The Bank of England has warned UK insurers of the risks associated with securities lending the securities lending industry and has called for more structure in regulating the industry internationally. At a speech given at the Association of British Insurers last week, Paul Tucker, deputy governor Financial Stability at the BofE, called for greater awareness among insurers that their securities lending activities could contain elements of shadow banking.
He noted that insurers are integral to securities lending as lenders and nothing must be done to jeopardize the essential functions of securities lending. However, he said, securities lending also allows anyone holding a portfolio of stocks and bonds to build themselves an in-house shadow bank. All it takes is to lend out securities for cash, and for the cash to be lent or invested in higher-yielding assets. AIG blew up when its stock-lending shadow bank an insurance company suffered a run. Although in Europe securities lending is typically against stock collateral rather than cash, we mustnt pretend to ourselves that that is a foolproof mitigant. Collateral swaps can involve maturity transformation and leverage. And the market is invisible including, I suspect, to many of the asset managers who outsource stock lending to their custodians.
In the draft financial services bill, introduced by the UK Treasury in January, it was decided that the Bank of England would be the main regulator of the insurance industry. The bill is working its way through parliament and is expected to be adopted in 2013.
In his speech, Tucker noted various steps are underway to catch up with the opaque nature of securities lending. Domestically, the Financial Services Authority (FSA) last week issued guidance to insurers on liquidity swaps in order to get senior management focused on the risks associated with lending out high-quality securities against lower quality collateral.
Internationally, the authorities are going to have to go further, he said, putting some structure around these markets. The Financial Stability Board has work underway to that end, led by the FSAs David Rule. And in the UK, the Securities Lending and Repo Committee, chaired by Andrew Hauser at the Bank, is engaging the industry in dialogue. The Bank wants, in line with our traditions, to find market-led solutions where we can. One issue is transparency. Maybe we should at least contemplate introducing a Trade Repository. If we are moving towards greater transparency in derivative markets, why not do so in a core financing market.
(JDC)