The U.S. SEC now allows brokers to use a wider range of stocks—specifically large American company stock baskets included in the Russell 1000 and S&P 500 indexes—as collateral when borrowing securities from large institutional investors.
Previously, companies could only use safer, traditional assets as collateral, such as cash, U.S. government bonds, or bank guarantees. With the new rule, brokers can also leverage diversified portfolios of large stocks. This change increases brokers' flexibility in fundraising and managing trades.
The new collateral class targets the securities lending market
Previously, Rule 15c3-3 limited acceptable collateral to only a few instruments. Brokers who borrowed shares from institutional customers to cover failed trades or short sales could only pledge a limited amount of assets as collateral.
The new regulation introduces the concept of “Eligible Equity Collateral,” which refers to a diversified basket of the customer's margin securities or the broker's own securities from the Russell 1000 and S&P 500 indices.
Also, unleveraged ETFs (exchange-traded funds) that track these indices are accepted as collateral.
Strict conditions define who can participate
The use of this collateral arrangement is limited to “Eligible institutional securities lenders.” Eligibility conditions are:
The lender must be an eligible institutional buyer by definition, under the securities lending “Rule 144A,” or
Own at least $100 million worth of securities at their own discretion, or
Act through an agent bank that is authorized for at least $100 million worth of securities lending.
Brokers must over-collateralize loans by 1% if the securities are denominated in major currencies; euro, pound, Swiss franc, Canadian dollar, and Japanese yen. In other cases, the collateral must be 5% over the loan amount.
All collateral must be held at a bank or with a registered broker.
The parties jointly agree on concentration and diversification requirements. Collateral is valued anew daily, and if the asset no longer meets the conditions, there is a five-business-day deadline to meet the requirements.
The commission issued a guidance letter to market participants along with the regulation:
Securities Industry and Financial Markets Association (SIFMA), and
International Securities Lending Association (ISLA)
The commission selected Russell 1000 and S&P 500 stocks based on their liquidity, low volatility, market depth, and the scale of issuers.
“The aim of this regulation and the guidance letter provided to SIFMA and ISLA is to improve liquidity and strengthen risk management in the securities lending market,” the regulator clarified.
The widespread adoption of the new system by market participants will become clear in the coming months.
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