A look at the RMA response to the FSB paper on shadow banking (Finadium subscribers only)

The comments letters to the FSB on shadow banking are starting to come in. Today we look some of the points made in the January 14, 2013 response from the RMA.

The letter was sent on behalf of several RMA members, including BNY Mellon, BlackRock, Citi, Northern Trust, State Street and others in the agency securities lending markets. It was in response to the FSB consultative document Strengthening Oversight and Regulation of Shadow Banking: A Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos dated November 18, 2012.

The letter starts out by reminding the FSB that sec lending is already subject to extensive regulatory oversight and that Basel III, Dodd-Frank, and European guidelines promulgated by ESMA will only increase the amount of rules and regs the business will be living under. Going further, the RMA said “…because the underlying objective of agency securities lending is to provide relatively low-risk, incremental revenue to the lender, agency securities lending programs are generally conservative in focus and operation…” This is a theme repeated through the letter: please take a look at how we operate; we already do/suffer enough. The RMA urged regulators to beware of “…excessively granular disclosure…”, “…authorities should ensure that funds are not required to disclose specific information that could cause them competitive harm…” and “…the inappropriate imposition of the ‘one size fits all’ standards…” These are all fair points and we agree with the technicalities. But, we wonder if the RMA should take a cue from ISLA and recognize that regulators know a lot of this already; we think the conversation has shifted to “how do we get things done now.”.

The FSB and other regulators favor trade repositories on a broad scale. The RMA took exception, favoring periodic position reports as a way to look at systemic risk vs. trade reporting. The RMA said, “…Transaction reporting would likely also provide excessively granular, and in certain cases, misleading data (e.g., transaction-based reporting could reflect transactions which ultimately don’t settle or the terms of which subsequently change)…:” While trade reporting needs to be carefully implemented to avoid misleading or incomplete data sets and achieve data that actually says something, we are inclined to think the RMA might have a losing argument on their hands. Third party vendors (EquiLend, Markit and SunGard) collect exposure data for benchmarking and other purposes – but it doesn’t connect the dots in a way that is always very useful for regulators. The RMA believes “…these vendor relationships could be leveraged to create an exposure reporting system without the need to build a separate transaction reporting system…” That sounds right, but why stop at periodic risk reports when it could evolve into a full-blown trade repository? Maybe this is a question of public transparency vs. regulatory transparency, where the former is harmful but the latter is fine.

Not surprisingly, the RMA came out against minimum haircuts. The RMA noted that the FSB already recommended exempting “demand-driven” cash collateralized securities lending activity from minimum haircuts. But the RMA advocated including agency repo trades as well as non-cash collateralized trading too. Given that lenders (of securities) already receive overcollateralization of 2% to 10%, trades are marked to market daily, lenders are typically indemnified against borrower default, and regulators already impose regulatory and capital requirements on the activity, the RMA felt minimum haircuts was a bridge too far. Adding insult to injury could be Dodd-Frank 165(e) and Section 610 exposure limits constraints that will serve to limit systemic risk. Finally, the RMA suggests that since sec lending banks are likely to be subject to FDIC Orderly Liquidation Authority (OLA) rules, that the risk of a default creating systemic issues are remote. We agree that all of this regulation and market practices will make sec lending resilient to financial shocks. However the banks aren’t done yet in their efforts to loosen up or remove some of these provisions. We concur that minimum haircuts are a bad idea, but wonder if lobbyists will double back and contradict some of the RMA’s points later.

The RMA repeatedly argued that client’s risk appetites differ, so applying a “one size fits all” approach does the market a disservice. Whether on cash reinvestment or what constitutes “acceptable collateral”, the RMA pushed an agenda which allows clients to modulate the amount of risk they want to take vs. the FSB approach of regulators protecting clients from themselves.

The FSB consultative document was thought out and clearly written by people with a deep understanding of the securities lending and repo markets. Likewise, the RMA’s response was also well considered, although in places it read a bit like the “lady doth protest too much”. The RMA makes great points – there is no doubt about that – but we really do wonder about the strategic direction they have taken. The debate is hardly over.

A link to the FSB paper “Strengthening Oversight and Regulation of Shadow Banking: A Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos” is here. 

A link to the RMA letter is here.

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