SEC Roundtable to Address Lack of Transparency in Securities Lending

The Securities and Exchange Commission’s upcoming roundtable on securities lending and short sales aims to shed light on a lucrative area of the market that’s generally considered opaque. The day and a half of panel discussions is likely to represent the most detailed public discussion yet of securities lending.

James Brigagliano, co-acting director of the SEC’s Division of Trading and Markets, said last week that the purpose of the roundtable is "not to front-run a discrete regulatory initiative." He pointed out that the "lending market is opaque," according to many market participants, and that "the SEC would "like to shed some light" on the topic. He spoke at an Investment Company Institute conference in New York last Thursday.

Securities lending refers to the loan of securities by institutions with large portfolios to prime brokers and others. Those firms need to borrow securities to support short sales by their customers. Those customers include hedge funds, trading firms and retail investors, among others. Securities lending programs are often managed by custodian banks, which hold the securities, on behalf of the investors whose shares are being loaned.

Brigagliano noted that the SEC is "concerned about a potential lack of transparency with pricing" for stock borrows, adding that it’s also "hard for people to assess supply." He went on to point out that "new models to create platforms that would add transparency" to the securities lending market have recently emerged, and that now is a "good time to discuss the state of lending."

The panels will cover topics such as current securities lending practices, compensation arrangements, possible pre-borrow requirements for short sales, and additional short-sale disclosures that could be imposed on borrowers. The roundtable will take place this week, on Sept. 29 and 30.

Speakers at the six panels will include representatives from institutional investors, banks and prime brokers, vendors, exchanges, custodian banks, self-regulatory organizations and academia. A total of 39 panelists will participate in the roundtable.

At the ICI meeting, Brigagliano highlighted one of the SEC’s concern with securities lending programs. Investors whose shares are being loaned, he said, may be subject to a "misuse of collateral."

This concern involves the reinvestment of collateral associated with stock borrows through securities lending programs. During the financial crisis last fall and winter, many institutions with lending programs lost money when collateral from prime brokers and others who had borrowed shares to support short sales was invested in short-term debt instruments. Those investments were intended to be conservative investments, but after the collapse of Lehman Brothers, when the Reserve Primary Fund broke the buck, some collateral reinvestment programs lost money.

SEC Chairman Mary Schapiro also highlighted this concern in a statement last Friday. "Securities lending was once thought to be a way to earn a few extra points of return [for institutions with lending programs], with little or no risk," she said. "Events of last year reveal the risk was present. As a result, we need to consider ways to enhance investor-oriented oversight of this multi-trillion dollar market."

In addition to providing an overview of securities lending, the SEC roundtable will explore the possibility of requiring pre-borrows for short sales. Currently, shares do not have to be pre-borrowed for short sales if the shares are deemed readily available.

"We also must focus on a flip-side of securities lending–short selling," Schapiro said in a statement. "That’s why the roundtable will also examine potential short sale pre-borrow and hard locate requirements and short sale disclosures." Another issue to be raised, according to the SEC’s notice, is "whether investors would benefit from adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities." The comment period for issues addressed in next week’s roundtable will last until Oct. 30.