Fran Garritt, director of global markets and securities lending at the Risk Management Association (RMA), explains how the association is working to promote best practices in securities lending as the industry adapts to the evolving regulatory, legal, and tax landscape.
Securities Lending Council
RMA’s Securities Lending Council is made up of representatives from a number of agent lender firms. The Council works closely with the subcommittees to determine key areas of industry concern and the most appropriate means of addressing them. The Council also works closely with other industry groups such as the International Securities Lending Association (ISLA) and the Pan Asia Securities Lending Association (PASLA) to coordinate industry responses to global issues.
The Council, with support from the Legal, Tax, and Regulatory Subcommittee, has worked closely with regulators on the implementation of Single Counterparty Credit Limits (SCCL) in the US. Through these efforts, the finalized version of the SCCL will be significantly less disruptive to the securities lending industry than earlier proposals. Under earlier proposals, a significant amount of loans would have had to be recalled from the largest borrowers.
The Council has also worked on the implementation of Basel III and advocated for a more risk-sensitive standardized approach to calculating credit exposures for securities finance transactions. Through these efforts, the Basel Committee released a new finalized calculation methodology that takes into account the correlation and diversification of lending and collateral portfolios. Once adopted at the jurisdictional level this should result in a reduction in the cost of indemnification for agent lenders.
US and international developments
Over the past year, RMA’s Legal, Tax, and Regulatory Subcommittee (LTR) has focused on determining the impact on the US securities lending industry from recent non-US market developments and regulations. One such development was ISLA’s implementation of the new form GMSLA pledge agreement. This agreement allows borrowers to pledge collateral in support of loans, rather than transferring title to such collateral as was traditionally done under English law. The LTR tracked developments in this space for several years and brought the latest developments to the attention of its participants as they occurred, including when ISLA formally launched the form of agreement in 2018.
Members of the LTR also worked closely with the International Swaps and Derivatives Association (ISDA) and ISLA on the development and implementation of the US Resolution Stay Protocol. Specifically, LTR was instrumental in ensuring that a viable mechanism exists for allowing agents to adhere on behalf of their clients. This change allows agent lenders to efficiently modify their client and borrower agreements using the protocol. The LTR also worked to develop an industry standard form of client consent, expanding an agent lender’s authority to take appropriate resolution-related actions on behalf of its clients. As the applicable US rules come into play for most of the effected market in July 2019, LTR will continue to monitor developments and consider whether industry action is needed to address any unforeseen consequences stemming from the US Resolution Stay Protocol or the adherence process.
Domestically, the US experienced the impact of the first National Day of Mourning to be held in many years. This took place on December 5 2018, in remembrance of former US President George H.W. Bush. Members of the LTR have been working closely with the Securities Industry and Financial Markets Association (SIFMA) and the relevant exchanges and depositories to debrief on the impact of the associated partial market closures. The objective of these discussions is to have an industry consensus as to the best practices for making market closure decisions, taking into consideration all relevant areas of the markets, including securities lending.
In Latin America, RMA has continued to play a significant role in helping to educate our various constituents as well as offer assistance to those local market participants who have requested inputs. In late 2018 we partnered with EquiLend to publish a Latin America Users Guide, which has been met with positive feedback from the industry as a whole. With the help of various RMA members we saw the launch of Peruvian securities lending in April of this year; the Bolsa de Valores de Colombia has reached out to discuss its plans to launch an OTC product; B3 in Brazil continues to be a great partner in the overall efforts; and we continue to liaise with local providers in Mexico as they too contemplate wholesale changes to local securities lending. Lastly, we have been approached by numerous members regarding the formation of a regional securities lending association, an effort we are seriously considering and discussing with relevant parties.
Technology and operations
Much like the rest of the industry, securities lending operations teams are dealing with transformation and change across multiple areas. Most notably, these changes are coming in the form of new technologies, regulatory/market implementations, and industry drives to reduce risk and improve efficiency. Operations has been the front line for many of our firms’ robotics initiatives and is ample ground for machine learning and artificial intelligence (AI). While the regulations continue to settle themselves out, the impact on operations is coming into focus. The Securities Financing Transaction Regulation (SFTR), Central Securities Depositories Regulation (CSDR), and implementation of central counterparties (CCPs) are the most impactful events in the near term, with SFTR potentially having a significant impact on what an operations team is responsible for completing on a daily basis. While there is much occurring in these areas, RMA is focused on moving forward with industry-wide efficiencies across non-cash collateral in the US and in addressing the risk that global corporate actions pose to our firms.
Corporate actions continue to present significant risk to the stock borrow/loan industry, with recent challenges pertaining to exponential increases in event volume and complexity. The industry has seen limited advancement on a strategic solution that would provide enhancements to effectively manage the inherent risk — which makes this an opportunistic time to mobilize and take action. A working group consisting of representatives from the global stock borrow/loan as well as asset servicing communities has been established to identify existing and forthcoming challenges globally; to collaborate among industry leaders to prioritize the greatest areas of risk; to propose strategic enhancements; and to coordinate with industry vendors to build viable solutions. There is a great opportunity to harmonize the demand of the industry for enhancements that effectively manage risk and position the industry for future success.
Over the past year, RMA’s SFTR working group has been coordinating industry updates with ISLA to share information with RMA members, and to help establish global best practices for SFTR trade reporting. The primary issues raised by RMA include identifying trade reporting information dependencies, by both the lenders and borrowers, on the agent lenders, as well as the extraterritorial impact of SFTR trade reporting requirements for out-of-scope lenders (e.g. US-domiciled lenders).
The RMA SFTR working group continues to promote the importance of close coordination across all global trade associations, trade repositories, and vendors to create awareness of potential issues and to agree on SFTR trade reporting interpretations with the goal of minimizing trade reporting failures. This coordination has resulted in ISLA’s development of various securities lending trade reporting intricacies (e.g. timing and life cycle events) for the European Securities and Markets Authority’s (ESMA) consideration, as well as the promotion of ISLA’s efforts to establish best practices for the global securities lending industry. Specifically, issues relating to certain mandatory reporting fields, including the lack of legal entity identifiers (LEIs) for both trading counterparties and securities issuers, have been raised and are in the process of being resolved. Finally, RMA’s SFTR working group has recommended that ISLA consider drafting a standard form of delegated reporting agreement for SFTR market participants to promote consistency and efficiencies to comply with SFTR trade reporting requirements.
The Tax Subcommittee is currently monitoring several recent tax developments affecting the securities lending market. In France, a new withholding tax of 30% on manufactured payments from French borrowers referencing underlying French dividend income is scheduled to take effect on July 1 2019. Although the tax is recoverable if the lender can establish that the transaction’s principal purpose was not tax avoidance, it is still expected to have a negative effect on the supply of French equities to French borrowers over record date.
The Subcommittee is also tracking proposed legislation in Canada that, if enacted, is projected to have an overall positive effect on non-Canadian lenders. Among other provisions, the proposal would exempt manufactured payments paid by Canadian borrowers that reference dividends from non-Canadian securities from Canadian withholding tax. Such payments are currently subject to Canadian withholding tax at a rate of up to 25%, which generally limits the flow of non-Canadian supply to Canadian borrowers.
Aside from recent market developments, the Tax Subcommittee is also finalizing a comment letter to the IRS and Treasury Department to request regulatory guidance on the tax implications of securities lending transactions with a fixed term. These transactions present significant risk to certain securities lenders (e.g. sovereign wealth funds) because of the lack of certainty with respect to their treatment under current US tax law, which diminishes supply and liquidity in a growing segment of the securities lending market.