After issuing an initial document for public consultation in November 2021, the US Securities and Exchange Commission has now published the SEC 10c-1a Final Rule designed to promote transparency in securities lending markets by requiring parties to report the material terms of the trade by end of day on T+0. Bob Currie reports
On Friday 13 October, the Securities and Exchange Commission (SEC) confirmed its final design for implementation of SEC Rule 10c-1a (under the Securities Exchange Act of 1932), almost 18 months after the close of its two-part public consultation held in Nov-Dec 2021 and March 2022.
In proposing this regulatory package, the SEC contends that the securities lending market is opaque and there is a lack of comprehensive information on current market conditions. These gaps, the US securities regulator believes, create inefficiencies in the securities lending market and make it difficult for borrowers and lenders to know whether the terms of their loans are consistent with market conditions.
Although some market participants, such as certain registered investment companies, are required to periodically make certain disclosures regarding their securities lending activities, the SEC notes that parties to securities lending transactions in the US have not previously been required to report the material terms of those transactions.
With these concerns in mind, the SEC issued the draft Proposed Rule 10c-1 for public consultation in late November 2021. This proposal required lenders to report the material terms of securities lending transactions to a registered national securities association (RNSA), along with details of securities on loan and available for loan.
In this initial public consultation, the SEC put forward 97 questions in its consultation document but gave the industry just 30 days to respond prior to the close on 7 January 2022. Reacting to the weight of feedback received during this initial consultation and the unanswered questions that this presented, the SEC voted to reopen public consultation through an additional 30-day window which extended until 1 April 2022.
Securities Finance Times provided a two-part examination of the content and potential implications of the SEC Proposed Rule 10c-1, and the main points raised by respondents to the consultation process, in SFT Issues 296 and 297 published in February 2022.
Available for loan securities
Almost 18 months after the close of this second round of consultation, the SEC has now released final rules for 10c-1a implementation.
On the same day, it also adopted new Rule 13f-2, which will require institutional investment managers that meet specified disclosure thresholds to submit confidential monthly reports detailing their short-selling activity and short positions. These reports will be filed on the newly-adapted Form SHO.
One of the most noteworthy amendments in the 10c-1a Final Rules is that the SEC has removed a requirement for lenders to report details of securities currently on loan and securities available for lending.
This was a point of concern for a number of respondents in their feedback to the SEC during the initial public consultation on the Proposed Rule draft. For example, the Securities Industry and Financial Markets Association (SIFMA), in its consultation response submitted on 7 January 2022, expressed concerns that the SEC’s proposal, requiring firms to calculate and report securities “available to lend”, may paint a picture which “grossly overinflates’ the number of securities available for lending.
SIFMA indicated that this would be likely to create a “wholly inaccurate and unhelpful understanding of what is actually available to lend” — and generate confusion regarding market liquidity and pricing. Potentially, this may also compromise trading strategies based on the exaggerated availability data and it may potentially expose the market to heightened risk (p 8).
With this in mind, SIFMA advised that the Commission should take more time to find an appropriate solution, one which mitigates the risk of overstatement while providing a useful source of data. “One idea which may merit consideration could be to reference publicly available data on a security’s total share float — which would be both accurate and readily available,” says SIFMA.
Igor Kaplun, global head of business development at S&P Global Market Intelligence Cappitech, indicates that his company agrees with the SEC’s decision to remove the obligation to report securities “available for loan”. This could have created confusion regarding how to interpret when a particular security is available for lending, he says, potentially resulting in an inaccurate picture of what is available for loan. He adds that the 10c-1 design advanced in the Proposed Rule would have created significant operational challenges and might have had a significant impact on lending and borrowing behaviour.
For Kishore Ramakrishnan, managing director and capital markets advisory leader at regulatory consultancy Treliant LLC, the SEC’s decision — to remove its earlier requirement for firms to report their securities inventory available for loan — is a positive to emerge from the consultation process and comes as a relief for many within the industry. “The Proposed Rule met with stiff resistance from the market since it was operationally burdensome and did not add any meaningful value in terms of fulfilling the transparency objective in the functioning of securities lending markets,” says Ramakrishnan.
