Deadline looming for securities lending info

Securities lending agents are racing the clock to provide key information on their lending clients to broker-dealers so that those clients — including plan sponsors, mutual funds and central governments — get a clean bill of credit health.

March 31 is the first deadline. The deadline agreement was made by the securities lending industry task force that has been spearheading the push toward more disclosure and the Securities and Exchange Commission, which regulates broker-dealers.

By that date, broker-dealers are expected to have certified the creditworthiness of the institutions from which they borrow securities. To do that, they need information such as company name, place of business and some financial records. On Oct. 1, principal-level, loan-by-loan details will be required to be reviewed daily by broker-dealers.

But while lenders might be OK with providing the information, smaller lenders might be surprised to see their lending activity change after the broker-dealers review them.

The information being sent to broker-dealers is innocuous, said Robert A. Wittie, a partner in the Washington office of the law firm Kirkpatrick & Lockhart Nicholson Graham LLP. "There's nothing terribly dramatic about the idea that you're going to be identified, that your name, rank and serial number is going to borrowers," he said.

"What is going to be a little bit more interesting or potentially uncomfortable or troublesome for beneficial owners is that the reason this whole exercise is occurring is so that borrowers will make a credit determination about all outstanding loans," Mr. Wittie added. "That implies some financial information is going to be provided. The documentation that calls for that at this stage is pretty non-specific as to what information is going to be provided."

Securities lending executives agreed the potential exists for lending levels or utilization rates to change for smaller lenders.

"I think it's a potential depending on who you are, but then again so much of a credit decision is based on the size of financial assets," said Eugene Picone, senior vice president and global products executive for securities lending and execution products at JPMorgan Chase & Co., New York. "If you're a big lender, you probably have a better credit rating ... you'll probably end up getting a better credit score."

Mr. Wittie agreed the size of the lender could play a role.

"You may be a smallish kind of lender who's used to having 15% to 20% utilization and all of a sudden you're only going to have 10% because borrowers are saying, ‘I don't want to be that exposed,'" he explained. "It all remains to be seen, but I don't think there's any reason to be pessimistic or frightened about it."

Leslie Nelson, managing director in global securities lending at Goldman Sachs & Co., New York, said some beneficial owners might see lending activity change if information that broker-dealers now have on them proves to be incorrect.

"To the extent it turns out that as a result of more precise identification of the underlying principal, we realize it was an entity different from who we thought it was previously, or to the extent they were not willing to provide information through their agents that would allow us to qualify them, then it could change," he said.

Mr. Nelson, one of the leaders of the Agency Lending Disclosure Taskforce, an industry collaboration organized in 2003 by financial consulting firm Capco Group Inc., New York, that is helping set disclosure parameters and deadlines, added that any changes would not take place until broker-dealers are required to review loan-by-loan details later this year.

"The way I think about the March 31 date for requalifying existing principals is that it gets us to the point of knowing as precisely as possible who it is that we're allowing to be our counterparties," he said. "Beyond Oct. 1, that's when individual broker-dealers and agent lenders will need to deal with levels of exposure that we as broker-dealers might not be comfortable with. It will be an ongoing daily process each broker-dealer is going to need to manage.

"We don't know how much exposure we have with each individual principal, but once that information is available, we — for the first time — will need to look at those exposures relative to our appetite and manage those individual principal loan balances in conjunction with agent lenders."

JPMorgan Chase's Mr. Picone said the Oct. 1 deadline "is where the rubber meets the road," with the more challenging task for broker-dealers of handling reams of data on securities loans.

Still, he added: "The March deadline has had its share of bumps and there are still issues around disclosure and brokers signing disclosure agreements, making sure they hold the information we give them near and dear to their hearts."

No plan sponsors have refused to provide such information to broker-dealers, securities lending industry officials said, but some still have raised questions and concerns about doing so.

Michael W. McDermott, a first vice president and client service manager in Pittsburgh-based Mellon Financial Corp.'s global securities lending unit, said he received "a ton" of telephone calls from beneficial owner clients after Mellon sent a letter to them outlining the information sharing process late last year.

"Once we took customers through it — we had a number of conversations — they were fine," he said. "It probably sounded worse than it is. The common theme (of questions and concerns) was about the nature of the data and what broker-dealers were going to use it for."

At Northern Trust Co., Chicago, current contracts with beneficial owners include the distribution of some information, according to Angi Meyers, senior vice president.

"As a matter of fact, this is not new," she said. "A number of borrowers are already requiring certain pieces of information about clients and pre-approval. It just wasn't standard across all broker-dealers."

But as part of this disclosure process, agent lenders like Northern Trust are renegotiating confidentiality agreements with broker-dealers to ensure that any information from beneficial owners is not misused.

"There has been a need for agents generally speaking to add confidentiality agreements or renegotiate them," Ms. Meyers said. "We're not going to send any files to any broker-dealer until we've got a confidentiality agreement in place."

One potential hang-up rests with the SEC, which must decide whether to exempt broker-dealers from performing what's called customer identification procedures on beneficial owners. The procedures stem from anti-money laundering provisions in the USA Patriot Act.

"Borrowers are currently performing the credit requalification of principal lenders to meet the March 31 deadline while waiting to see if regulators will provide … relief for borrowers" from the customer identification procedures, explained Brad Smith, a managing principal at Capco.

Ms. Meyers said if regulators reply soon and allow the exemption, the March deadline is not likely to be at risk, "but if they come back negatively or too late, the March date might not be reasonable.