Securities Finance November 19, 2012

FSB Publishes Recommendations on Mitigating Risk in Securities Lending

The Financial Stability Board (FSB) yesterday published a consultation paper on its recommendations related to improvement in transparency, regulation and structural aspects of securities financing markets to strengthen oversight and regulation of the shadow banking system.

The recommendations are part the FSBs focus on five specific areas in which the it believes policies are needed to mitigate the potential systemic risks associated with shadow banking:

-To mitigate the spill-over effect between the regular banking system and the shadow banking system; 
-To reduce the susceptibility of money market funds (MMFs) to runs; 
-To assess and mitigate systemic risks posed by other shadow banking entities; 
-To assess and align the incentives associated with securitization; and 
-To dampen risks and pro-cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of runs.

The FSB consultative documents contains 13 policy recommendations to address shadow banking risks in securities lending and repos to enhance transparency, strengthen regulation of securities financing transactions and improve market structure.

The publication of the policy documents follow the Cannes Summit in November 2011, when G20 Leaders endorsed the FSBs report Shadow Banking: Strengthening Oversight and Regulation which sets out recommendations with a work plan to further develop them during the course of the year. 
Various workstreams have been launched under the FSB to develop policy recommendations to mitigate potential systemic risks in the following areas: banks interactions with shadow banking entities; money market funds; other shadow banking entities; securitization; and securities lending and repos. Workstream 5 (WS5) makes the recommendations on securities lending.

The FSB is seeking comments to the following recommendations by January 2013:

1. Authorities should collect more granular data on securities lending and repo exposures amongst large international financial institutions with high urgency. Such efforts should to the maximum possible extent leverage existing international initiatives such as the FSB Data Gaps Group, taking into account the enhancements suggested by WS5.

The report contains a list of data fields that WS5 thinks would be useful. These data could be collected in various ways, including through regulatory reporting, market surveys and trade repositories.

2. Trade repositories (TRs) are likely to be the most effective way to collect comprehensive repo and securities lending market data. The FSB should consult on the appropriate geographical and product scope of such TRs. The FSB should encourage national / regional authorities to undertake feasibility studies for the establishment of TRs for individual repo and securities lending markets, as well as co-ordinate and facilitate those efforts. Depending on the consultation findings on the appropriate geographical and product scope of TRs, the FSB should also establish a working group to identify the appropriate scope and undertake a feasibility study for one or more TRs at a global level. Such feasibility studies should involved market participants.

3: As an interim step, the FSB should co-ordinate a set of market-wide surveys by national / regional authorities to increase transparency for financial stability purposes and inform the design of TRs. Such market-wide surveys should make publicly available aggregate summary information on securities lending and repo markets on a regular basis.

4: in calling for improvements in corporate disclosures, the FSB said it should work with standard setting bodies internationally to improve public disclosure requirements for financial institutions; securities lending, repo and wider collateral management activities as needed, taking into consideration the items noted above.

5: looking at improvement in reporting by fund managers to end investors the FSB recommends authorities should review reporting requirements for fund managers to end-investors in line with the proposal by WS5. These requirements look at global data (the amount of securities on loan as a proportion of total lendable assets and of the funds assets under management; concentration data (the top 10 collateral securities received by issuer, top 10 counterparties of repo and securities lending); repo and securities lending data breakdowns (by collateral type, by currency, by maturity tenor, by geography, cash versus non cash collateral, maturity of non-cash collateral and settlement/ clearing).

6: In looking at the policy recommendations related to regulation the FSB recommends that regulatory authorities should introduce minimum standards for the methodologies that firms use to calculate collateral haircuts. Those guidelines should seek to minimize the extent to which these methodologies are pro-cyclical. Standard setters (BCBS) should review existing regulatory requirements for the calculation of collateral haircuts in line with this recommendation.

7: in principle, there is a case for introducing a framework of numerical floors on haircuts for securities financing transactions where there is material pro-cyclicality risk. Such floors would work alongside minimum standards for the methodologies that firms use to calculate collateral haircuts. However, the FSB said it should be mindful of possible unintended consequences for market liquidity and the functioning of markets. The FSB should consult on whether a framework of numerical floors would be effective and workable in achieving the policy objectives.

8: Regulatory authorities for non-bank entities that engage in securities lending (including securities lenders and their agents) should implement regulatory regimes meeting the proposed minimum standards for cash collateral reinvestment in their jurisdictions to limit liquidity risks arising form such activities.

9: Authorities should ensure that regulations governing rehypothecation of client assets address the following principles: financial intermediaries should provide staff sufficient disclosure to clients in relation to re-hypothecation of assets so that clients can understand their exposures in the event of a failure of the intermediary; in jurisdictions where client assets may be re-hypothecated for the purpose of financial client long positions and covering short positions, they should not be rehypothecated for the purpose of financing the own-account activities of the intermediary and only entities subject to adequate regulation of liquidity risk should be allowed to engage in the re-hypothecation of client assets.

10: An appropriate expert group on client asset protection should examine possible harmonization of client asset rules with respect to re-hypothecation, taking account of the systemic risk implications of the legal, operational, and economic character of rehypothecation.

11: Authorities should adopt minimum regulatory standards for collateral valuation and management for all securities lending and repo market participants.

12: Authorities should evaluate the costs and benefits of proposals to introduce CCPs in their securities lending and repo markets, especially in cases where important funding providers in the repo market are currently not participating in existing CCPs.

13: Changes to bankruptcy law treatment and development of Repo Resolution Authorities (RRAs) may be viable theoretical options but should not be prioritized for further work at this stage due to significant difficulties in implementation.

The FSB is also publishing today its second annual Global Shadow Banking Monitoring Report. The 2012 Monitoring Report has broadened its coverage to include 25 jurisdictions (all 24 FSB member jurisdictions and Chile), compared with 11 jurisdictions in 2011, and includes analyses on interconnectedness between banks and non-bank financial entities as well as on a specific non-bank financial subsector, namely finance companies. The main findings are:

- Non-bank financial intermediation grew rapidly before the crisis (in parallel with the regular banking system), from an estimated $26 trillion in 2002 to $62 trillion in 2007. It has continued to increase since, although at a slower pace, to $67 trillion at end 2011.

- There is considerable diversity in the relative size, composition and growth of the non-bank financial intermediaries across jurisdictions. For example, the size of the shadow banking system continues to be large relative to the regular banking system in the US and in a number of other jurisdictions. 17 jurisdictions out of 25 saw an increase in non-bank financial intermediaries since the crisis; half of these jurisdictions are emerging markets and developing economies undergoing financial deepening.

- Data granularity is improving, with the share of unidentified non-bank financial intermediaries within overall non-bank intermediation falling from 36% in 2010 to 18% in 2011. However, further improvements are needed in jurisdictions that still lack granular data to adequately capture the magnitude and nature of risks in the shadow banking system.

The FSB's full consultative document can be accessed here

(JDC)


If you have any comments about this story or news tips, contact:
Janet Du Chenne in London at jduchenne@globalcustodian.com 
or Jake Safane in New York at jsafane@globalcustodian.com

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