Transparency objectives
According to EquiLend’s head of RegTech solutions Kevin McNulty, the SEC has two transparency objectives with Rule 10c-1: to provide information for supervisory oversight and to create more general public awareness. “I think in terms of general design, which involves relatively few data fields and one-sided reporting only, the rule should generally meet these objectives,” he says. “On the public disclosure, the SEC has balanced a desire to level the information playing field between all investors with the concern that certain disclosures could discourage activity and damage market liquidity.”
Jonathan Lee, money markets reporting director at Kaizen, believes that the SEC has found a good initial balance in the regulatory design that it has put forward in its 10c-1a Final Rule. This was always going to be a fine line to tread, he notes, and there will be further opportunity to review and refine these initial provisions, in consultation with FINRA, when the Rule is live and when the market starts to see transaction data being published.
Particularly for the retail investor, Lee believes that 10c-1a will deliver a significant advance in the level of price transparency that they are able to see around securities lending transactions. With this, they will be better positioned to make informed decisions around their securities lending activities, particularly in the context of the US equity markets.
S&P Global Market Intelligence Cappitech’s Igor Kaplun indicates that the final rule provides clarity for participants in the SFT industry. “While there may be complexities for many firms in meeting compliance — depending on their size, sophistication and resources — the final rule is workable and fair,” he says. Moving ahead, the firm will examine FINRA’s rules carefully to understand the technical and operational requirements and how these affect implementation. By providing aggregate data to the general public on a T+1 basis, this will offer greater transparency to retail investors in a timely manner.
As a US broker-dealer and ATS, Provable Markets indicates that the 10c-1a Final Rule is a step in the right direction towards meeting the SEC’s objective of promoting greater transparency in US securities lending markets. “It is no secret that those directly and indirectly involved in the securities lending marketplace, including retail investors and buy-side firms, have been pushing for greater transparency for a long time,” notes Provable Markets' CEO Matt Cohen. Currently, it can be challenging to pull together data from a number of sources available in the market and to aggregate and validate this data, not to mention costly. “We are not ignoring that nothing is free, including the implementation and ongoing compliance demands 10c-1a will bring, but it hopefully bridges a gap,” says Cohen. Consequently, for many lenders and borrowers it will be valuable to have a golden source of SBL transaction data generated from end-of-day trade reporting delivered to FINRA.
According to Adrian Dale, head of regulation, digital and market practice at the International Securities Lending Association (ISLA), [the reporting commitments required under] this final rule potentially does address immediate transparency challenges. “However, as I wrote in my response letter to the SEC, we may find that what is being requested is not sufficient,” he says. “This raises a concern that any required revisions will add further development costs for firms — not least for those who will now be required to form new partnerships to publish their data.”
End-of-day reporting
In addition to removing the commitment to report “available for loan” securities, the Commission has also revised the requirement to report new and modified trades within 15 minutes of execution that was advanced in the original proposal.
For securities lending transactions, it is commonly the fee or rebate rate that principally determines the earnings of the securities lender and borrower. This rate can typically be renegotiated during the lifetime of the loan and, with this in mind, there may not be a strong alignment between the time that the SBL trade is executed and the return benefits accruing to the lender and borrower over the transaction lifecycle. Critics have indicated that the proposed 15-minute reporting window would have added significant operational burden and cost to market participants, without providing significant transparency benefits.
Taking this feedback into account, the SEC’s Final Rule has dropped the 15-minute reporting requirement for securities lending trades and now requires lenders to report loan data to an RNSA — FINRA is currently the only RNSA that has been approved to receive this trade reporting — by the end of each trading day.
FINRA will maintain this information confidentially and will release only a subset of this information for public viewing on the next business day.
This information released on T+1 will include details of the time of the loan transactions, the collateral used and pricing information such as the loan’s rate. FINRA will also release aggregated data for the previous day’s loan activity, broken down by security.
However, FINRA will not disclose details of the loan amount on T+1. Rather, this information will remain confidential for a further 20 days.
