The securities lending industry faces the double-edged sword of lack of demand from borrowers and increasing regulation in the form of Shadow Banking, Dodd Frank and FATCA. Amidst these changes, the industry is lobbying to ensure that at least the changes are implemented in the right way whether they are fair or not. Industry participants at the 17th Annual European Beneficial Owners Securities Lending Conference today heard how key participants from the agent lender, borrower and legal community were responding to the regulatory demands.
Key to these regulations is Dodd Frank, notably Dodd Frank 165, which deals with counterparty credit limits. In a regulation panel at the conference, this rule was identified as being the most draconian in view of the extra-territoriality arrangements and single counterparty credit limits. Michael McAuley, managing director, global head of Product Strategy, BNY Mellon explained: In the new rules, you cannot have an exposure to anyone in excess of 25% of surplus and if you are a big lender that gets extended to 10% of surplus. This is treated as credit risk and includes all affiliations e.g. a European arm of a US company. The limits of the credit exposure are calculated by the services provided. With the haircut you decrease the value of collateral for the haircut and the difference gives you the net credit exposure. When you use collateral to offset credit exposure you have an exposure to the collateral issuer. This is limited to 25% of the German affiliate in this case the calculation could have a severe impact. Were hopping to change that to more accurately reflect counterparty risk.
Scott Olson, senior managing director, Product Development and Tax, State Street, added: Basel 3 is looking to imply single counterparty credit limits. Ourselves and joint industry groups met with the regulators and put in comment letters, arguing against some of Dodd Frank 165. We think the haircuts are draconian and we argued against them. We are already using existing models to offset counterparty risk.
Other regulations discussed at the conference include short selling, MIFID / MIFIR, market abuse and derivatives regulations and AIFMD, notably the subject of depository liability.
Olson said industry participants have been working with the Financial Stability Board to give input on the shadow banking regulations, particularly how they encapsulate securities lending. It means supervising unregulated funding sources as a byproduct of systemic risk, he noted. Five FSB work streams are in place to implement the shadow banking regulations.
McAuley said the securities lending work stream has been divided into three key issues with a target to come up with the regulations in December. These issues include the potential for a trade repository and mandating certain margin levels, he noted. Commenting on trade reporting, Olson said: “We know the SEC is looking at implementing a data feed with Dodd Frank and we know theyre talking to the FSB about a trade repository.
Separately, on the borrower side, Olson said that margins that are too high and would affect liquidity. Peter Economou, chief risk officer, eSecLending added that with high margin requirements, the regulators are managing for worse case scenario, which puts constrains on the industry on a daily basis.
On the subject of collateral reinvestment and moves to regulate this area, Olson noted his companys testimony before the US regulator on money market funds in the height of AIG debacle, but added this was an exceptional case. Now cash collateral is more organized and restricted but it should not be over-regulated,” he said.
Economou notes: From 2008-2009 in relation to collateral reinvestment regulators identified thats where losses were and not on securities lending. They want to bring back the securities and take the pure leveraging out of market place.
Duncan Drummond, executive director, Legal and Compliance Division, Morgan Stanley noted: The take on shadow banking is deliberately vague and there is ambiguity in the interpretation of the proposals. In terms of liquidity and collateral transactions – within a one year duration they set out minute standards for risk managers.
In conclusion, the regulations affecting securities lending do not have a lot of detail and regulators are well behind in their implementation. There is very little finalized and there is not a large amount of regulations in final form. We are not knocking the regulation but the regulators have backlog and theyre well behind in the task of regulations. The upcoming election in the US could have a significant impact on some of the more controversial pieces like Volcker Rule.
-Janet Du Chenne