97-19132. Revised Policy Statement on Securities Lending  

  • [Federal Register Volume 62, Number 139 (Monday, July 21, 1997)]
    [Notices]
    [Pages 38991-38994]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 97-19132]
    
    
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    FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
    
    
    Revised Policy Statement on Securities Lending
    
    AGENCY: Federal Financial Institutions Examination Council.
    
    ACTION: Notice of revised policy statement.
    
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    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 
    20552 (202/906-5744).
        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:
    
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    Purpose
    
        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 
    margin.
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        \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:
         The sale and repurchase (loan) of U.S. government or 
    federal agency securities.
         Cash is received by the seller (lender) and the party 
    supplying the funds receives the collateral margin.
         The agreement is for a fixed period of time.
         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.
         The confirmation received by the financial institution 
    from a borrower broker/dealer classifies the transaction as a 
    repurchase agreement.
        \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 
    these transactions.
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        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 
    definition above.)
        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 
    collateral delivery.
        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.
    
    Guidelines
    
        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.
    
    Recordkeeping
    
        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.
    
    Administrative Procedures
    
        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.
    
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        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 
    borrower.
        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 
    management.
        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 
    federal agencies.
    
    Collateral Management
    
        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.
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        \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.
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        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 
    trustee.
    
    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 
    invested.
        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.
    
    Written Agreements
    
        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
    
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    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 
    unnecessary risks.
        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 
    use.
    
    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.
    
    Indemnification
    
        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.
    
    Regulatory Reporting
    
        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,
    Executive Secretary.
    [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
    
    
    

Document Information

Published:
07/21/1997
Department:
Federal Financial Institutions Examination Council
Entry Type:
Notice
Action:
Notice of revised policy statement.
Document Number:
97-19132
Dates:
Effective immediately.
Pages:
38991-38994 (4 pages)
PDF File:
97-19132.pdf