Securities Lending Technology
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Transparency Taking Hold
Demands for greater disclosure are altering securities lending market
July 10, 2006
Custodian banks acting as agent lenders in securities finance transactions are facing increased calls for transparency from borrowers and lenders. Broker-dealers are feeling similar pressures from regulators. These demands are prompting agent lenders to add to the services and information they provide to customers and trading counterparties at the same time that their margins on so-called plain vanilla transactions are being squeezed.
In securities lending, transparency takes two forms, with automation an ingredient in both. One calls for understanding a transaction's terms and risk, including the price at which the securities were borrowed. The second is the disclosure of the underlying lender and the borrower of the securities.
"Transparency has increased with regard to
underlying lenders and separately with regard to the risk and
reward of the securities lending transaction, but there is no link
between the two elements," explains Paul Wilson, SVP and director
of securities lending in London for the JP Morgan Worldwide
Securities Services unit of JP Morgan Chase & Co.
Broker-dealers now calculate regulatory capital on an agency basis--or the exposure related to the entire loan amount for a particular security received from the agent lender--since current industry practices prevent the broker-dealer from knowing the underlying principals who supplied the securities through the agent lender. As a result, they can't determine their capital exposure to each principal lender. This will largely change under the agency lending disclosure (ALD) initiative, which will be fully in place by Oct. 1. As part of this initiative, the Securities and Exchange Commission, New York Stock Exchange and National Association of Securities Dealers have reinterpreted broker-dealer recordkeeping and regulatory capital requirements and will now ask brokers to calculate credit limits and regulatory capital charges based upon the underlying lender.
Since the first phase of ALD went into effect in September 2005, borrowers have had to prequalify the principal lender and then confirm this qualification with the agent lender before trading. Agent lenders then have to disclose the lender's legal name and tax identification number to the broker-dealer's credit department, along with any other information the credit department requests. With the second-phase deadline in October, the agent lender will have to transmit the type of securities and the number of shares loaned, the loan's current mark-to-market value, the loans returned and the posted collateral.
Global consultancy Capco, which is the project manager for an industrywide ALD task force in the U.S., estimates that up to 130 lending agents and borrowers will be affected. Each lending agent represents an average of 300 principal lenders.
ALD as Catalyst
"Agency lending disclosure has been a catalyst for addressing the issue of transparency," says Dave DiNardo, manager of product development and project management in the global securities lending unit of Mellon Financial Corp. in Pittsburgh. "Gathering the information on principal lenders from several departments was burdensome. But the most time-consuming part of the new SEC interpretation is getting agreement on standard message formats and files between broker-dealers and custodian banks."
Many banks and brokerages will use either a communications hub from the Depository Trust & Clearing Corp., SunGard Securities Finance's Loanet or the EquiLend Holdings platform to share details of underlying lenders and securities with one another. Loanet recently added a module that calculates credit limits and regulatory capital charges, and John Grimaldi, the SunGard EVP in charge of the product, says, "We have created a full-blown solution that enables broker-dealers and custodian banks to reduce the amount of work they have to do in reconciling positions held on lent securities."
