Bank of England: sending mixed signals and reading tea leaves in securities lending

Editor’s note: following the publication of this post, discrepancies were pointed out to us between the article on which this post is based and and the text of the actual speech. On March 22 we published a correction and update to the post below. The March 22 post is here.

An article in today’s Financial Times cited Paul Tucker, the Bank of England Deputy Governor, as saying that securities lending by insurance companies should have greater oversight in order to not become a form of shadow banking. We found the article to be confusing and in some cases potentially inaccurate. In particular, we are concerned about Mr. Tucker’s portrayal of what is securities lending and what caused AIG’s securities lending-related losses. On the other hand, we wonder whether his thinking about a trade repository for securities lending transactions makes sense. Our comments follow.

The FT article cites Mr. Tucker as speaking at a London insurance conference and mentioning securities lending possibly becoming a form of shadow banking. Mr. Tucker is also chair of the Committee on Payment and Settlement Systems (CPSS), a frequent partner of IOSCO in producing important recommendations on global clearing and settlement matters. Framing securities lending as a maybe-it-is-or-maybe-it-isn’t creates confusion when spoken by a major global regulator, especially when securities lending has been cited by the Financial Stability Board as in fact being part of shadow banking. Mr. Tucker’s comment begs the question, is securities lending currently shadow banking or isn’t it? If it isn’t, then why is the Financial Stability Board, another CPSS partner, writing about it that way?

Mr. Tucker’s comments that AIG was in part brought down by securities lending perpetuates a false myth. In fact, as is well documented in the press, AIG lost some US$5 billion by investing in subprime mortgage-backed securities in its cash collateral reinvestment pool. Its securities lending program worked fine; its risky bets on cash collateral reinvestment did not work out so well. As regulators delve into the depths of how securities lending works, these distinctions matter. It is disappointing to hear a regulator saying that securities lending toppled AIG. It simply didn’t.

Lastly, Mr. Tucker mentioned a trade repository for securities loans. He didn’t say CCP (thankfully), but the FT article noted that he would like to see the market easier to monitor and regulate. This is a noble goal and one that echoes back to the Fed’s Dec 2011 paper on the nuts and bolts of monitoring securities lending and repo. Is the Bank of England heading in the same direction?

This analysis may be reading into the tea leaves a bit much, but the vagueness of some of Mr. Tucker’s comments left us wishing for a bit more clarity on position and future directions.

The FT article is here.

The Fed’s white paper on monitoring securities lending and repo is here.

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