Reflecting on these changes, EquiLend’s McNulty observes that the SEC has tried to balance their objective of increasing general public awareness of securities lending activity with concerns that real-time publication could increase the risk that information may reduce firms’ willingness to engage in the market.”
For McNulty, it is also important to recognise what the SEC did not change from the consultation document circulated in November 2021. “The SEC remains determined to capture market activity between prime brokers and their customers,” he observes. “This is an area where SIFMA and others pushed back heavily in the original consultation and where I expect there will be some discussion around the interpretation of the final rule.”
In responding to industry consultation, the SEC has taken industry feedback in removing its original requirement for a 15-minute reporting window, notes Provable Market’s Cohen. FINRA will also delay the release of securities loan transaction volume data to prevent leakage of information relating to firms’ SBL trading strategies. “In making these amendments to the Proposed Rule, the SEC clearly sought to strike a balance among the diversified feedback from a wide range of respondents and has attempted to tailor the final rule to align more closely with the requirements of the securities lending market and the workflow it employs”, says Cohen. This is also evidenced by the many footnotes to comment letters in their final rule and industry calls. “It is encouraging to see this type of engagement in such a complex market structure,” he adds.
For ISLA’s Adrian Dale, changing the requirements [from a 15-minute reporting window] to an end-of-day distribution certainly eases the challenge firms had expressed, and so is a positive and pragmatic conclusion. He notes that some market participants would have welcomed further amendments and others have continued apprehension about how this ‘new’ data may be used — for example, whether this data could be employed as leverage for new commercial offerings. Some are also concerned that potential misrepresentation of this data could adversely shape the direction of future regulatory proposals.
While 15-minute reporting might be appropriate for cash equities markets, Kaizen Reporting’s Lee indicates that for securities lending transactions — particularly for the retail investor — much of this information would be largely noise and would not provide any additional information that is useful to the investor. This published data is likely to be more useful in normal market conditions, rather than in a highly volatile market, Lee suggests. However, lending fees and rebate rates are generally more stable in normal market conditions and, consequently, there is not a strong case in these conditions to require 15 minute reporting.
McNulty indicates that loans transacted on EquiLend’s NGT platform can be reported in near real-time. Although there is now only an obligation to report loan activity at the end of the day, he believes that there could be a lot of value in FINRA accepting files throughout the day in order to publish transaction identifiers (UTIs) in a timely fashion.
“One thing we learned from the Securities Financing Transactions Regulation (SFTR) is that modifications to transactions can occur very quickly after execution, and if these happen before a UTI is generated, it can cause complications,” explains McNulty. “We will certainly be discussing this issue with FINRA as they develop their rules and platform.”
Regulatory scope
Significantly, the SEC has also redefined the scope of eligible transactions captured under 10c-1a and the range of firms that are required to report. The Final Rule replaces the term “securities loan” [used in the Proposed Rule] with “covered securities loan”, explains Treliant’s Ramakrishnan. In doing so, the final rule provides additional guidance in its preamble that makes a distinction between reportable securities loans from repos and other financing transactions.
“It is worth noting that the final rule places the onus of reporting responsibility on lenders and lending agents, mindful of the fact that broker-dealers that borrow securities from their customers are required to report such loans,” he adds (see box below).
“On balance, we feel that the 10c-1a Final Rule is a net positive for the industry,” concludes Provable Markets’ Matt Cohen. The scope of the reporting regime is now drawn in terms of covered persons and covered loan transactions in an attempt to bring greater clarity to which transactions and parties are covered under 10c-1a, though some ambiguity remains and engagement from the market will be key as FINRA shapes its final rule and best practices are formulated.
It is noteworthy that the final rule does not include central counterparties, which serve as buyer to every seller and seller to every buyer in the SBL transaction and therefore sit on both sides of the trade. The “covered person” category excludes any clearing agency that provides only a CCP function, thereby minimising risk that SFT trade reporting from CCPs would result in duplication of reporting for any covered loan transaction.
Learning from SFTR?
SEC Rule 10c-1 looks quite different in its initial and final design from the SFTR reporting template in Europe — with 12 reporting areas for example, compared with 155+ reporting fields in SFTR. Given the significant differences in their approach to gathering SBL trade information and promoting transparency, SFT asked to what degree will Rule 10c-1a deliver different regulatory outcomes to that delivered in Europe by SFTR.
