Sunday, January 13, 2013
Securities lending is a potentially pro-cyclical source of funding, raising the possibility that participants will have to dump securities during times of financial stress. It can lead to unexpected connections among disparate market players, such as insurance companies and hedge funds. As a result, securities lending may contribute to the opacity of the financial system and erode the willingness of participants to take on counterparty risk. In addition, it is a source of contagion, with the distress of one firm ramifying throughout the financial system in unpredictable ways.
Regulatory authorities should introduce minimum standards for the methodologies that firms use to calculate collateral haircuts. Those guidelines should seek to minimise the extent to which these methodologies are pro-cyclical. Standard setters (e.g. BCBS) should review existing regulatory requirements for the calculation of collateral haircuts in line with this recommendation.
Financial intermediaries should provide 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 financing client long positions and covering short positions, they should not be re- hypothecated 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.