Outreach Blog

Friday, October 13, 2023

SEC Adopts Long Awaited Securities Lending Disclosure Rule

Persuasive Public Comment Helps Mold the Final Rule


Author: David Schwartz J.D. CPA

 

The Securities and Exchange Commission (SEC) has adopted a new rule, rule 10c-1, to increase transparency in the securities lending market. The rule requires certain persons to report information about securities loans to a registered national securities association (RNSA). The RNSA will then make certain information publicly available. The final approval of rule 10c-1 follows a twice-extended comment period and is informed by numerous public comment letters and 51 meetings between the SEC and commenters, including one with CSFME. In the release, the Commission was open about the extent to which the comments from the industry changed their thinking between the proposal and the final release and when it influenced the end result. 

 

The Final Rule

The rule addresses the limited availability of public information in the securities lending market. The SEC believes that the lack of transparency can create challenges for borrowers and lenders to determine the state of the market and whether the terms they receive align with market conditions. Moreover, the rule also aims to facilitate the oversight of the securities lending market by the SEC.[1] 

The rule requires covered persons (defined below) to report certain information about securities loans, including the identity of the parties to the loan, the number of securities loaned, the loan rate, and the collateral posted. The rule also requires covered persons to report certain confidential information to the RNSA, such as the borrower's identity and the purpose of the loan (i.e., Reg. T permitted purposes or any other purpose). However, the RNSA will not make this confidential information publicly available.
 

  • Information to be reported: The final rule requires reporting of the following information for each securities loan:
    1. The name of the issuer and ticker symbol of the security.
    2. The date and time the transaction took place.
    3. How the transaction was executed (which platform, if any).
    4. Terms of the lending transaction include the type and amount of collateral used, the associated rebate rates, fees, and charges, the loan duration, and the type of borrower.
    5. Confidential data elements, such as the legal names of the parties to the loan, whether the loan will be used to close out a fail to deliver, and whether a broker-dealer has loaned to a customer from its own inventory.
       
  • Covered persons: The Commission responded to many commenters’ requests, including ICI, Blackrock, MFA, and others, for clarity regarding the market participants that would be required to report securities loans under the rule Commission by defining a “covered person” to be:
     
  1. any person that agrees to a covered securities loan on behalf of a lender (“intermediary”) other than a clearing agency when providing only the functions of a central counterparty or central securities depository;
  2. any person that agrees to a covered securities loan as a lender when an intermediary is not used, unless the borrower is a broker or dealer borrowing fully paid or excess margin securities; or
  3. a broker or dealer when borrowing fully paid or excess margin securities.

What is Public and When?
 

          Transaction-by-transaction data 

  • 11 data elements (excluding the amount) must be made publicly available within one business day of the covered securities loan being effected.
  • The amount of the reportable securities loaned must be made publicly available within 20 business days of the covered securities loan being effected.
  • The same disclosure schedule applies to loan modification data elements.

 

          Aggregated data

  • Information pertaining to the aggregate transaction activity and distribution of loan rates for each reportable security must be made publicly available within one business day of covered securities loans being effected or modified.

 

In other words, the RNSA must disclose detailed information about each individual securities loan on the morning of the next business day, except for the amount loaned, which is disclosed 20 business days later. The RNSA must also disclose aggregated information about all loans for each reportable security on the morning of the next business day.

 

Key Differences from the Proposal

Published in December of 2021, the proposal received considerable public comment, requiring the Commission to extend the initial 30-day comment period twice, once due to a technical problem receiving comments, and then again to consider whether there would be any effects of proposed Rule 13f–2 that the Commission should consider in connection with proposed Rule 10c–1. Throughout the final release, the Commission notes where persuasive public comment informed the ultimate text of the rule.

The following are the key changes to the final rule 10c-1 from the proposing release:

  • Timing of reporting: The final rule requires reporting of loan data elements within one business day of the transaction rather than the proposed reporting timeframe of 15 minutes after the securities loans are effected. The final rule also requires reporting of loan modification data within one business day of the modification.[2]

    This change to the reporting time appears to be responsive to numerous commenters, including ICI, AIMA, State Street, and RMA, who suggested that it would be more practical to adopt end-of-day reporting instead of 15-minute reporting due to the nature of the market. Additionally, the RMA argued that adopting a T+1 standard would address the SEC's transparency concerns, reduce implementation costs, and align with the existing SFTR securities loan reporting regime.
     
