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Regulatory burden is the main concern for RMA
07 September 2011
As a series of regulatory developments start to affect the securities lending, the Risk Management Association’s director of securities lending and market risk, Christopher Kunkle, explains how the sector will cope. Annabelle Palmer reports
Global Investor/isf: There are a vast number of
regulatory developments for the financial sector now - which is
the most important for the securities lending industry?
Chris Kunkle: They are all important. The
reason we decided to have a regulatory front-end to the
conference is because theres so much occurring in the US,
Europe, and Asia at the moment. Were looking at how
regulations could negatively affect the securities lending
industry, what could be misunderstood or misinterpreted, and
how securities lending relates to various other industries such
as the short selling and the prime brokerage industries.
With respect to the Dodd-Frank
regulation, we have worked hard with the Securities and Exchange
Commission (SEC), as has the Securities Industry and Financial
Markets Association (SIFMA) and others, to help them
understand securities lending so we dont get an
uninformed policy affecting the business. That has been very
Another concern is
the Federal Deposit Insurance
Corporations (FDIC) Orderly
Liquidation Authority (OLA). If there is a default of
systemically important financial institutions there are certain
requirements for the liquidation of collateral. Securities
lending may fall into this and OLAs stay provision means
a court, or creditor, could hold up the ability to liquidate
collateral. The collateral could drop in value so you
dont want it held for a day or five days. Thats a
fairly significant issue.
Is there a possibility that these developments will
coalesce into a global regulatory standard?
Basel III is a generally accepted financial standard in the
banking arena. And theInternational Organisation of
Securities Commissions in Spain has representatives from
various exchanges and regulators that participate on its board
as part of a global regulatory process.
Global regulatory standards are not there yet, but various
regulators do look at what is going on with other regulators.
The Fed watches what goes on in London, London watches what
goes on in the Fed, and Asian regulators look to see what the
SEC is considering in terms of securities finance regulation.
But I dont know if they are perfectly correlating.
Stability Board is also an organisation that is also going
to affect global coordination from a regulatory
Are central clearing counterparties (CCPs) a positive
development? Can they mitigate counterparty risk in securities
We are all still learning about CCPS. You see a lot of
a discussion about them, but are they driving away the
bilateral securities lending arrangement? And will they fully
replace that? I dont think so.
Its not that I dont want them to succeed but I
dont think they have proven they mitigate risk yet. Some
lenders have a relationship where they have to go to a
participant that can clear on the central clearing counterparty
and hence you are actually still doing a bilateral arrangement
with the people that then trade into the underlying CCP. I
think a lot of learning still needs to be done.
Also, the idea that both the borrower and lender provide margin
to the CCP, in the form of additional collateral, does not make
sense to the beneficial owner and will be a hard sell.
So beneficial owners are not too happy about it
They wont do it if they have to provide an
additional margin and their by-laws may not even permit that.
They dont have to do it in a bilateral arrangement right
now. Go tell a large mutual fund or pension fund: you are
going to have to provide additional 102% collateral into the
CCP. Its not going to go down well.
Also, prove to me in a massive default, or even a slight
default, that a CCP is better at liquidating. A CCP
doesnt have capital so who are you going to go to? All of
your participants?I am neither for CCPs nor against them. They
had just better prove where they are going to mitigate risk and
Is securities lending risky?
If you lend securities and take cash collateral, the cash
collateral has to be invested. In the 2008 liquidity crisis
problems occurred. You have several lawsuits going on right now
because clients lost money. Many invested according to proper
guidelines but if they had a portion of broker paper, such as
Lehman or structured investment vehicles (SIVs) they took a
Remember that SIVs were in the portfolios of a majority of US
money market funds under 2(a)-7 guidelines and they were
acceptable investments in those vehicles. This was not a
securities lending investment pushing some outer realm of
Did people understand the risks at that time?
I came from a client relationship management
background and I feel my clients and other agents clients
were firmly aware of what they were doing. I know at several
firms I have been at, we went out of our way to make people
understand where their money was being reinvested.
How do you compare what happened in 2008 with the
collateral reinvestment problems that happened in 1994 with the
collar and cap mortgages?
I think it was drastically different. In the early 1990s there
were sometimes not comprehensive investment guidelines in place
and investments may have exceeded product guidelines. In 2007,
these investments were clearly mandated in investment
agreements and clients were aware that these investments were
In 1994 the securities lending industry learned a lesson. It
got improved investment guidelines and, worked with clients to
understand them. In 2007 to 2008 the liquidity crisis
exacerbated the ability to liquidate investments, whereas in
1994 those investments that had issued guidelines were most
likely too aggressive.
Is the prolonged low interest rate environment a
problem for the securities lending sector?
It hurts US government lending. It hurts long bond
government investing. With interest rates so flat it makes it
hard to help clients make a profit in their government
investments. However, it is more value-based, intrinsic lending
than volume- based lending now. Back in the day many used to
lend a lot of assets. Now you are lending assets that are
intrinsically beneficial and I think that can be a good
The world has woken up a little on the equity books. Equity
lending is more driven because people are lending equities to
cover for strategies or to cover shorts, not just to generate
additional investment, and revenue, from collateral
So equities are more appealing than fixed income from a
collateral reinvestment perspective?
Well corporate bond lending has continued to do well
but low interest rates do make equities more attractive from an
intrinsic revenue standpoint. At the moment when you put out
equity there is high demand for a specific trade going on. It
is more lucrative for the client and you can help the client
make more on their portfolio.
The scary part here is now you have a volatile equity economy
and you have an interest rate that is very low, so the
conundrum for any investor is where do you put your money?
Thats why companies are hoarding so much cash.
Has market volatility changed the US use of cash in
I dont think its changed our use of cash.
I think there is an extra eye on the safety of reinvestment but
yields are so flat that you really have to find value in the
demand of that security as opposed to the reinvestment.
Overnight repo is a safe investment for the most part but that
has a low yield too. So you have to make sure you get your
security priced well. If you are not getting much on the
loan, you are not getting much in the reinvestments, and it is
sometimes not worth the risks of putting on the loan.
What other market conditions are affecting the demand
The short selling bans mean that there are stocks that
are not being borrowed to cover shorts. So thats
something that is and could continue to affect securities
lending income. The tough thing about short selling bans is
at least with the US ban after the financial crisis
it doesnt work. The US short selling ban was a
reactionary move and when you looked at the numbers afterwards,
it didnt help stock volatility that much.