Friday, September 13, 2013

FSB Issues its Final Policy Framework on Sec Lending and Repo

On August 29, 2013, the Financial Stability Board (FSB) issued its finalized policy framework for its securities lending and repo workstream. As part of a larger examination of shadow banking, the FSB focused on five specific areas in which policies are needed to mitigate the potential systemic risks associated with shadow banking, with one of these five areas being securities lending and repo. Following up on their November 2012 consultation paper, the FSB has issued its final Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos.  This document sets out recommendations for addressing financial stability risks in this area, including enhanced transparency, regulation of securities financing, and improvements to market structure. It also includes consultative proposals on minimum standards for methodologies to calculate haircuts on noncentrally cleared securities financing transactions and a framework of numerical haircut floors.

The final policy framework is based around eleven recommendations:

Recommendation 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 Initiative, taking into account the enhancements suggested in this document. 
Recommendation 2: Trade-level (flow) data and regular snapshots of outstanding balances (position/stock data) for repo markets should be collected. Regular snapshots of outstanding balances should also be collected for securities lending markets and further work should be carried out on the practicality and meaningfulness of collecting trade-level data. Such data should be collected frequently and with a high level of granularity, and should also capitalise on opportunities to leverage existing data collection infrastructure that resides in clearing agents, central securities depositories (CSDs) and/or central counterparties (CCPs). National/regional authorities should decide the most appropriate way to collect such data, depending on their market structure, and building on existing data collection processes and market infrastructure where appropriate. Trade repositories are likely to be an effective way to collect comprehensive repo and securities lending market data. Regulatory reporting may also be a viable alternative approach. 
Recommendation 3: The total national/regional data for both repos and securities lending on a monthly basis should be aggregated by the FSB which will provide global trends of securities financing markets (e.g. market size, collateral composition, haircuts, tenors). The FSB should set standards and processes for data collection and aggregation at the global level to ensure consistent data collection by national/regional authorities and to minimise double-counting at the global level. 
Recommendation 4: The Enhanced Disclosure Task Force (EDTF) should work to improve public disclosure for financial institutions’ securities lending, repo and wider collateral management activities, taking into consideration the items noted above. 
Recommendation 5: Authorities should review reporting requirements for fund managers to end-investors against the FSB’s proposal, and consider whether any gaps need to be addressed. 
Recommendation 6: Regulatory authorities for non-bank entities that engage in securities lending (including securities lenders and their agents) should implement regulatory regimes meeting the minimum standards for cash collateral reinvestment in their jurisdictions to limit liquidity risks arising from such activities. 
Recommendation 7: Authorities should ensure that regulations governing rehypothecation of client assets address the following principles: 
  • 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 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.

Recommendation 8: An appropriate expert group on client asset protection should examine possible harmonisation of client asset rules with respect to re-hypothecation, taking account of the systemic risk implications of the legal, operational, and economic character of re-hypothecation. 
Recommendation 9: Authorities should adopt minimum regulatory standards for collateral valuation and management for all securities lending and repo market participants. 
Recommendation 10: Authorities should evaluate, with a view to mitigating systemic risks, the costs and benefits of proposals to introduce CCPs in their inter-dealer repo markets where CCPs do not exist. Where CCPs exist, authorities should consider the pros and cons of broadening participation, in particular of important funding providers in the repo market. 
Recommendation 11: Changes to bankruptcy law treatment and development of Repo Resolution Authorities (RRAs) may be viable theoretical options but should not be prioritised for further work at this stage due to significant difficulties in implementation.

The recommendations focus heavily on data gathering, capture, and disclosure and rehypothecation.  The FSB appears to be attempting to tackle the issue of complex collateral chains resulting from rehypothecation, potentially by restricting rehypothecation. These restrictions, however, are fairly benign in that they seek global harmonization of rules and preventing intermediaries from using client assets to generate their own liquidity.  Presumably, most jurisdictions already follow the FSB's guidelines, so the framework proposed does not present a major shift for them.

Mandatory minimum haircuts remain an open issue, however.  The FSB is expected to issue final recommendations on haircuts in the spring of 2014.
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