  • Scope of persons required to report: The final rule expands the scope of persons required to report to include all persons who agree to a securities loan, regardless of whether they use a broker-dealer or other intermediary. This change is intended to increase transparency in the securities lending market by capturing all parties to a loan transaction. Notably, the final rule allows persons other than banks, brokers, dealers, and clearing agencies to act as intermediaries (i.e., lending agents) and permits covered persons to use third-party vendors to help fulfill their reporting obligation. These elements of the final rule should address some of the implementation costs raised by numerous commenters, including CSFME and ASC, by increasing competition among intermediaries.
     
  • Scope of securities required to be reported: The final rule expands the scope of securities required to be reported to include all securities that are reported or required to be reported to CAT, TRACE, or RTRS, or any reporting system that replaces one of these systems (reportable securities[3]). Commenters like ICI, Citadel, AIMA, and State Street pointed out to the Commission that the proposed rule failed to provide securities lending market participants with clarity regarding the specific types of transactions subject to the rule 10c-1 disclosure regime. They also pointed out substantial uncertainty about the territorial scope of the 10c-1 reporting obligation. This change in the final rule is intended to clarify the scope of the reporting requirement and ensure that all significant securities lending transactions are captured in the reporting system.

The final release introduces the concept of the “covered securities loan,” which refers to a transaction in which one person – either on that person’s own behalf or on behalf of one or more other persons – lends a “reportable security” to another person. The final release adds exclusions for:

  1. positions at a registered clearing agency that result from central counterparty services or central depository services, and
  2. the use of margin securities by a broker or dealer unless such broker or dealer lends such securities to another person.

These exceptions seem to be responsive to commenters who warned the Commission about the treatment of central clearing and loans from customer margin accounts under the proposal. According to the Commission, these exceptions “should help prevent the double counting of securities loans and support the integrity of publicly available data by excluding redundant and potentially misleading information.”[4]
 

  • “Available to loan" and "on loan" amounts: Proposed Rule 10c-1 required that by the end of each business day information concerning securities “on loan” and “available to loan” would be provided to an RNSA and made public. Under the final rule, however, the Commission seems to have been persuaded by commenters, including SIFMA, ICI, MFA, and AIMA, to remove this requirement based on concerns that daily publishing of on-loan and available-to-loan data would expose firm and customer investment strategies. The commenters also noted, consistent with proposed rule 13f-2 with respect to short sale activity, that aggregating collected data prior to publication can significantly reduce the risk of trading strategy leakage.

 

Effective Date

The final rule will be effective 60 days after being published in the Federal Register. The new rule has compliance dates determined as follows, with the first loan reporting required in roughly 26 months’ time:

  1. within four months of the effective date, an RNSA must propose rules;
  2. the proposed RNSA rules must be effective no later than 12 months after the effective date;
  3. starting on the first business day 24 months after the effective date, covered persons must report information required by the rule to an RNSA; and
  4. within 90 calendar days of the reporting date, RNSAs must publicly report information.

 

[1] As directed by the Dodd-Frank Act, the Commission proposed these rules to:

 

  • Supplement publicly available information,
  • Close data gaps in the securities lending market,
  • Minimize information asymmetries between market participants, and
  • Provide market participants with access to pricing and other material information.
     

Section 984 of the Dodd-Frank Act provides the Commission with the authority to increase transparency, among other things, with respect to the loan or borrowing of securities.  It also mandates that the Commission promulgate rules designed to increase the transparency of information available to brokers, dealers, and investors. 

 

[2] The SEC leaves it to the RNSA to define exactly what time is the “end of the business day,” “morning of the business day,” or what holidays should not be considered a “business day,” to give an RNSA the discretion to structure its systems and processes as it sees fit and implement its rules accordingly. (see footnote 72 in the Final Release).

 

[3]  A reportable security is a security for which information is already reported or required to be reported to existing reporting regimes.

[4] See Final Release, p. 86.

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The CSFME’s Regulatory Outreach Programs

Regulatory reform has become a collaborative process. Where once market supervisors promulgated rules without regard for input from practitioners, today’s reform process has evolved into a dialogue of mutual respect for the opinions of all stakeholders in the capital markets. The process of regulatory outreach has become embodied in virtually every developed markets in the world.

The CSFME has adopted a role of facilitating this collaborative dialogue at all stages of the professional contribution process. Starting with students’ contributions to published commentary letters, through panel presentation and webinars, right up to trade association initiatives, the CSFME provides assistance through education, data compilation, analysis and commentary for some of the most pressing issues in contemporary markets.

