[Federal Register: July 21, 1997 (Volume 62, Number 139)]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
Revised Policy Statement on Securities Lending
AGENCY: Federal Financial Institutions Examination Council.
ACTION: Notice of revised policy statement.
SUMMARY: The Task Force on Supervision, acting under delegated
authority from the Federal Financial Institutions Examination Council
(FFIEC), has revised the policy statement on ``Securities Lending'',
and is recommending that the FFIEC member agencies adopt and implement
the updated policy statement. The Council's three banking agencies
adopted the policy pursuant to section 1006(b) of FIRA. It was not
published in the Federal Register.
EFFECTIVE DATE: Effective immediately.
FOR FURTHER INFORMATION CONTACT:
FRB: Angela Desmond, Senior Counsel, Division of Banking
Supervision and Regulation, Board of Governors of the Federal Reserve
System, 20th & C Streets, NW, Washington, DC 20551 (202/452-3497).
OCC: Roberta L. Ouimette, National Bank Examiner, Asset Management
Division, Office of the Comptroller of the Currency, 250 E Street, SW,
Washington, DC 20219 (202/874-5331).
OTS: William J. Magrini, Senior Project Manager, Supervision
Policy, Office of Thrift Supervision, 1700 G Street, NW, Washington, DC
FDIC: Kenton P. Fox, Senior Capital Markets Specialist, Division of
Supervision, Federal Deposit Insurance Corporation, 550 17th Street,
NW, Washington, DC 20429 (202/898-7119).
The text of the Revised Policy Statement follows:
Financial institutions are lending securities with increasing
frequency. In some instances a financial institution may lend its own
investment or trading account securities. More and more often, however,
financial institutions lend customers' securities held in custody,
safekeeping, trust or pension accounts. Not all institutions that lend
securities or plan to do so have relevant experience. Because the
securities available for lending often greatly exceed the demand for
them, inexperienced lenders may be tempted to ignore commonly
recognized safeguards. Bankruptcies of broker-dealers have heightened
regulatory sensitivity to the potential for problems in this area.
Accordingly, we are providing the following discussion of guidelines
and regulatory concerns.
Securities Lending Market
Securities brokers and commercial banks are the primary borrowers
of securities. They borrow securities to cover securities fails
(securities sold but not available for delivery), short sales, and
option and arbitrage positions. Securities lending, which used to
involve principally corporate equities and debt obligations,
increasingly involves loans of large blocks of U.S. government and
federal agency securities.
Securities lending is conducted through open-ended ``loan''
agreements, which may be terminated on short notice by the lender or
borrower.1 The objective of such lending is to receive a
safe return in addition to the normal interest or dividends. Securities
loans are generally collateralized by U.S. government or federal agency
securities, cash, or letters of credit.2 At the outset, each
loan is collateralized at a predetermined margin. If the market value
of the collateral falls below an acceptable level during the time a
loan is outstanding, a margin call is made by the lender institution.
If a loan becomes over-collateralized because of appreciation of
collateral or market depreciation of a loaned security, the borrower
usually has the opportunity to request the return of any excessive
\1\1 Repurchase agreements, generally used by owners of
securities as financing vehicles are, in certain respects, closely
analogous to securities lending. Repurchase agreements however, are
not the direct focus of these guidelines. A typical repurchase
agreement has the following distinguishing characteristics:
<bullet> The sale and repurchase (loan) of U.S. government or
federal agency securities.
<bullet> Cash is received by the seller (lender) and the party
supplying the funds receives the collateral margin.
<bullet> The agreement is for a fixed period of time.
<bullet> A fee is negotiated and established for the transaction
at the outset and no rebate is given to the borrower from interest
earned on the investment of cash collateral.
