What is LDV ?

Who benefits from LDV?

LDV benefits all participants in the securities finance industry.  Lenders are better able to exercise their corporate governance responsibilities and, since lenders recall fewer loans, overall securities lending volume and revenue increase.  Loan, borrow, and collateral portfolios are more stable, allowing agents and brokers to more effectively manage investment, counterparty, and operational risks.  Corporate issuers receive more proxy votes from long-term investors, allowing them to reach quorum more quickly and at lower cost, and counterbalance votes of short-term activists.  Higher loan volumes also improve financial market liquidity and price discovery.


What is Lender-Directed Voting, or LDV?

LDV is a new process that matches securities lenders' loaned shares to broker securities that would otherwise go unvoted, enabling lenders to direct proxies without recalling loans.  It substantially improves existing market practices, which require lenders to recall loan in order to vote proxies.  Recalls are inefficient in that they reduce overall lending and borrowing revenue, and create instability in loan, borrow, and collateral portfolios. 

Why haven't lenders voted on loaned shares in the past?

Historically, institutional securities lenders had to forgo voting rights on loaned shares because there was no mechanism to vote without recalls.  Recent technology and transparency improvements in securities finance markets, however, enable loaned shares to be matched with broker shares that would otherwise go unvoted.  In particular, the Agent Lender Disclosure Initiative made apparent the direct counterparty relationship between lenders and broker-borrowers and provided brokers with detailed loan data necessary to include lenders in their proxy allocation routines.

Are there enough unvoted shares to cover lender voting interest?

Approximately 60 billion U.S. equities go unvoted each year[1], while roughly 15 billion shares are on loan[2], suggesting that sufficient votes could be available to meet lender vote demand.  However, it is unlikely that lender voting interest will be fully covered for all issues, such as those with particularly contentious proxy events or that are hard-to-borrow in securities lending markets. 

[1] www.broadridge.com/investor–communications /us/Broadridge_Proxy_Stats_2010.pdf
[2] Data from RMA securities lending composite, assuming $20 average stock price

Does the broker have the lender’s shares on the proxy record date?

1.  U.S. Federal Reserve Regulation T (“Reg T”) defines the permitted purposes for the extension of credit in the borrowing and lending of securities. In general, all of these purposes involve settling trades through re-delivery of the borrowed securities. Most often, the broker’s need to borrow has arisen after failing to receive securities required for an impending trade settlement, either as the result of an operational breakdown or after a short sale.

2.  Given the broker-borrower’s mandatory compliance with Reg T, it can be argued that borrowed shares, which are re-delivered in the settlement of a trade, are not available on the broker’s books (as a technical matter, the position would be held at DTCC) in order to earn voting rights on the proxy record date. However, this argument would only be true per se if the settlement took place on the proxy record date, because an analysis of the ongoing process reveals that the proxy votes, not just the entitled shares, are properly treated as fully fungible on the broker-borrower’s books.

3.  Reg T does not require that the borrowed shares be returned to the original lender when a subsequent receipt of securities is used to offset the original failure-to-receive. At that point, the borrower can certainly return the securities to the original lender. Yet, an active borrower can also compliantly decide to close a loan of the same securities with a different institutional lender whose terms may have become less attractive or from another broker-dealer lender who may be viewed as more likely to recall shares at an inconvenient time in the future, especially if the shares were borrowed for an ongoing short position. Still another reason may exist to hold the securities if the broker considers the return on its cash collateral, received through a rebate from the lender, to be very attractive compared with other investment options. In all those cases, as well as for actively traded issues where there may be a high risk of ongoing settlement failures, the broker can simply keep the newly-received shares in its inventory, balanced against its obligation to the lender.

4. As a result of efficient management of its settlement obligations, a broker – perhaps all brokers – may well have borrowed positions on their books on proxy record dates. The brokers would have gained the right to assign proxies or even to vote at the next corporate meeting as a direct result of the original loans from institutional lenders. In effect, the proxies are fungible on the brokers’ books, along with the borrowed shares themselves subject, of course, to an equitable assignment of proxy rights in compliance with stock exchange rules. Yet, brokers are not expressly permitted to assign proxies to their institutional lenders. At this point, the Lender Directed Voting (“LDV”) argument gains relevance and substance.

