While the Volcker rule – which this week was approved by both the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Corporation (FDIC) – explicitly sanctions securities lending by US banks, other aspects of its parent bill could make the activity more difficult.
Part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Volcker rule seeks to ban US deposit-taking banks from engaging in proprietary trading and limits their ability to invest in private equity firms and hedge funds. The US Federal Reserve proposed its first version of the regulation earlier this week. It will seek public comment until 13 January 2012.
Under Volcker, banks cannot – on their own account –acquire or take a covered financial position for sixty days or less, unless they can demonstrate that the position was not acquired for short-term resale, benefitting from actual or expected short-term price movements, short-term arbitrage profits, or hedging one or more of any such position.
However, the rule exempts securities lending, which the Federal Reserve Bank defines as acquiring or taking a position that arises from a transaction in which a bank lends or borrows a security temporarily to or from another party under a written securities lending agreement, as long as the lender retains ownership of the security and can terminate the transaction and recall the loaned security.
Even with such exemption, a report from BNY Mellon Asset Servicing, which anticipated the move, said: “the Volcker rule calls into question the ability of agent lenders to manage certain unregistered cash collateral reinvestment pools”.
BNY Mellon warned that assets currently invested though an unregistered pool structure would need to move to separately managed accounts or to a mutual fund or other permitted commingled fund structures.
Unlike many other instruments, stock lending is a type of transaction that can be quickly exited. Yet while Volcker sanctions securities lending, there are ancillary Dodd-Frank regulations that will hav the effect of increasing the quality and amount of collateral required by lenders.
“Volcker allows securities lending and there does not seem to be any issues which restrict those types of transactions,” said Steven Lofchie, co-chairman of the financial services department at New York law firm Cadwalader Wickersham and Taft. “However, there are certain capital requirements under Dodd-Frank which could limit a bank’s ability to lend securities.”