconditional put option of, five business days or less.
4.14
RESOLUTION NO.1 0-51
RESOLUTION TO SELECT AN OPTION FOR THE SECURITIES LENDING PROGRAM OFFERED BY THE BANK OF NEW YORK MELLON
WHEREAS, The Board of Administration (Board) of the Water and Power Employees' Retirement Plan (WPERP) hired the Bank of. New York Mellon (BNY) in January 2005; and
WHEREAS, the Board chose to participate in BNY's securities lending program (SLP) which has generated annual revenues to the Plan of approximately $8 million in 2008 and $4.5 million through November 2009; and
WHEREAS, the revenue generated from participating in the SLP is shared between WPERP (85%) and BNY (15%); and
WHEREAS, WPERP was invested in the ASL ERISA Short Term Fund (ASL Pool) for the cash collateral received for securities on loan; and .
WHEREAS, as a result of the financial crisis, BNY restructured the ASL Pool by moving securities with longer maturities (up to three years) into a separate fund called the ASL Liquidating Fund and the defaulted Sigma Finance SIV into a separate liquidation trust; and
WHEREAS, BNY further restructured the SLP by establishing a new Pooled Employee Overnight Fund and modifying the investment guidelines of the existing ASL Pool to be compliant with -Rule 2a-7 of the Investment Company Act of 1940 (Rule 2a-7); and
WHEREAS, the following options are available to the Board:
1. Remain in the ASL Pool which will now use investment guidelines consistent with Rule 2a-7 of the Investment Company Act of 1940 to invest in securities used by the collateral assets,
2. Move to the overnight pool option which only allows overnight investments, or 3. Exit the securities lending program.
NOW, THEREFORE, BE IT RESOLVED, the Retirement Plan Manager is hereby authorized to implement Option NO.1 as outlined above.
I 'HEREBY CERTIFY, the foregoing is a full, true, and correct copy of a Resolution adopted by the Retirement Board of Administration [created by Section 1102 (b) of the Los Angeles City Charter] at its regular meeting held on January 13, 2010.
Sangeeta Bhatia Retirement Plan Manager
4.15