<bullet> The confirmation received by the financial institution
from a borrower broker/dealer classifies the transaction as a
\2\2 Brokers and dealers registered with the Securities and
Exchange Commission are generally subject to the restrictions of the
Federal Reserve Board's Regulation T (12 CFR Part 220) when they
borrow or lend securities. Regulation T specifies acceptable
borrowing purposes and any applicable collateral requirements for
When a securities loan is terminated, the securities are returned
to the lender and the collateral to the borrower. Fees received on
securities loans are divided between the lender institution and the
customer account that owns the securities. In situations involving cash
collateral, part of interest earned on the temporary investment of cash
is returned to the borrower and the remainder is divided between the
lender institution and the customer account that owns the securities.
Definitions of Capacity
Securities lending may be done in various capacities and with
differing associated liabilities. It is important that all parties
involved understand in what capacity the lender institution is acting.
For the purposes of these guidelines, the relevant capacities are:
Principal: A lender institution offering securities from its own
account is acting as principal. A lender institution offering
customers' securities on an undisclosed basis is also considered to be
acting as principal.
Agent: A lender institution offering securities on behalf of a
customer-owner is acting as an agent. For the lender institution to be
considered a bona fide or ``fully disclosed'' agent, it must disclose
the names of the borrowers to the customer-owners (or give notice that
names are available upon request), and must disclose the names of the
customer-owner to borrowers (or give notice that names are available
upon request). In all cases the agent's compensation for handling the
transaction should be disclosed to the customer-owner. Undisclosed
agency transactions, i.e., ``blind brokerage'' transactions in which
participants cannot determine the identity of the counterparty, are
treated as if the lender institution were the principal. (See
Directed Agent: A lender institution which lends securities at the
direction of the customer-owner is acting as a directed agent. The
customer directs the lender institution in all aspects of the
transaction, including to whom the securities are loaned, the terms of
the transaction (rebate rate and maturity/call provisions on the loan),
acceptable collateral, investment of any cash collateral, and
Fiduciary: A lender institution which exercises discretion in
offering securities on behalf of and for the benefit of customer-owners
is acting as a fiduciary. For purposes of these guidelines, the
underlying relationship may be as agent, trustee, or custodian.
Finder: A finder brings together a borrower and a lender of
securities for a fee. Finders do not take possession of the securities
or collateral. Securities and collateral are delivered directly by the
borrower and the lender without the involvement of the finder. The
finder is simply a fully disclosed intermediary.
All financial institutions that participate in securities lending
should establish written policies and procedures governing these
activities. At a minimum, policies and procedures should cover each of
the topics in these guidelines.
Before establishing a securities lending program, a financial
institution must establish an adequate recordkeeping system. At a
minimum, the system should produce daily reports showing which
securities are available for lending, and which are currently lent,
outstanding loans by borrower, outstanding loans by account, new loans,
returns of loaned securities, and transactions by account. These
records should be updated as often as necessary to ensure that the
lender institution fully accounts for all outstanding loans, that
adequate collateral is required and maintained, and that policies and
concentration limits are being followed.
All securities lent and all securities standing as collateral must
be marked to market daily. Procedures must ensure that any necessary
calls for additional margin are made on a timely basis.
In addition, written procedures should outline how to choose the
customer account that will be the source of lent securities when they
are held in more than one account. Possible methods include: Loan
volume analysis, automated queue, a lottery, or some combination of
these methods. Securities loans should be fairly allocated among all
accounts participating in a securities lending program.
Internal controls should include operating procedures designed to
segregate duties and timely management reporting systems. Periodic
internal audits should assess the accuracy of accounting records, the
timeliness of management reports, and the lender institution's overall
compliance with established policies and procedures.
Credit Analysis and Approval of Borrowers
In spite of strict standards of collateralization, securities
lending activities involve risk of loss. Such risks may arise from
malfeasance or failure of the borrowing firm or institution. Therefore,
a duly established management or supervisory committee of the lender
institution should formally approve, in advance, transactions with any
Credit and limit approvals should be based upon a credit analysis
of the borrower. A review should be performed before establishing such
a relationship and reviews should be conducted at regular intervals
thereafter. Credit reviews should include an analysis of the borrower's
financial statement, and should consider capitalization, management,
earnings, business reputation, and any other factors that appear
relevant. Analyses should be performed in an independent department of
the lender institution, by persons who routinely perform credit
analyses. Analyses performed solely by the person(s) managing the
securities lending program are not sufficient.