5. As noted, in addition to holding the shares cum voting rights, the broker also retains an obligation to its original lender. Indeed, one could argue that an institutional lender's ownership rights are stronger than those of other “beneficial owners” to whom the broker owes shares in the same securities. That is partly due to the distinction that can be drawn between the institutional lenders, who do not receive proxy assignments, and the broker’s own margin customers and hedge fund clients, who do receive proxy assignments. The distinction resides in the timeline of their property rights: the former owned the shares fully prior to lending them to the broker, while the latter required broker-financing in order to acquire their positions. Although we have seen that the institution’s shares may now be on the broker’s books, it is very likely that the financing customers’ shares are out on loan, i.e., hypothecated as collateral to source the broker’s own funding needs. And, in such cases, those positions are truly not in the brokers’ DTC account, although the brokers may well be assigning proxy rights to their accountholders. One can ably argue that those proxies would more equitably be assigned to the institutional lenders.

How can lenders instruct broker shares?

Brokers administer proxy allocation routines to distribute proxies to their customers.  Since broker shares are held in fungible bulk and lenders have beneficial ownership to loaned shares, brokers can include lenders in their allocation routines.  After brokers allocate proxies to lenders, standard proxy processes are followed to garner and submit voting instructions and submit them to corporate issuers.  For example, proxies are assigned to Broadridge accounts designated for the lenders, then are instructed by lenders or ISS on the lenders' behalf.

Could lenders also instruct custodians' unvoted shares?

Regulatory and operational considerations may pose challenges to matching custodians' unvoted shares with lenders’ loan positions.  In particular, custodian shares are not held in fungible bulk, as are broker shares, which presents difficulties when considering custodial allocation of proxies across lender accounts. Furthermore, custodians are not counterparties on loans, so the lenders are not beneficial owners to any of the custodians’ unvoted shares.

Does LDV contribute to “over-reporting,” since lenders’ shares were delivered to new buyers who now have the associated voting rights?

Existing proxy reconciliation processes are sufficient to address any potential "over-reporting" issues.  For example, brokers already use post-reconciliation processes to mitigate the risk of over-reporting that may arise from assigning proxies to margin customers whose shares may have been loaned or rehypothecated.

How do brokers decide which lender(s) are assigned proxies?

Beneficial owners and regulators have expressed concerns about voting opportunities being directed to preferred lenders or leveraged for beneficial loan terms.  In the same way that agent lending queues are designed so that lenders get equitable access to borrower demand, brokers need pre-defined and algorithmic “proxy queues” to ensure equitable assignment of voting opportunities.  Furthermore, on-going auditing and validation of proxy assignments may be needed to ensure against development of a “market for votes.” 

What if proxies are not available from a lender's borrower, but are from another broker?

Reallocation of the loans to brokers with available proxies would increase overall lender voting opportunities.  However, numerous other loan factors would need to be taken into account, such as counterparty risk assessments and credit limits, loan prices, and collateral types and quantity.  Considering these factors, loan reallocations may not be in the overall best interest of lenders and borrowers, and will have to be considered on a case-by-case basis.

How can lenders know, before record date, how many proxies they will be assigned?

To the extent that lenders receive proxies through LDV, they will not have to recall loans to regain voting rights.  However, broker holdings change daily and varying numbers of investors vote, so the number of proxies that can be assigned to lenders cannot be known with certainty until just before the meeting date, which is typically two months after lenders must make record date recall decisions.   The number of available proxies must therefore be forecasted, taking into account factors such as each broker's customer base, the scarcity of shares in the securities lending market, and the expected materiality of proxy ballot items.

Corporate Governance Blog

Thursday, January 10, 2019

Taking Stock of Blockchain for Improving Securities Services

Initial hype has ebbed and real progress is being made

The early torrent of media hyperbole about distributed ledger technologies (DLT), such as blockchain and shared ledgers, has now been supplanted by reflection on lessons learned. Scaling concerns were allayed to some degree by DTCC’s November 2018 report that its study of throughput capacity for DLT was sufficient to handle massive U.S. equity trading volumes.

More positive ink came as a group of 15 global banks reportedly eased ahead from initial testing to a planned 2Q19 start date for adopting the newly re-coded $11 trillion Trade Information Warehouse at DTCC, in which IBM created a shared ledger for tracking the lifecycle events of 98% of all credit default swaps.

IBM’s other blockchain projects also showcased their user benefits in 2018, for example, in ventures with Walmart -- to track produce from farm to shelf -- and with Maersk – to track shipping containers from port to port.



Jamie Dimon of JPMorgan Chase reiterated his view that blockchain is “real,” as the bank filed a U.S. patent application in late 2017 for a blockchain-based cross-border payment system. In May 2018, the bank also introduced Dromaius, a blockchained prototype for capital market services.

