FSB Lowers Minimum Haircuts in Latest Shadow Banking Regulatory Proposals

Ahead of the G20 Summit in Russia next week, the Financial Stability Board has published new proposals regulating the shadow banking industry, which include rules requiring minimum haircuts for securities lending and prohibiting brokers from rehypothecating clients’ assets for brokers’ own usage.

The proposals also aim to limit traditional banks’ exposure to shadow banks, reduce the risk of runs on money market funds, and increase overall transparency of the industry.

For securities lending, the new framework reduces the collateral requirements that the FSB put forth in November 2012, but still requires minimum haircuts higher than those typically taken now.

On the low end, corporate bonds with less than one year until maturity would require 0.5% over-collateralization, whereas main-index equities would require a 4% haircut. At the highest end, the FSB proposes a 7.5% haircut on lower-rated assets. In comparison, the FSB’s 2012 guidelines suggested haircuts as high as 15% for main-index equities and 25% for the lowest-rated assets.

“I do not believe at this time, the way the minimum has been presented, that it will cause much impact. But the FSB is setting a precedent and is leaving the door open to change, which could cause greater impact down the road,” said Josh Galper, managing director at Finadium, a securities finance consultant.

For the rehypothecation of clients’ assets, the FSB proposes the broad recommendation that local regulators should require brokers to provide “sufficient disclosure”so that beneficial owners “understand their exposures in the event of a failure of the intermediary.” Furthermore, brokers can lend securities on behalf of their clients’ positions, but can not use these securities to collateralize brokers’ own trades.

“Generally speaking, I feel that the framework is important to be aware of but do not necessarily construe massive changes for securities lending and repo market participants at this time,” said Galper.

The FSB plans to develop a revised framework in the spring of 2014, which they will report to the G20 in November 2014. Implementation would then occur in 2015.