The U.S. SEC now allows broker-dealers to use a broader range of stocks – namely baskets of large U.S. companies from the Russell 1000 and S&P 500 indices – as collateral when borrowing securities from large institutional investors.
Previously, companies were only allowed to use safer, traditional assets such as cash, U.S. government bonds, or bank guarantees as collateral. With this new rule, they can now also use diversified portfolios of large stocks. This change gives broker-dealers more flexibility in how they raise funds and handle their transactions.
New collateral category targets securities lending markets
Previously, rule 15c3-3 under the Exchange Act allowed only a limited number of instruments to be accepted as collateral. Broker-dealers who borrowed stocks from institutional clients to cover failed trades or short positions had little flexibility regarding the collateral for these loans.
The new measure introduces ‘Eligible Equity Collateral’, or a diversified basket of securities from customer margins or broker-dealer portfolios, comprised of stocks in the Russell 1000 and S&P 500 indices.
Unrelated ETFs (exchange-traded funds) that track these indices are also eligible.
Strict conditions determine who may participate
Only ‘Qualified Institutional Securities Lenders’ may utilize this new collateral arrangement. The following conditions apply:
A lender must be a qualified institutional buyer as defined under Rule 144A of the Securities Act of 1933, or
Own at least $100 million in securities under management, or
Trade through an agent bank that manages at least $100 million in outstanding securities loans.
Broker-dealers must over-collateralize loans by 1% for securities listed in major currencies, such as the euro, British pound, Swiss franc, Canadian dollar, and Japanese yen, and by 5% for all other currencies.
All collateral must be held at a bank or a registered broker-dealer.
Both parties must adhere to agreements on diversification and spreading. The collateral is adjusted daily according to market value. If a security or borrower no longer meets the conditions, there is a five-business-day period to resolve this.
The Commission also provided an interpretive letter to market participants upon the publication of the decision, as an additional guideline for:
The Securities Industry and Financial Markets Association (SIFMA) and
The International Securities Lending Association (ISLA)
The Commission chose securities from the Russell 1000 and S&P 500 due to their high liquidity, low volatility, deep market, and the scale of their issuers.
“This decision, along with an interpretive letter to SIFMA & ISLA, is intended to improve liquidity and strengthen risk management in the securities lending sector,” the regulator explains.
In the coming months, it will become clear whether market participants will widely transition to these new rules for securities lending.
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