Northern Trust was awarded two patents in 2018 for elements of its private equity blockchain solution, followed in November by an announcement of the first-ever capital call based on those patents.  

Two more successful blockchain pilots were announced in 2018, for securities loans made by the Dutch banking group ING and by Sberbank, Russia’s largest bank. It’s worth noting, however, that these were plain vanilla repo-type loans in that neither involved equities as collateral.



Not all developments in 2018 were so positive. In March, clouds formed at a major conference in the Bahamas after SEC chairman Clayton said blockchained tokens are securities, effectively killing the planned presentation by Overstock.com of tZero, a crypto-securities exchange. Clearly, the regulation of equity trades, not to mention the ongoing administration and custody of equities were unfamiliar aspects to the assembled blockchain enthusiasts.

Additional challenges were laid out when the Phase II test of a repo blockchain at DTCC failed to meet its goals. In an interview, vice chairman Larry Thompson of DTCC cited insights from that work.

Looking back, the early DLT success stories were based on the use of “permissioned” ledgers, which offer governed transparency while eliminating the time- and resource-consuming authentication process (proof-of-work) used in public blockchains, such as those underlying the Bitcoin and Ethereum cryptocurrencies. For instance, DTCC would retain governance of access to their ledgers, while participants in securities finance markets would have to manage various aspects of “entitlements, KYC and AML checks, data sharing and consensus protocols.” Data retention requirements of up to 10 years can also create capacity problems for shared ledgers with many participants.  

Consultants have piled on, listing problems with the initial DLT concepts for securities finance. But there’s no doubt that the industry is taking on the challenge.



In October, 2018, State Street acquired Charles River Systems, a major front office systems developer, for $2.6 billion in an effort, according to CEO Ron O’Hanley, “to deliver a global front-to-back platform for asset managers and asset owners that will be unique in the investment servicing industry.”

Many elements in DLT will appeal to asset managers, as well as to the enforcement divisions of their regulators. For example, a central feature of shared ledgers is their end-to-end tracking capability, as evident in IBM’s Walmart and Maersk projects. Controlled transparency, as well as tracking is a major attraction in the planned TIW shared ledger at DTCC. Nearly instantaneous updates are sine qua non for peer-to-peer blockchains, which should lower the costs of resolving breaks in the trade reconciliation and proof process.  

Designing client-centric features in DLT requires time and a holistic systems philosophy. The work being done in related areas may pave the way for securities finance, as explained by two executives working “under the hood” on DLT projects at State Street.


"Every step that we're taking is aimed at replacing legacy,” says Frank D’Agnese, Managing Director and Head of Technology for Securities Finance at State Street. “That fits into the overall strategic goals here. Because of the scale of some of the systems we have, we have to run parallel. The trick is to understand how we break up the process. Do we create a new stack and put the clients on it? Do we put a flow on it? Do we put a market on it? That kind of thing. We're still making those choices now."

The operating units within the bank must be equal partners in the systems design process, as explained by Nick Delikaris, Managing Director and Global Head of Trading and Algorithmic Strategies at State Street: "It's not just a Distributed Ledger Technology issue or about any one technology. It's about the entire ecosystem of interconnecting elements that build on one another to facilitate a transformational solution. We need to address how we access different pieces of data shared between many counterparties while also having the appropriate safeguards to ensure compliance from a regulatory standpoint as well as meeting client privacy expectations. These are just some of the topics that need to be addressed to create a robust solution.”

“We expend significant effort to set up appropriate security barriers around our internal network” adds Mr. D’Agnese. “Whether you're writing to an open-source blockchain or you're buying a vendor's solution, security and access take on a different context. Who has the entitlement to write blocks to the chain and access to the authentication mechanisms? Is it a public or a private chain?”



In addition to the internal clients, DLT designers must also work outside the bank. Mr. Delikaris points out that, “With these technologies, we often partner with our clients so the final system is not a surprise.  We go through an engagement process that defines the operating model, details the specifications of the model and, more generally, deals with the most important, and sometimes contentious, issues ahead of implementation.

"To get the full-scale benefits of DLT, you need buy-in from the participants in the broader market depending on the scope of the problem you're trying to solve. Most banks, including us, are implementing DLT solutions internally so we can understand the best practices and implementation details. The next phase involves using this technology in the broader transactional workflow where interaction occurs with external participants, clients and vendors. As you can imagine, that is a tougher path to production because it relies on broad collaboration that can complicate the operating model."