DLT and Preferred Securities Financing

We believe the widespread use of encrypted third-party ledgers, blockchains, and smart contracts (i.e., DLT) is inevitable in securities finance, and that those technologies will permit lending agents to offer new revenue opportunities to their clients. Among these, we believe that certain agents will use DLT to help their lenders expand their loan books by opening their lendable portfolios on a preferential basis to the hedge funds in which they've already invested, as well as to other trusted counterparties, a concept we have dubbed, “Preferred Securities Financing.”  

CSFME is openly soliciting participation in a research initiative to assess the potential benefits to securities lenders from the use of DLT and data sourced from new regulatory disclosures. Specifically, our research will focus on how DLT, blockchain, and smart contracts can facilitate Preferred Securities Financing.  Learn More about our DLT Securities Finance Initiative

Research and Analysis of the Effects of Financial Regulatory Reforms

Given the sweeping changes in financial market regulation following the financial crisis, CSFME has turned its focus to questions relating to to how these changes are affecting the risks and economics of bank activities. The purpose of the Center’s research in this area is to foster sound policymaking and effective regulation with minimal adverse and unintended consequences. CSFME studies supervision and regulation of global financial institutions, the effects of reregulation on the global financial industry, optimal roles and methods of regulation in securities markets, corporate governance at financial institutions, and the most effective metrics and methods of data collection for understanding and measuring the effects of regulations on the global financial landscape. 

Lately, in response to a call from the FDIC for research on financial sector policy and regulation, the Center submitted a paper modeling the indirect costs to markets of bank regulatory reform.  The paper critiques regulators’ models for assessing these costs, and provides empirically-based suggestions for a more complete dynamic model of the long-term effect of bank capital reform.  Mindful of the Basel Committee's ongoing reviews of modeling tools, i.e., May 2012 and March 2016, the Center's critique is intended as a constructive addition to the holistic conceptual base of the regulatory reforms.

The Center also continues to provide input on regulatory proposals.

In March of 2016, CSFME submitted a comment letter to the Bank for International Settlement's (BIS) December 2015 consultative document regarding step in risk.  While supporting generally the goals of the Basel Committee to minimize the potential systemic implications resulting from situations where banks may choose to provide financial support during periods of financial stress to entities beyond or in the absence of any contractual obligations, the Center expressed some concerns and offered some suggestions regarding the approach taken by the Consultation. Drawing on practical experience, the Center offered an example from the trade finance sector supporting its belief that the nature of step-in risk may be one example of an acceptable, non-diversifiable exposure, given the potential positives for the economy at large.

In February 2015, CSFME submitted a comment letter in response to the Financial Stability Board’s November 2014 consultative document, Standards and Processes for Global Securities Financing Data Collection and Aggregation. In its letter, the Center identified additional metrics that may be necessary to assess properly the risk of collateral fire sales associated with securities lending transactions.  In particular, CSFME asserted that FSB and sovereign regulators must expand the data initiative beyond position aggregates, to include risk mitigation resources as well as termination activity.

Students Learn to Evaluate and Contribute to the Reform Process

As the level of intensity surrounding the reform process continued to build in 2013, the CSFME began to bring a fresh perspective to the reform process. By working with finance students and the US regulatory agencies, CSFME hoped to challenge the settled views of stakeholder by introducing the views of those whose careers would be shaped by the outcome of the reforms.

In the spring of 2013, a select group of Fordham University economics students met in Washington with officials at the U.S. Treasury, Office of Management and Budget, Federal Reserve Board, and the Securities and Exchange Commission. The CSFME helped arrange the meetings and funded the logistics. By all accounts, the experience was very positive for students and regulators alike.

Buidling upon the success of the 2013 pilot program, in 2014, both Fordham and the CSFME decided to expand the outreach program and formalized the Regulatory Outreach for Student Education program as the ROSE program. Honor students in finance and economics were selected by the deans of four schools within the university: the Graduate School of Business Administration, Fordham College at Lincoln Center, the Gabelli School of Business, and Fordham College at Rose Hill. The students were organized into four teams representing their schools. The CSFME selected a contemporary issue of career significance, the Financial Stability Board’s Consultative Document on G-SIFI designation of non-bank, non-insurer financial institutions. Each team was charged with studying the issues in debate, then presenting their opinions in the manner of a formal comment letter to the FSB. Over four months, the students reviewed earlier opinion pieces, met with practitioners and regulators, and then submitted their opinions. Without influencing their opinions, the CSFME arranged access to research materials and opinion leaders, then reviewed their letters and, as appropriate, recommended submission on university letterhead. In April, 2014, the four teams’ letters were published by the FSB on its website. In recent memory, no university had ever had one letter, much less four, published on a regulatory website. To finalize the 2014 ROSE program, the CSFME arranged for all four teams to present their opinions to the key regulators at the Federal Reserve Board and the SEC in Washington, D.C. The day of meetings ended with regulators’ praise at the degree to which the students had understood the issues and presented their opinions clearly.

