Clarifying the WSJ article on seclending and repo term changes (Premium Content)

The Wall Street Journal released an article yesterday, “Regulators Call for Short-Term Loan Changes to Handle ‘Too-Big-to-Fail’“, that may have seemed alarmist. It’s not. Here’s what’s going on.

The article says “Under the changes proposed, firms trading with a troubled financial institution would agree to temporary waivers of certain contractual rights they currently enjoy, such as the ability to terminate their contracts early, buying regulators and the firm time to arrange a lifeline.”

This is just an expansion of what’s already in Dodd-Frank to a more global conversation. As part of Dodd-Frank’s Orderly Liquidation Authority (OLA) and what we’ve seen so far in European crisis management proposals, governments can take over a failed or failing financial institution. In 2012 we co-wrote a paper with BNY Mellon on this topic. We cite it here because frankly, not that much has changed. At the time, we said:

“In spite of the unknowns, OLA appears to be an area of Dodd-Frank that offers some benefits to financial markets including securities lending. While exact details remain to be seen, the following are now clear:

• Securities loans are considered qualified financial contracts regardless of collateral type along with defined rights for holders of those contracts.
• There is a reasonable probability that overcollateralized qualified financial contracts would be transferred to a solvent bridge company.
• The orderly unwind process of OLA provides some assurance to the financial markets that securities lending contracts will be maintained with a government established bridge company or another creditworthy counterparty.
• The one day stay applies to all loans regardless of collateral and is an improvement over current SIPA proceedings for loans collateralized by securities.

The FDIC rulemaking process with respect to OLA continues and there are a significant amount of regulations still to be written. Those regulations will need to be evaluated as they are produced in order to determine the full impact of the OLA provisions. In addition, how those regulations are implemented by the FDIC will also have an impact. Still, the significant power granted to the FDIC under OLA and the fact that this will be an administrative rather than a judicial process places a premium on obtaining answers that are favorable to securities lending.”

This paper is no longer online and has been updated by other documents. However, there does not appear to have been any significant forward movement by US regulators in clarifying some of the uncertainties above.

The WSJ article is referring to this same conversation being had by global regulators. It’s no change from what we’ve known since 2010 and 2011; the difference is that the Financial Stability Board is looking at the issue and working on a global solution. We expect it will look a lot like OLA in the end, and be similar to liquidation stays already in place for OTC derivative contracts. As the WSJ article notes:

“Now, regulators want firms to apply similar changes to the key short-term contracts like repos and securities lending agreements, said industry executives involved in the discussions. ‘Work is under way amongst market participants to expand the process to other types of contracts,’ said Eva Hüpkes, adviser to the secretariat of the Basel, Switzerland-based Financial Stability Board….”

We are very pleased to see securities lending and repo in the news, and the WSJ has done a great job lately in their coverage. We just want to keep the conversation balanced.

Securities Finance Monitor has been documenting the evolution of this conversation for some years. For those interested and concerned, we recommend for further reading:

Will automatic stays on securities financing trade defaults really help? We doubt it. – March 12, 2015

Regulators ask for ISDA to delay derivatives liquidations; is repo next? – November 11, 2013

Understanding the difference between SIPC and OLA stays to securities lending transactions – February 26, 2012

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