Mr. D’Agnese, State Street’s head of securities finance technology agrees, saying “The nature of technology is very much about collaboration. It's not going to be one magical solution coming from one area of the world. It's going to be really collaborative. I think DTCC, for example, has done a great job because they've been in a good position to bring all the core participants together to help that process along."



There were fears in the early 1970s that securities depositories such as DTCC would put bank custodians out of business. Obviously, that didn’t happen. Current fears that distributed ledger technology will eliminate the need for intermediaries are also unwarranted. History has shown that intermediaries will always find a way to build on new technology and regulation, remaining essential to the investment process. 

“Back in 2015, references to blockchain were always connected with Bitcoin,” according to Mr. Delikaris, State Street’s global head of trading and algorithmic strategies. “As time went on, it became more apparent how powerful this underlying technology is and how broad its application in Finance (and beyond) could be. That realization started a multi-year plan of investigating use cases, prototyping the technology and collaborating with a variety of external entities. Most people understood if they didn’t invest in understanding this technology, they could be left behind, or worse, disintermediated, when it eventually goes into production. We are finally at a point now where you are seeing production systems going live.”



Every production systems investment must gain a return, as suggested by DTCC’s vice chair Mr. Thompson in the earlier cited interview. “We continue to advocate for identifying use cases in areas of the post-trade environment that are either highly manual, or where volumes are small and data models and protocols are standardized.”

Mr. D’Agnese agrees that State Street and others have that goal in focus. “It can be a massive challenge managing a corporate action event. There is a great degree of risk and financial consequence in running a bad election. And across the industry, it is still a fairly manual process. There's a lot of hand-holding.  To the extent that shared ledgers can help track those events in a more automated way to take the risks and costs out of it, that's a big benefit."


This article was reprinted in the January 2018 edition of Global Investor, (c) 2018.

Ed Blount is executive director of the Center for the Study of Financial Market Evolution. As Citibank’s operations head for global securities services in 1974, Mr. Blount set up the first ADR depositary account at DTCC. In 2007, he sold his IT consultancy, now FIS/ASTEC Analytics, to SunGard Data Systems. Since then, Mr. Blount has testified regularly as a capital markets expert before all three branches of the U.S. federal government.


Corporate Outreach Milestones


May 8, 2014: Council of Institutional Investors; - CII Elects New Board, Names Jay Chaudhuri Board Chair. http://www.bloomberg.com/news/2014-01-31/north-carolina-treasurer-may-cede-pension-control-5-questions.html )

February 2014:  Swiss Minder Initiative implies the value of LDV. http://www.ipe.com/switzerlands-minder-initiative-will-cripple-securities-lending-experts-warn/10000947.article.

January 2014FL SBA begins their SecLending Auction Program with eSecLending.

November 27, 2013 – CSFME staff call with Glass Lewis Chief Operating Officer. He gave his commitment for cooperation and support for LDV, and most importantly, he suggested that perhaps we should discuss with a Broadridge/State Street/Citi the scenario that permits Citi to forward an “Omnibus Ballot” of proxies to State Street, which State Street would then take and assign the proxies to their pension lenders/LDV participants, which would then be incorporated into a single ballot and sent to Broadridge. This eliminates the secondary ballot issue. While this description is oversimplified, Glass Lewis was fairly certain the parties involved could operationally create such a combined ballot. Responding to the question on cost, the Glass Lewis executive stated that the cost depends on the number of voting policies a fund has. Most funds have one policy; therefore, depending on the client, the cost would be $.75 – $2.00 per ballot.

October 21, 2013 – CSFME staff call with ISS Chief Operations Officer. He committed his cooperation and support to advance LDV’s implementation into the markets. He responded to the question about cost: “It depends on the client and the services they use. $6-7 per ballot on average.”

June 25-28, 2013 – CSFME staff attended ICGN Annual Conference in NY, NY. Spoke with executives of CalSTRS; ICGN Chair and Blackrock about LDV.  We received favorable comments and encouragement from each.

June 6, 2013: CSFME meets with Chief Investment Officer for NYC Pension Funds. While very much in favor of the LDV concept, the comments that the NYC Pension Fund Boards are for the most part followers in new initiatives and would prefer a roll-out by other funds first.

April 5, 2013: ‘SEC gives CSFME limited approval for LDV going forward’ providing brokers assign proxies only from their proprietary shares.

March 26, 2013 – CSFME and its legal team presented the case for LDV to SEC Commissioner Dan Gallagher. Present by phone and speaking on behalf of LDV were representatives of FL SBA who spoke about the difficulty of timely recall of shares on loan following release of record date and issues on agenda; and a representative from CalSTRS who spoke about their recall policy affecting income.

