OFR Looks at Securities Lending
The Treasury's Office of Financial Research (OFR) posted a blog entitled, "Shedding Light on Securities Lending," which says, "An OFR working paper released today analyzes new data measuring securities lending activity. A securities loan is a transaction in which the lender (a securities owner) temporarily transfers securities to another party (a securities borrower) for compensation. Both securities lending and repurchase agreements (repos) play critical roles in our financial system in money and collateral markets. Analyzing and measuring activity in these markets are key components of the OFR's work in shadow banking." OFR also released a paper, "A Pilot Survey of Agent Securities Lending Activity, which says, "This paper reports aggregate statistics on securities lending activity based on a recently concluded pilot data collection by staff from the Office of Financial Research (OFR), the Federal Reserve System, and staff from the Securities and Exchange Commission (SEC).... A securities loan is a transaction in which the lender (a securities owner) temporarily transfers securities to another party, a securities borrower, for compensation.... This transfer is secured by collateral which can be cash, securities, or another form of financial commitment such as a letter of credit." The OFR paper continues, "The lender derives compensation from the interest earned on cash collateral reinvestment. The total compensation for the lender is a function of the investment returns on the cash collateral and the rebate rate. Lenders typically share a portion of their total compensation with the agent and it is common for the lender to retain most of it.... There may be the potential for systemic stability risks associated with securities lending. For example, in many securities loans against cash collateral, the securities and the cash collateral must be returned on demand. However, cash is generally reinvested, and its sudden withdrawal may result in losses of the collateral's principal value due to liquidity and maturity transformations. During the 2007-09 financial crisis, some securities lenders experienced large losses stemming from aggressive practices of cash reinvestment. For example, cash received in securities loan transactions was reinvested in higher yielding but long-dated and less liquid securities. In one case, these losses were so sizable that they contributed to distress at American International Group, Inc. (AIG), threatening a disorderly liquidation that would have destabilized global financial markets." It says, "After the financial crisis, many securities lenders revised their collateral management policies to reduce exposures to risks emanating from cash reinvestment in long-dated or high-risk assets. Cash collateral reinvestment practices of some lenders have reportedly become more conservative since the financial crisis. In addition to regulatory limits imposed on some securities owners, regulators have taken further steps to reduce risks and improve transparency of cash pools that securities owners commonly use for cash reinvestment purposes." The OFR piece comments, "There were, on average, $1 trillion in securities loans outstanding or about 11 percent of the lendable assets. The collateral received was about equally split between cash ($532 billion) and noncash ($487 billion)." Finally, under "Table 12. Collateral Types Accepted by Securities Owners," it states, "Chart 1 reports information on the reinvestment of cash collateral. For each collection date, the percentage of total cash collateral reinvested is calculated in each of 18 reinvestment categories specified in the pilot data submission request. The most common reinvestment choice was money market securities, including asset-backed commercial paper (ABCP). This option represents over 19 percent of cash collateral reinvestment for each reporting date. Other top reinvestment choices include various types of repos, prime money market funds, as well as direct investment by securities lenders that do not rely on agents for cash collateral management services."
