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Good for regulators, good for business

A global trade repository for all securities lending transactions is part of the Financial Stability Board’s plans to overhaul shadow banking. There would be knock-on benefits for the industry too.

The FSB has made its intentions clear: it wants transparency in securities lending. A global trade repository for all transactions is one of its proposals this week for bringing that about.

Regulators would clearly benefit from better access to data. But the industry — often derided for its opacity and its links to short selling — could also use this data to its advantage.

Securities lending suffered in the wake of the Lehman Brothers bankruptcy, with a swathe of lawsuits launched in the wake of heavy cash collateral reinvestment losses.

Many complainants said they had no idea that this dull, incremental source of income had evolved, with collateral being reinvested in what turned out to be toxic assets.

The nature of fees in the business has also come under fire, with claims that lending agents take a slice of clients’ profits but suffer nothing in the event of losses attracting mainstream media coverage.

The industry has been on the defensive ever since and any efforts to improve its image are hampered because is an already complicated business and using data from different sources will provide no clear idea of the overall picture.

That global view matters when a Norwegian pension fund’s assets may be lent to a US custodian, which can then lend them to a UK prime brokerage that in turn can lend them to a hedge fund in the Cayman Islands.

That is without even mentioning where the cash collateral received by the pension fund is invested — or whether it is comingled with other beneficial owners from other jurisdictions.

A single, global trade depository — collecting information on type and value of collateral, haircuts, maturity dates and so on — would not only allow regulators to keep tabs on systemic risk, but would also provide an invaluable source of information for the industry both to defend and benchmark itself.

Philosophical question

Such data would also help move forward the debate on short selling from its current quasi-moral philosophy status. Regulators would be able to see, ahead of the game, if large short positions were being built against specific businesses and act accordingly.

That action — it should be noted — ought not to be aimed against investors, of course. Only in very exceptional circumstances might that ever be appropriate. The advantage to regulators might be rather to flag up warning signs about those businesses being targeted. Plenty of those typically — and lazily — labelled as spivs and speculators had managed to notice that something was amiss with Lehman, for instance, well before regulators became truly exercised.

The industry should also welcome regulation in the form of a trade repository over a central counterparty. While the CCP model has a place in securities lending, nobody wants what would be an industry changing development imposed by across the board by regulatory force.

Since the 2007/08 financial crisis, the banking industry knows it can no longer hide in the shadows. Securities lending has been more hidden than most but it now has an unprecedented opportunity to move into the light.

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