Participants:

Alastair O’Dell, Global Investor/ISF, chair
Craig Starble, chief executive, eSecLending
John Griffin, senior risk manager and head of derivatives & trading counterparties, Himco
Tred McIntire, managing director, Goldman Sachs Agency Lending
Doug Brown, managing director, Americas sales and relationship management, State Street
Mike McAuley , managing director and global head of product and strategy, BNY Mellon


Chair: What is the most important regulatory issue at the present time?

Tred McIntire: Regulation is definitely at the top of everybody’s mind, from the Financial Stability Board (FSB) shadow banking taskforce’s policy recommendations published in August, to the final Basel III rules coming into effect, to Dodd-Frank.

We think that the final Basel III rules and risk-weighted asset calculations are one of the more important new regulations with potential impact to the lending community. An important takeaway from the October RMA Conference was the discussion of how this element of Basel III may impact the way agents look to indemnify against borrower default.

On the Dodd-Frank side, the two elements on which we are most focused are Section 984(b), the initiative calling on the Securities and Exchange Commission to promote greater transparency around securities lending and repo, and Section 165(e), which is designed to limit the credit exposure of industry players to each other.

John Griffin: We may say they are harming the market, but from the regulators’ perspective they are strengthening it. Taking leverage and velocity out of the system seem the intended consequences rather than unintended consequences.

McIntire: Indemnification against borrower default is an important risk mitigant to a number of lenders. At one recent meeting with regulators, several mutual funds indicated that without indemnification, they might withdraw their supply from the market. This would have potentially adverse implications for liquidity and how markets function.

From a financial accounting standpoint, indemnified agency lending balances have always been treated as a contingent liability and have not been brought onto balance sheets. Basel III will change this dynamic by including them in certain regulatory capital calculations.

Craig Starble: It is clear the regulations are going to increase costs to those agents that use their balance sheet to provide indemnification. But we indemnify through an insurance policy, due to the size of our balance sheet and the structure of our company, so we have an opportunity.

Going forward, I see a real opportunity to satisfy some of the demand from the clients who may not be able to do business with the custodians anymore because of price changes. If clients need indemnification, we can provide it.

Mike McAuley: Another important regulatory issue is the leverage ratio. While the proposed rules have no material impact on indemnified agency lending, they could have a significant impact on the demand side of the lending market as well as the repo market. Leverage has always been considered a backstop to capital requirements but it could become the constraining ratio.

Also, there are differences in the leverage and capital requirements between the US and the rest of the world that could create an unlevel playing field. Under Dodd-Frank, the Collins amendment requires the largest banks to calculate risk-weighted assets under both the standardised and the advanced approaches and use the larger of the two numbers in the denominator of the capital ratios.

For indemnified lending transactions, the standardised approach which applies a very draconian haircut-type methodology produces a significantly larger risk-weighted asset number than the advanced or value-at-risk (VAR) methodology. This creates a large disparity between economic and regulatory capital for lending and repo transactions.