While regulatory pronouncements on securities lending have tended to be long on “we are concerned” and short on “here’s what we’ll do about it,” the most recent report from the Financial Stability Board on Shadow Banking starts to discuss concrete actions that regulators might consider.
According to , published on October 27, 2011, the FSB has brought up three specific areas for potential action: regulating cash collateral pools, requiring minimum margin and improving market infrastructure. While each of these topics could be the subject of a graduate thesis, our initial comments are as follows.
Attempts to regulate cash collateral pools would be met with nonchalance by the majority of principal lenders. The fact is, about 90% of cash collateral pools are already in US money market (2a-7) pools or pools that follow similar guidelines (sources: RMA and Finadium). This is likely to be the vehicle that regulators would pick for mandating an investment style for cash collateral anyhow, meaning no change for market participants. The remaining 10% would require changes to their holdings that could potentially decrease revenues (and risk, theoretically but in no way guaranteed). We do understand why the FSB would want to regulate cash collateral pools – no one wants frozen or poor quality collateral – but the market has already self-adjusted.
The next point on requiring minimum margin could really only go one direction: up. Current margin (really, the collateralization amount) is at 102% or 105%, or more in specific circumstances for lower value collateral. By referencing the March 2010 report from the Committee on the Global Financial System, the FSB is implying that minimum collateralization rates could be set by regulators depending on the broader economic climate (procyclicality). This would have a massive range of unintended consequences but the main one would be to slow securities lending activity (and by extension, short selling, derivatives market making, repo returns, etc.).
Lastly, the FSB looks to improve market infrastructure for secured funding markets. This is a bit of a head scratcher in securities lending for developed markets, as the infrastructure provided by Equilend, SunGard and others is really quite good. This seems like either a box that needs to be checked or a recommendation from people who haven’t looked closely at the subject yet. However, when you get to bilateral repo or emerging markets, the FSB could have a point.
The next installment from the FSB on Shadow Banking is expected in 2012.