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Is iShares Really Being Sold?
Written by Paul Amery   
April 01, 2009 06:13 (CET)

There could be a Pulitzer Prize in there for investigative reporting, Jim, if your story turns out to be true.

One of Jim's smaller scoops is to reveal that Barclays apparently turned down offers in excess of US$ 6 billion for iShares, in order to accept CVC's lower bid of $4.3 billion and keep the securities lending business at Barclays Global Investors.

What's going on? Weren't Barclays in sore need of cash to stave off the arrival of the UK Treasury and the takeover of the board by the apparatchiks of UKFI? 

A cursory look at Barclays' accounts reveals that the bank earned £389 million from securities lending last year, a big increase from £241m in 2007 and £185m in 2006. Not all of the securities lending revenue comes from iShares - Barclays had just over £1 trillion under management at the end of the year, with iShares representing around 22% of the total.

We revealed in a survey last year that Barclays takes a 50% cut of lending revenues from any shares lent out from within its iShares ETFs. As iShares has often mentioned in its marketing literature, securities lending revenues for an investor can easily cover an ETF's total expense ratio. The flip side of this is of course that, if the bank retains half the revenues from lending and the investor's half covers fund fees, the bank gets to double what it earns from the TER.

So securities lending is clearly a very profitable business for Barclays Global Investors. But why have revenues from this activity gone up so much? Securities lending expert Roy Zimmerhansl, who wrote a guest blog for IU.eu a few months ago, threw some light on this for me by explaining that securities lenders earn money too from reinvesting the cash collateral they receive when shares are lent out. The interest spreads available to lenders who do this shot up last year, explaining a lot of the increase in Barclays' revenues. 

Also, according to Zimmerhansl, "there isn't enough scale in iShares to make it a top-tier lender on its own, so the private equity buyer would have to rely on a third party provider. BGI's competitiveness as a lender would be damaged, although not destroyed by giving up the iShares volumes." There are clearly synergistic reasons to keep the lending activities at Barclays.

Whatever the intricacies of the securities lending business - and it's a complicated one for outsiders to understand - these considerations explain why the bank was willing to shun an extra $2 billion on the purchase price and keep the lending arm at BGI. No doubt iShares, under its new owners, will have a contract to pass its securities lending activities back to BGI. Zimmerhansl also points out that BGI, by becoming an arms-length provider of securities lending activities to iShares, neatly sets itself up in the third-party lending business, and will be able to offer similar services elsewhere too.

But with securities lending being tied back into Barclays, even after the CVC purchase, Barclays retaining a share interest in the new venture, through warrants, and the bank financing over two thirds of the purchase itself, the question arises - is iShares really being sold?

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