Credit and Concentration Limits
After the initial credit analysis, management of the lender
institution should establish an individual credit limit for the
borrower. That limit should be based on the market value of the
securities to be borrowed, and should take into account possible
temporary (overnight) exposures resulting from a decline in collateral
values or from occasional inadvertent delays in transferring
collateral. Credit and concentration limits should take into account
other extensions of credit by the lender institution to the same
borrower or related interests. Such information, if provided to an
institution's trust department conducting a securities lending program,
would not be considered material inside information and therefore, not
violate ``Chinese Wall'' policies designed to protect against the
misuse of material inside information. Violation of securities laws
would arise only if material inside information were used in connection
with the purchase or sale of securities.
Procedures should be established to ensure that credit and
concentration limits are not exceeded without proper authorization from
When a lender institution is lending its own securities as
principal, statutory lending limits may apply. For national banks and
federal savings associations, the limitations in 12 U.S.C. 84 apply.
For state-chartered institutions, state law and applicable federal law
must be considered. Certain exceptions may exist for loans that are
fully secured by obligations of the United States government and
Securities borrowers pledge and maintain collateral at least 100
percent of the value of the securities borrowed.3 The
minimum amount of excess collateral, or ``margin'', acceptable to the
lender institution should relate to price volatility of the loaned
securities and the collateral (if other than cash).4
Generally, the minimum initial collateral on securities loans is at
least 102 percent of the market value of the lent securities plus, for
debt securities, any accrued interest.
\3\ Employee Benefit Plans subject to the Employee Retirement
Income Security Act are specifically required to collateralize
securities loans at a minimum of 100 percent of the market value of
loaned securities (see section concerning Employee Benefit Plans).
\4\ The level of margin should be dictated by level of risk
being underwritten by the securities lender. Factors to be
considered in determining whether to require margin above the
recommended minimum include: the type of collateral, the maturity of
collateral and lent securities, the term of the securities loan, and
the costs which may be incurred when liquidating collateral and
replacing loaned securities.
Collateral must be maintained at the agreed margin. A daily ``mark-
to-market'' or valuation procedure must be in place to ensure that
calls for additional collateral are made on a timely basis. The
valuation procedures should take into account the value of accrued
interest on debt securities.
Securities should not be lent unless collateral has been received
or will be received simultaneously with the loan. As a minimum step
toward perfecting the lender's interest, collateral should be delivered
directly to the lender institution or an independent third party
Cash as Collateral
When cash is used as collateral, the lender institution is
responsible for making it income productive. Lenders should establish
written guidelines for selecting investments for cash collateral.
Generally, a lender institution will invest cash collateral in
repurchase agreements, master notes, a short-term investment fund, U.S.
or Eurodollar certificates of deposits, commercial paper or some other
type of money market instrument. If the lender institution is acting in
any capacity other than as principal, the written agreement authorizing
the lending relationship should specify how cash collateral is to be
Investing cash collateral in liabilities of the lender institution
or its holding company would be an improper conflict of interest unless
that strategy was specifically authorized in writing by the owner of
the lent securities. Written authorizations for participating accounts
are further discussed later in these guidelines.
Letters of Credit as Collateral
Since May 1982, letters of credit have been permitted as collateral
in certain securities lending transactions outlined in Federal Reserve
Regulation T. If a lender institution plans to accept letters of credit
as collateral, it should establish guidelines for their use. Those
guidelines should require a credit analysis of the financial
institution issuing the letter of credit before securities are lent
against that collateral. Analyses must be periodically updated and
reevaluated. The lender institution should also establish concentration
limits for the institutions issuing letters of credit and procedures
should ensure that they are not exceeded. In establishing concentration
limits on letters of credit accepted as collateral, the lender
institution's total outstanding credit exposures from the issuing
institution should be considered.
