Following her participation at IMN’s Beneficial Asset Holder conference in Arizona this past January, we invited Anita Ryan from eSecLending to comment on the differences between stays to securities lending transactions with US counterparties under the Securities Investor Protection Corporation (“SIPC”) and the Orderly Liquidation Authority (“OLA”). Anita writes:
Securities lending and repo transactions fall within the category of “qualified financial contracts” and as such, are exempted from the automatic stay under U.S. bankruptcy laws. This means that when a borrower or repo counterparty becomes insolvent, the lender/buyer can immediately “close out” the transactions, i.e., seize and/or liquidate the collateral to satisfy the repurchase price or to purchase replacement securities. There are two exceptions to this treatment – the SIPC stay and the OLA stay.
Upon the insolvency of a U.S. broker dealer that is a SIPC member, SIPC can apply to federal court for a stay that prevents the lender or repo counterparty from liquidating non-cash collateral posted by the broker dealer. The SIPC stay could last weeks, as it did in Lehman’s default, and in so doing, imposes market risk on counterparties. Those seeking relief from the SIPC stay can apply to have it lifted but that can take several days. While this SIPC stay sounds severe, why hasn’t it been more of a material issue for our industry? I suggest two primary reasons. First, it only impacts non-cash collateral and since the U.S. securities lending market is predominately versus cash, most of the lending market has not been materially impacted whenever the SIPC stay has applied. Second, the timing of some recent SIPC stays have enabled counterparties to close out their exposures before the stay began. In the case of Lehman Brothers Inc., the U.S. broker-dealer, the SIPC stay did not commence until Friday September 19, 2008, which was the end of the week in 2008 that started with the Monday insolvencies of Lehman Brothers Holdings Inc. and Lehman’s European entities. This timing allowed those with overnight or “open” exposure to LBI to end their loans or repo trades before SIPC applied for and obtained a stay.
While SIPC stays are nothing new for our industry, the same cannot be said for the OLA stay. OLA is the government’s reaction to the dilemma it faced between bailing Lehman out or letting it fail. Enacted as part of Dodd-Frank, the OLA process can be applied to a variety of non-bank financial institutions in the U.S., most notably broker-dealers, and is triggered when certain federal regulators affirmatively recommend, and the Treasury Security determines, that the OLA process should be used for an entity whose failure would pose a significant risk to the stability of the U.S. economy. When the OLA process is triggered, the FDIC is appointed receiver and counterparties are precluded from declaring an event of default and closing out qualified financial contracts based on the receivership or insolvency until 5 p.m. the next business day, at which point the stay expires or the contracts have been transferred to a bridge entity. Once the FDIC is appointed receiver, all delivery and payment obligations of either party are suspended until the earlier of (i) the end of the OLA stay period or (ii) notice from the FDIC that the qualified financial contracts have been transferred to a bridge entity, thereby precluding terminations based on performance failures during some or all of the stay period.
Can both a SIPC stay and an OLA stay apply? No, Dodd-Frank mandates that the OLA stay would trump a SIPC stay, meaning a broker-dealer placed under the OLA process would be subject to the one day stay rather than a longer stay period allowed under SIPC.
Anita Bapooji Ryan
This material is for information purposes only and does not constitute legal, tax or investment advice. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.