One student team even offered suggestions that regulators had not previously considered and praised for their creativity. “We always know what the trade groups will say, but you brought a fresh perspective.” That team, Fordham College at Lincoln Center, was awarded the 2014 ROSE Award for Analytic Excellence. In retrospect. each student completed the program with a credit that will not only endure on their resumes but also contribute to the evolution of the financial markets through the Twenty First Century.

In 2015 and 2016, Fordham formalized the ROSE Program as a for-credit course in their curriculum. The focus of the 2016 ROSE Program was the Bank for International Settlement's December 2015 consultative document proposing a preliminary framework for identifying, assessing and addressing step-in risk potentially embedded in banks' relationships with shadow banking entities.  Five teams of graduate and undergraduate students in economics, finance, accounting, management, and law researched and drafted comment letters on the consultation and submitted their letters to a panel of distinguished industry judges.  After reviewing each excellent submission, the judges then one winning letter to be presented at a visit to the Federal Reserve Bank on April 27, 2016. The winning team's letter was submitted in full to the BIS, along with a summary of the key ideas from the letters from each of the other four teams, and the submission was published on the organization's website with those of the consultation's other commenters.   All five teams of Fordham Scholars visited Washington, DC on April 27, 2016 and met with officials at the Fed, Treasury Department, and FINRA.  

Institutional Securities Lenders respond to Academic Criticisms

In 2006 the Center was created, initially for the purpose of testing academic criticisms of the securities lending markets. With funding and data support from the Risk Management Association, CSFME found “no strong evidence to conclude that securities lending programs have been used to any great extent to manipulate proxy votes or exercise undue influence on Corporate Governance issues.” Our study also found that “broker borrowbacks” had contributed to spikes in lending activity around record date – the same phenomenon that the academics had misinterpreted as evidence of hedge fund manipulation – due to the efforts of brokers to meet recall notices from securities lenders. In effect, the brokers were scrambling to acquire votes for their customers, not building positions to swing corporate elections. The academics had fatally misinterpreted their findings!

Ed Blount of CSFME testified at the SEC’s Roundtable on the results of the research in September, 2009. Then, the CSFME white paper, published in 2010, was submitted to the SEC as an attachment in response to a consultative document on the “Proxy Plumbing” process. As a result of the Center’s contribution to the collaborative process, the misguided call for reform of securities lending began to subside. Once again, securities borrowers were fairly recognized to be honest brokers in the corporate governance arena.

Securities Lenders consider new means to retain their Voting Rights

In a follow-up to the Empty Voting project (“Borrowed Proxy Abuse” as it came to be known), the CSFME responded in 2011 to requests by the participating securities lenders, by turning its attention to ways in which those lenders might be able to retain their corporate governance rights, while still benefiting from the income attributable to their securities loans. After all, as many studies have found, securities lending contributes significantly to the efficiency of market operations. Why should lenders be forced to choose between their loan fees and fiduciary duties to vote their shares, especially if they are contributing to market efficiency?? With independent funding, the CSFME retained attorneys from two prestigious Washington D.C. law firms, Stradley Ronon and Sidley Austin, to investigate the legal underpinnings to market practices which force pensions, mutual funds, insurers and other institutional securities lenders to give up their voting rights when they lend portfolio securities. In practice, margin customers of brokers also lend their securities, yet they usually retain voting rights -- and most of them aren’t even long-term beneficial owners. Both groups of beneficial owners retain dividend rights, so why, institutional investors asked, shouldn’t institutions also keep their voting rights? With the benefit of exhaustive legal research, CSFME filed a petition with the Securities & Exchange Commission to initiate a pilot program to test new market procedures by which recently-introduced efficiencies in market operations might permit lender to retain votes.  Learn more about Paradoxical Erosion of Corporate Governance

In 2013, the SEC approved that pilot program, largely in response to the encouraging recommendations of the International Corporate Governance Association, as well as the California State Teachers Retirement System and the Florida State Board of Administration.

That pilot was initiated in 2014. Simultaneously, the CSFME began to apply the results to new initiatives in Canada and Switzerland, where the pressure to meet fiduciary voting obligations was intensifying.  More about Full Entitlement Voting



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