Securities should be lent only pursuant to a written agreement
between the lender institution and the owner of the securities
specifically authorizing the institution to offer the securities for
loan. The agreement should outline the lender institution's authority
to reinvest cash collateral (if any) and responsibilities with regard
to custody and valuation of collateral. In addition, the agreement
should detail the fee or compensation that will go to the owner of the
securities in the form of a fee schedule or other specific provision.
Other items which should be covered in the agreement have been
discussed earlier in these guidelines.
A lender institution must also have written agreements with the
parties who wish to borrow securities. These agreements should specify
the duties and responsibilities of each party. A written agreement may
detail: Acceptable types of collateral (including letters of credit);
standards for collateral
custody and control, collateral valuation and initial margin, accrued
interest, marking to market, and margin calls; methods for transmitting
coupon or dividend payments received if a security is on loan on a
payment date; conditions which will trigger the termination of a loan
(including events of default); and acceptable methods of delivery for
loaned securities and collateral.
Use of Finders
Some lender institutions may use a finder to place securities, and
some financial institutions may act as finders. A finder brings
together a borrower and a lender for a fee. Finders should not take
possession of securities or collateral. The delivery of securities
loaned and collateral should be direct between the borrower and the
lender. A finder should not be involved in the delivery process.
The finder should act only as a fully disclosed intermediary. The
lender institution must always know the name and financial condition of
the borrower of any securities it lends. If the lender institution does
not have that information it and its customers are exposed to
Written policies should be in place concerning the use of finders
in a securities lending program. These policies should cover the
circumstances in which a finder will be used, which party pays the fee
(borrower or lender), and which finders the lender institution will
Employee Benefit Plans
The Department of Labor has issued two class exemptions which deal
with securities lending programs for employee benefit plans covered by
the Employee Retirement Income Security Act (ERISA)--Prohibited
Transaction Exemption 81-6 (46 FR 7527 (January 23, 1981), supplemented
52 FR 18754 (May 19, 1987)), and Prohibited Transaction Exemption 82-63
(47 FR 14804 (April 6, 1982) and correction published at 47 FR 16437
(April 16, 1982)). The exemptions authorize transactions which might
otherwise constitute unintended ``prohibited transactions'' under
ERISA. Any institution engaged in lending of securities for an employee
benefit plan subject to ERISA should take all steps necessary to design
and maintain its program to conform with these exemptions.
Prohibited Transaction Exemption 81-6 permits the lending of
securities owned by employee benefit plans to persons who could be
``parties in interest'' with respect to such plans, provided certain
conditions specified in the exemption are met. Under those conditions
neither the borrower nor an affiliate of the borrower can have
discretionary control over the investment of plan assets, or offer
investment advice concerning the assets, and the loan must be made
pursuant to a written agreement. The exemption also establishes a
minimum acceptable level for collateral based on the market value of
the loaned securities.
Prohibited Transaction Exemption 82-63 permits compensation of a
fiduciary for services rendered in connection with loans of plan assets
that are securities. The exemption details certain conditions which
must be met.
Certain lender institutions offer participating accounts
indemnification against losses in connection with securities lending
programs. Such indemnifications may cover a variety of occurrences
including all financial loss, losses from a borrower default, or losses
from collateral default. Lender institutions that offer such
indemnification should obtain a legal opinion from counsel concerning
the legality of their specific form of indemnification under federal
and/or state law.
A lender institution which offers an indemnity to its customers
may, in light of other related factors, be assuming the benefits and,
more importantly, the liabilities of a principal. Therefore, lender
institutions offering indemnification should also obtain written
opinions from their accountants concerning the proper financial
statement disclosure of their actual or contingent liabilities.
Securities borrowing and lending transactions should be reported by
commercial banks according to the Instructions for the Consolidated
Reports of Condition and Income and by thrifts according to Thrift
Financial Report instructions.
Dated at Washington, DC this 16th day of July 1997.
Federal Financial Institutions Examination Council.
Joe M. Cleaver,
[FR Doc. 97-19132 Filed 7-18-97; 8:45 am]
BILLING CODE 6210-01-P, 6720-01-P, 6714-01-P, 4810-33-P