Outreach Blog

Sunday, November 21, 2021

SEC Proposes Sweeping Securities Lending Disclosure Rules

Bringing Securities Lending Out of the Dark.


Author: David Schwartz J.D. CPA

On November 18, 2021, the Securities and Exchange Commission (SEC)  proposed broad disclosure rules intended to "provide transparency in the securities lending market." As directed by the Dodd-Frank Act[1], the Commission proposed these rules to:

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

Further, the data elements proposed to be collected are intended to provide regulators with the information necessary to perform effective market surveillance. "This proposal would bring securities lending out of the dark," according to SEC Chair Gary Gensler.

 

Reporting by all lenders and their agents.

 

Proposed Exchange Act Rule 10c-1 would require all lenders to report within 15 minutes of clearing a list of material terms of each securities lending transaction to a "registered national securities association," (RNSA) namely, the Financial Industry Regulatory Authority (FINRA). In turn, FINRA would make some of this information available to the general public.[2] In addition, the proposed rule would require lenders to report at the end of each trading day the total number of shares they have lent in each security and the number of shares they have available to borrow. The focus of proposed Rule 10c-1 is on lenders only. 

 

"The Commission preliminarily believes that any person that loans a security on behalf of itself or another person, which would include banks, insurance companies, and pension plans, should be required to provide the material terms of lending transactions to ensure that proposed Rule 10c-1 is appropriately designed to increase the transparency of information available to brokers, dealers, and investors, with respect to the loan or borrowing of securities." [3]

 

Although the proposed rule places an obligation on "each person that loans a security on behalf of itself or another person to provide information to an RNSA," if a lender/beneficial owner is using a lending agent, the lending agent would have the obligation to provide the 10c-1 information to an RNSA on behalf of the lender/beneficial owner.[4]

 

Public and Non-public Disclosures

 

The disclosures that would be required for each lending transaction include (1) information identifying the securities lent (i.e., the name of the issuer and ticker symbol, or ISIN, or CUSIP); (2) the date and time the transaction took place; (3) how it was executed (which platform, if any); and (4) terms of the lending transaction, including the type and amount of collateral used, the associated rebate rates, fees, and charges, duration of the loan, and type of borrower. The Commission proposes that all of this information would be made available to the public through FINRA. The Commission also proposes to collect some information that would not be publicly disclosed. This includes 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. 

 

A different approach from the EU.

 

The SEC has taken a somewhat different approach to securities lending disclosure than their regulatory counterparts in Europe. Foremost is scope. The SEC's proposal is strictly limited to securities lending transactions. SFTR applies broadly to all securities financing transactions, including repurchase transactions and secured loans (repos), buy/sell-backs, securities lending and borrowing, commodities lending and borrowing, and margin lending. As proposed, Rule 10c-1 would apply only to lenders or their agents. In contrast, the EU's Securities Finance Transaction Regulation (SFTR) requires reporting from both borrower and lender counterparties (explicitly excluding agents), introducing some messy reconciliation and double-counting issues that the SEC has avoided with its approach.[5] Also, the SEC proposes to collect only a dozen or so material data points for each transaction, while SFTR requires 153. The Commission also chose to make more of the data collected available directly to the public and more quickly. Raw SFTR data is only available to approved trade repositories and regulators, and the public can only access aggregated data on a rolling monthly basis. 

 

SEC responds to its mandate under Dodd-Frank.

 

The specific approach taken by the SEC is a direct response to the mandate given to the agency under Section 984b of the Dodd-Frank Act. The language of the statute required the Commission to "promulgate rules designed to increase the transparency of information available to brokers, dealers, and investors, with respect to loan or borrowing securities."  While SFTR focuses on providing regulators information to monitor the concentration of leverage and potential points of failure, the SEC's proposal follows its mandate to provide better data to the broader audience of investors, market participants, and regulators. 

 

Securities lending transparency and GameStop. 

 

The Commission intends the proposed securities lending disclosure to give both market participants and regulators a better handle on market conditions like those present in last year's GameStop squeeze.[6]  As New York Stock Exchange Chief Operating Officer Michael Blaugrund said in recent Congressional testimony,

 "[a] system that anonymously published the material terms for each stock loan would provide the necessary data to understand shifts in short-selling activity while protecting the intellectual property of individual market participants." [7]

 

A global move to more securities lending transparency.

 

The Commission's proposal is consistent with the FSB's and G-20's policy objectives for securities financing transaction (SFT) data collection. In November 2015, the FSB published the consultation paper, "Standards and Processes for Global Securities Financing Data Collection and Aggregation," building on policy recommendations to address financial stability risks in SFTs, particularly recommendations to improve the transparency of securities financing markets. The FSB followed up with the 2018 publication of "Securities Financing Transactions Reporting Guidelines" with greater specification of the kinds and types of SFT data desired. Capturing position-level data has been the focus since the inception of the SFT data collection initiative. The Commission's proposal is a step toward the FSB's vision for enhancing the ability of regulators "to oversee [securities finance transactions] that are vital to fair, orderly, and efficient markets." [8]

 

A short 30-day comment period.

 

Given the scope and potential effects of this proposal, comments will no doubt be plentiful. The Commission has opted for a short 30-day comment period. The abbreviated comment period indicates that the SEC would like to move on finalizing the regulations quickly. It may also suggest that the Commission does not anticipate making any significant changes to the proposal. 

 


 

[1] Pub. L. 111-203, 984(b), 124 Stat 1376 (2010) 

 

[2] The Proposing Release requests explicitly feedback on how much data reported to FINRA should be made public. Proposing Release Para. 70 at p. 75.

 

[3] Proposing Release at pp. 22-23. 

 

[4] Proposing Release at p. 78.

 

[5] Because of its broad scope and the transnational nature of securities finance, it can be challenging to determine which parties fall in the scope of SFTR reporting. See e.g., ICMA, "Are you obliged to report under SFTR? A checklist for non-European firms," Dec. 2020. 

In general, the following counterparties are considered "in-scope" of SFTR:

  • European Union (EU) counterparties
  • Non-financial counterparties
  • Financial counterparties
  • Any branches of EU entities domiciled outside the EU
  • Any branches of non-EU entities located in the EU

 

In addition, SFTR interpretations have created some broad exclusions freeing large numbers of counterparties from the scope of SFTR. For example, the European Commission and ESMA have confirmed that non-EU hedge funds (i.e., AIFs not established in the EU), are not subject to the reporting obligations of SFTR, even if their manager/advisor is authorized or registered under AIFMD, "except in respect of SFTs concluded in the course of the operations of a branch in the Union of the non-EU AIF", which will rarely apply.

 

[6] Notably, FINRA recently proposed Regulatory Notice 21-19, expanding short-selling disclosure. Short Interest Position Reporting Enhancements and Other Changes Related to Short Sale Reporting

 

[7] See Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part II: Hearing Before the H. Comm. on Fin. Serv., 117th Cong. (2021). 

 

[8] Proposing Release, p. 9. 

 

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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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