Our analysis of the FSB’s securities lending and repo policy framework

It’s not the big bang, but there are a number of important points in the new FSB publication, “Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos,” that market practitioners should note.

The document is the FSB’s final round of setting policy recommendations on many securities lending and repo-related topics, following their Nov 2012 document that laid out the main ideas. We provided a summary of the Nov 2012 recommendations here. In addition, this new framework introduces some stronger ideas around minimum haircuts that are still in the consultation stage.

This article highlights just the new and noteworthy parts of the just-released policy framework as a filter. It does not summarize all the recommendations as we found some to be self-evident or repetitive. These are just the highlights.

1) The FSB is putting “high urgency” on data collection, and has formed a new data experts group to work on data collection and aggregation at the global level – recommendations are expected by the end of 2014. Page 9 of the document provides a list of specific data elements that the FSB would like to see; these will come as no surprise to securities finance market participants. The FSB expects to set standards and processes for data collection, and three approaches are proposed in Annex 4. As we’ve discussed in other posts, getting data collection right, and then doing the right analysis, is hard, including transactions related to other asset classes. It will be important to see what the FSB’s data experts come up with.

2) Get ready for trade repositories, which have been long expected: “Trade repositories are likely to be an effective way to collect comprehensive repo and securities lending market data. Regulatory reporting may also be a viable alternative approach.”

3) Collateral re-use (ie, rehypothecation) is going to be a big deal. On the surface, most jurisdictions already follow the FSB’s guidelines and the new framework is no issue. But the FSB is asking if “the re-use of collateral be captured – what type(s) of information would be needed to do so?” This is another side to the EU’s commentary from last week about wanting to limit rehypothecation. For more details see our article, “Is the EU really thinking about restricting collateral chains? Boy, we hope not….” If the data can be captured, then regulators could choose to do something with it, or not.

4) The FSB expects more disclosure at the firm level, including a “’sources and uses of securities collateral’ statement that shows a breakdown of securities that can be delivered as collateral (e.g. securities borrowed, reverse repo securities, client assets with a right of use, collateral received on OTC derivatives) and uses of those securities as collateral (e.g. margin posted on OTC derivatives, repo financing, securities lending or collateral against securities borrowing, margin posted to CCPs).” There is a substantially new amount of disclosure here.

5) In what might be the toughest issue in the framework, the FSB is asking that “securities lending and repo market participants (and, where applicable, their agents) should only take collateral types that they are able following a counterparty failure to: (i) hold for a period without breaching laws or regulations; (ii) value; and (iii) risk manage appropriately.” Taking this to a logical conclusion, if a money market fund puts up cash for overnight sovereign debt repo, the actual sovereign debt collateral would need to fit into the MMFs own regulatory framework. That would eliminate a wide range of collateral options from repo shells based on specific cash provider types. Whether repo dealers, tri-party managers and cash investors could handle this is far from certain. This could get really difficult.

6) The FSB is establishing criteria for securities lending cash collateral reinvestments, but we’re not yet sure if this changes anything that 95% of beneficial owners do today or if there are really new rules here. The FSB is asking for the incorporation of “high level principles; considerations addressing liquidity risk, maturity transformation, concentration and credit risks; implementation guidelines (including recommended metrics for supervisory reporting and monitoring); stress testing and disclosure requirements.” The one new point is how far stress tests go on cash collateral pools.

7) “The securities lender and/or its agent should reinvest the cash collateral in a way that limits the potential for maturity mismatch.” Hmm, that might be tricky, especially if securities lending remains a predominantly overnight market and the supply of overnight investment opportunities is diminished. We can see this clause as really killing the GC market. We’ll have to wait and see how far regulators want to take this point.

8) We think that the rules on rehypothecation of client assets are pretty tame. The main points here are global harmonization of rules and that intermediaries can’t use client assets to generate their own liquidity. Fair enough.

9) As noted in our Thursday August 29 2013 news roundup, one of the meatier points is on securities lending CCPs. “Authorities should evaluate, with a view to mitigating systemic risks, the costs and benefits of proposals to introduce CCPs in their inter-dealer repo markets where CCPs do not exist. Where CCPs exist, authorities should consider the pros and cons of broadening participation, in particular of important funding providers in the repo market.” This is certain to generate substantial debate.

10) The FSB is supporting the idea of a Repo Resolution Authority in case of a counterparty default for the purposes of orderly liquidations. While not a priority for the FSB at this time, this is very interesting stuff, and likely to be taken up by the Federal Reserve in light of their recent report on fire-sale risk.

11) Annex 2 starting on page 22 is a must-read for anyone with interest in the minimum haircut debate. The FSB sets out its key principals, which we have seen before, and proposes some pretty small minimums (for non-CCP transactions only to get started). These figures are even lower than US triparty haircuts for the same assets, making us think that this may all be a moot point and just to set a floor on how low haircuts can go. On the other hand, the FSB gives powers to the BCBS and others to move haircuts to react to procyclicality, and maybe that’s the whole point of the exercise. Securities loans against cash collateral would be exempt from these minimums. Collateral transformations are included.

12) The FSB is paying attention to economically similar transactions with different rules, a recurring issue in regulation and an important point when discussing minimum haircuts: “The FSB highlights the potential for market participants to seek to avoid the proposed numerical haircut floors by booking transactions in different jurisdictions, which can be done relatively easily in these markets. It is therefore highly desirable that the proposed framework is implemented globally.” This gets back to the data collection issue – how will the FSB actually make all of these connections? TBD.

13) The FSB expects to issue final rules on minimum haircuts in the Spring of 2014.

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