March 13, 2013 – CSFME meet staff of Senator Rob Portman and Congressman Steve Stivers of Ohio. These meetings were for the purpose of lining up political support, should the SEC resist the LDV concept. We also met and spoke with CII Deputy Director Amy Borrus for one hour and 15 minutes for a scheduled 30 minute meeting.  She expressed great interest in the value of LDV to long-term beneficial owners.

January 17, 2013 – CSFME conference call with CoPERA Director of Investments.  Among CoPERA’s concerns were: (1) How are agents/brokers notified re: LDV? (2) Who moves or approaches first lender to agent or agent to lender? CSFME responds  that a side letter is needed between lender, agent and broker.

November 8, 2012 – CSFME conference call with Council of Institutional Investors (CII) detailing LDV. Some in attendance were opposed to securities lending because of their desire to vote 100% of recall. This position would be irrelevant giving CalSTRS’ change to policy on proxy recall.

October 24, 2012, 2PM – CSFME presents LDV to Broadridge Institutional Investor Group. At this meeting, a representative of CalSTRS states: “We would view brokers willing to provide proxies more favorably than those who would not.” We were also informed by CalSTRS that they were looking to change their 100% recall policy. A representative of SWIB led a discussion on International Voting Issues, and apparently was chairing 3 meetings to determine the following: 1. who is voting internationally? 2. What are the issues in the international markets? 3. How do we increase and improve international processes?

October 24, 2012, 11AM – EWB/KT conference call with ICGN.  Executives stated that the argument for LDV may not be as strong in a non-record date market, and asked what would be the cost for LDV.  They further stated that they would like to see the U.S. go with LDV first and would need more information and operational detail.

October 13, 2012 email note from Elizabeth Danese Mozely to Broadridge’s Institutional Investor Working Group: “TerriJo Saarela, State of Wisconsin Investment Board, will provide commentary on their fund’s interest in international voting and an update on her participation in the Council of Institutional Investors’ working group on international voting.  Our discussion will include the differences in process for voting abroad, share blocking, attendance at the meeting via proxy or Power of Attorney (POA), best practices available through the various laws and regulations, etc.”

September 18, 2012: CSFME contacts Blackrock/ICGN Chair for a brief on LDV.

August 13, 2012 – CSFME conference call with OTPP.  Discussion of LDV was not timely in that their SecLending Program stopped lending securities through agents in mid-2006. State Street is their custodian and they were using a tri-party repo through Chase to Lehman, until the Lehman collapse. All the assets sat at Chase. It was not clear who had voting rights. At the time of this discussion in August 2012, OTPP was thinking formulating an SLA because they do not have the capacity to lend securities on their own. We have had no discussion with them since.

August 2, 2012 – CSFME contacts Ontario Teachers’ Pension Plan (OTPP) regarding LDV.

March 19, 2012 – CSFME conference call with executive in charge of securities lending for Franklin Templeton

February 22, 2012ICGN sends LDV letter of support to the SEC, signed by Chairman of the ICGN Board of Governors.

September 30, 2011CalSTRS sends LDV letter of support to the SEC, signed by Director of Corporate Governance Anne Sheehan.

July 18, 2011Florida SBA sends LDV letter of support to the SEC, signed by Executive Director and Chief Investment Officer.

November 2011 – CSFME introduces Council of Institutional Investors editor to LDV.

July 5, 2011 – CSFME sends a Comment Letter to the Securities and Exchange Commission regarding LDV.

October 2010 – CSFME releases report: Borrowed Proxy Abuse: Real or Not? This report and the SEC’s Securities Lending and Short Selling Roundtable prompted the question from beneficial owners and regulators regarding the need to recall shares on loan to vote proxies, why can’t lenders receive proxies for shares on loan when we get the dividends? From this question, the idea for Lender Directed Voting was born.

January 2010 – SEC issues rules that brokers no longer have the discretion to vote their customers’ shares held in companies without receiving voting instructions from those customers about how to vote them in an election of directors. http://www.sec.gov/investor/alerts/votingrules2010.htm. The rule, periodically, contributed to the difficulty of corporate meetings attaining a quorum.

Fall 2009/2010 – Four public pension funds join CSFME in Empty Voting studies/LDV initiative; FL SBA, CalSTRS, SWIB and CoPERA.

September 29-30, 2009 - SEC Announces Panelists for Securities Lending and Short Sale Roundtable; http://www.sec.gov/news/press/2009/2009-207.htm