The SEC has proposed a radical and potentially very costly reporting regime for securities finance transactions to increase transparency "to brokers, dealers, and investors." Notably, the rule release's[1] extensive economic analysis section includes some potential alternatives to the proposed new reporting structure. While there is no requirement for the Commission to discuss or examine the economic effects of regulatory alternatives[2], in this case, they have presumably listed these particular options to focus potential commenters on specific ideas they want explored.
By merely posing these potential alterations without further discussion, the proposal seemingly outsources the economic analysis of its suggested alternatives to industry commenters. Also, by doing so, the Commission has hinted it is interested in hearing about well-supported alternatives, and may even be inviting counter-proposals. The alternatives offered by the Commission to its proposal fall into four broad categories:
- Options for the timing and scope of reporting and the extent of public disclosure;
- Alternatives for who is responsible for reporting;
- Alternatives to the entity to whom reports are made (i.e., RNSA, the Commission, or an NMS Plan entity); and
- The data holding period and financing options for RNSAs. [3]
In addition to these options, the Commission has posed 97 questions on every aspect of their proposed reporting and disclosure regime, including mechanics, potential costs, and benefits. An effective industry counter-proposal will have to be responsive to those questions, address the same disclosure aims as Rule 10c-1, and fall within the scope of the options the Commission has said it is open to considering.
Lenders Should have their Say.
Lenders bear the ultimate costs of implementing and maintaining the proposed 10c-1 disclosure regime. Modifying the proposal to increase the benefits lenders take from 10c-1 would be a fairer trade-off for the regulatory expenses they bear and perhaps offset to some extent the unfair distribution of compliance costs. Surely those who shoulder the brunt of the regulatory cost but little of the benefit of mandatory transparency are entitled to propose alterations of or alternatives to the proposed 10c-1 plan that may balance the benefits a little more or distribute the costs more equitably.
Making Mandatory Transparency More Valuable to Lenders
The information disclosed under rule 10c-1 would be too limited to provide much additional value to lenders. The data collected by an RNSA would not be sufficient to build peer groups for performance measurement and is not granular enough to assist with counterparty credit risk management. Lenders currently pay data providers and consultants for these metrics in exchange for their transaction data. One option that meets the transparency aims of Rule 10c-1 while simultaneously increasing the benefit to lenders is to expand the scope of data reported for each lending transaction. At first blush, that may sound even more burdensome. But, if lenders could pool their data for their own uses while still meeting their obligations under Rule 10c-1, they could:
- stop paying data providers to aggregate and analyze their data,
- use the pooled data to do end-to-end mapping,
- generate reliable proxy voting metrics,
- create peer groups for performance metrics,
- employ the mapped data to integrate ESG strategies into their securities lending programs, and
- validate the bona fides of their cross-border lending transactions.
The potential reductions in the costs associated with counterparty risk alone would be valuable enough to lenders to make this option worth financing and pursuing. Once a competitive feature offered by lending agents, bank capital charges have made borrower default indemnification an add-on, with the premiums paid by the lenders.
“Wisely and slow; they stumble that run fast.” [4]
With a 30-day comment period, the industry is working with one hand tied behind its back. Robust analysis takes time. And less than a month before the proposal's comment period closes, the industry groups representing the securities lending industry's biggest players have already petitioned the SEC for more time.
"Given the breadth of the vast new requirements proposed for the securities lending markets and the potential costs that they may impose on a broad range of participants in these markets, the Commission by providing only a 30-day comment period does not afford the public enough time to properly evaluate the Proposal." [5]
The Commission has indicated that it is open to alternatives. Lenders and agents can make a case for a more evenhanded distribution of costs and benefits that still achieves the Commission's regulatory aims without a radical rewrite of Rule 10c-1. However, because the SEC's rule 10c-1 proposal has outsourced the economic analysis of alternatives to the industry, we will need a little more time to make the case.
[1] Reporting of Securities Loans, Rel. No. 34-93613, 86 Fed.Reg. 69802 (proposed November 18, 2021),(codified at 17 CFR 240). ("Proposing Release").
[2] Executive Order (EO) 12866 states that agencies should assess the costs and benefits of regulatory alternatives. However, as an independent regulatory agency, the Commission is not legally bound by the requirements of EO 12866. Nonetheless, in some rule proposals, the Commission has discussed the costs and benefits of proposed alternatives.
[3] Proposing Release, 86 Fed.Reg. 69802, at 69845-50
[4] William Shakespeare, Romeo and Juliet, Act 2, scene 2.
[5] The Securities Industry and Financial Markets Association, The SIFMA Asset Management Group, The Risk Management Association, The Managed Funds Association, The Investment Company Institute, The Investment Adviser Association, and The Security Traders Association, November 23, 2021, https://www.sec.gov/comments/s7-18-21/s71821-9402961-262828.pdf
See also, Chris Iacovella, Chief Executive Officer, American Securities Association, December 2, 2021; and John L. Thorton, Co-Chair, Hal S. Scott, President, R. Glenn Hubbard, Co-Chair, Committee on Capital Markets Regulation, December 6, 2021.