The outcomes in the US will be different to Europe because the objectives and scope are different, notes S&P Cappitech’s Kaplun. The SEC is focused on providing transparency in the market to the general public and has required FINRA to publish the data in aggregate on T+1 and transaction by transaction on T+20. SFTR only requires for the data to be published in aggregate on a weekly basis and there is no transaction level detail available. In contrast, SFTR sought to give regulators access to the SFT data for monitoring of system risk and market abuse. Whether providing daily aggregate data and then delayed transaction data to the general public has significant value for retail traders and investors is still to be determined and the industry will really only know when the reporting requirements take effect in two years.
The European regulators and the SEC have taken different approaches and both, it appears, have their strengths and disadvantages. Rule 10c-1 focuses on a smaller set of data fields and, for EquiLend’s McNulty, this could arguably deliver transparency on lending in US securities that is easier to understand. The SEC will not, however, have data on loans of non-US securities by US lenders.
It is useful also to reflect on the overlap in scope between these two regulatory regimes. SEC Rule 10c-1 considers the securities that are lent and borrowed, essentially US securities and possibly cryptoassets, whereas reporting obligations under SFTR are determined firstly by the jurisdiction of the parties involved. This will mean that some transactions will need to be reported under both regimes.
Under the SEC 10c-1 regime, some of the data fields may need to be represented as multiple data points, observes S&P Cappitech’s Kaplun. For example, rates, fees, charges and rebates for the loan, as indicated in the SEC Final rules, may be represented as separate data points in the FINRA technical requirements. Having said that, Kaplun believes it will be easier to report than under the SFTR and, for those firms that already report under SFTR, the implementation will be significantly easier. Additionally, 10c-1 has explicitly excluded the reporting of repo transactions, while SFTR required the reporting of both SBL and repo trade information.
Unlike EU SFTR reporting obligations, SEC’s 10c-1 reporting regime at its core requires only basic data about trades to be reported by just one party to the trade — the lender or lending agent — confirms Treliant’s Ramakrishnan. SFTR’s 155+ fields — which is more than 10 times the number of reporting data elements outlined in SEC’s 10c-1 regime — is operationally burdensome and more challenging, given the dual-sided nature of reporting since it means more reconciliation efforts in Europe. Also, the need to store and process these many data elements is likely to cause data quality issues in the reporting infrastructure, which adds to the complexity of ensuring compliance with the SFTR regime.
At its core, suggests Ramakrishnan, SFTR was designed to support macro-prudential regulation — regulation aimed at monitoring and reducing risks to the stability of the overall financial system — and the primary consumers of SFTR data have been the European and UK central banks rather than regulators responsible for financial conduct.
Kaizen Reporting’s Lee believes that FINRA is likely to be stringent in implementation and enforcement with regard to reporting errors and late reporting. The lessons from SFTR come particularly from the implementation of standards, best practices and discipline, with broader adoption of post-trade contract compare and matching services.
“We would expect the equivalent controls layer to enhance booking practices and timeliness, with daily reconciliation processes, documented controls and quality assurance testing to provide comfort to beneficial owners, lenders, banks, brokers and agents alike,” says Lee. “On the one hand, the data requirements are significantly reduced relative to SFTR and this is single sided reporting. On the other hand, FINRA will enact far swifter justice for any reporting breaches.”
For ISLA’s Adrian Dale, SFTR has taught us all that reporting obligations are just that. They are a data schema devised for supervision that does not necessarily improve market operation. These can increase operating costs in a non-uniform manner, they may result in a higher cost of entry for some firms and, because of revisions required to accommodate market evolution, these may result in greater overall complexity.
“It is my belief that financial markets should operate through agreed standards and that the data models used in that market should then be leveraged to assist supervisors,” comments Dale. “Evolution in the operation of financial markets should therefore require a flexible approach to regulatory reporting, as opposed to the legacy snapshot method used in past decades.”
The second part of this article will be published in SFT Issue 340, released on 14 November.
