[co-author: Paul Leonardo Capuano]*
The Securities and Exchange Commission, in a November 18, 2021 release (Release),1 proposed Rule 10c 1 under the Securities Exchange Act of 1934 (Proposed Rule). If adopted, the Proposed Rule would require certain persons (generally, persons who lend securities or their agents) to report material terms of, and information related to, their securities lending activities to a “registered national securities association” (RNSA).
Comments on the Proposed Rule must be submitted by January 7, 2022
Background
Section 984 of the Dodd-Frank Wall Street Reform and Consumer Protection Act authorized the SEC to “increase transparency, among other things, with respect to the loan or borrowing of securities,” and mandated that the SEC “promulgate rules designed to increase the transparency of information available to brokers, dealers, and investors.” Prior to the Release, the SEC had not exercised its authority pursuant to Section 984, and therefore most lenders of securities and other securities lending transaction participants currently are not required to disclose the terms of their securities lending transactions.2 In the Release, the SEC described current securities lending markets as “opaque,” which, in turn, “creates inefficiencies in the securities lending market ... render[ing] it difficult for borrowers and lenders alike to ascertain market conditions and to know whether the terms that they receive are consistent with market conditions.” The SEC also noted that the lack of publicly available information related to the securities lending market impacts the ability of the SEC, RNSAs, self-regulatory organizations and other Federal financial regulators to “oversee transactions that are vital to fair, orderly, and efficient markets.”
The Release explains that the Proposed Rule is intended (among other things) to: provide market participants with transparency into pricing and other material securities lending terms; improve “price discovery” in securities lending markets; provide RNSAs with information relevant to their regulatory oversight functions, “including facilitating and improving [their] in-depth monitoring of member activity and surveillance and securities markets”; and improve the efficiency of securities lending markets while also lowering “barriers to entry for would-be participants in the securities lending market."
Overview of the Proposed Rule
In relevant part, the Proposed Rule would require any person that loans a security3 – whether on behalf of itself or another person (a lender) – to provide to an RNSA certain specified information related to such securities lending transaction, in a format and manner prescribed by the rules of the RNSA.
Persons Who Loan Securities
The Release clarifies that for purposes of the Proposed Rule, a “lender” is:
“any person[ ] that loans a security on behalf of itself or another person, including persons that own the securities being loaned (‘beneficial owners’), as well as third party intermediaries, including banks, clearing agencies, or broker-dealers that intermediate the loan of securities on behalf of beneficial owners (‘lending agent’).”4
As a corollary, the term “lender” would not extend to the borrower of securities in a securities lending transaction or any third party that intermediates the borrowing of securities on behalf of the borrower.5 The SEC explained that the associated reporting obligation under the Proposed Rule would extend only to lenders, in order to avoid potential double-counting of securities lending transactions, while also placing the reporting onus on the entities that the SEC believes are better positioned to provide such information.
The SEC requests responses to several questions related to the nature of the “persons” required to provide reporting under the Proposed Rule, including: whether the reporting obligation should be limited to persons registered with the SEC; whether certain categories of lenders should be excluded from the reporting obligation; and whether borrowers in connection with securities lending transactions should be subject to a reporting obligation.
RNSAs
Under the Proposed Rule, lenders would be required to provide the material terms of securities lending transactions to an RNSA. Currently, the Financial Industry Regulatory Authority, Inc. is the only RNSA. However, the Proposed Rule does not preclude reporting to non-FINRA RNSAs if such RNSAs are established in the future.6
The Proposed Rule also would permit RNSAs to collect reasonable fees from each person that provides the required Rule 10c-1 information to an RNSA.
The SEC requests responses to several questions related to the provision of the prescribed information to RNSAs, including whether the prescribed information should be provided to an entity other than an RNSA.
Persons Required to Report Information to RNSAs; Reporting Agent Obligations
The Proposed Rule would prescribe the specific person or entity required to report required Rule 10c-1 information to an RNSA. As proposed, if a lender uses an intermediary (e.g., bank or clearing agency) or broker-dealer (collectively referred to in the Release as “lending agents”) to lend its securities, the lending agent would assume the lender’s reporting obligation under the Proposed Rule. The lender or the lending agent, as the case may be, can enter into a written agreement with a broker-dealer (a “reporting agent”) to provide the required information to the RNSA. In such case, the lender or lending agent need only furnish the reporting agent with “access to” the information to be provided. If the lender does not use a lending agent or a reporting agent, then the lender itself must provide the required information to the RNSA.
In the event a reporting agent is retained, the reporting agent would be required to provide the specified information to an RNSA only if: it has entered into a written agreement with the lender or lending agent that explicitly permits the reporting agent to provide 10c-1 information on behalf of the relevant lender; and it is provided with “timely access” to the information required to be reported. “Timely access” is proposed to be defined as sufficient time for the reporting agent to provide such information to the RNSA within 15 minutes after the securities loan is effected or the terms of the loan are modified. If a reporting agent is not provided timely access, the reporting obligation would revert to the lender or the lending agent, as applicable.
The SEC proposes to subject reporting agents to certain requirements in addition to entering into a written agreement to provide the required information and to report such information to an RNSA. Specifically, a reporting agent also would be required to:
(i) Establish, maintain and enforce written policies and procedures reasonably designed to provide required information to an RNSA on behalf of another person in the manner, format and timeframe consistent with the Proposed Rule;7
(ii) Enter into a written agreement with an RNSA that permits the reporting agent to provide required information to the RNSA on behalf of another person;8
(iii) Provide the RNSA with: a list of each person and lending agent on whose behalf the reporting agent is providing required information to the RNSA; and an updated list of such information by the end of the day on the day such list changes;9 and
(iv) Preserve for a period of not less than three years, the first two in an easily accessible place, certain required information.10
The SEC requests comment in response to several questions related to relationships involving lenders, lending agents, reporting agents and RNSAs, including: whether other entities should be permitted to be lending agents or reporting agents; whether the requirement for reporting agents to establish written Rule 10c-1 policies and procedures is necessary or should be modified; what impact (if any) the recordkeeping requirements applicable to reporting agents would have on the liquidity of securities lending markets or the cash market for securities; whether any final rulemaking should specify the contractual terms of a written agreement between a reporting agent and a lender/lending agent; whether or why a lender would use a reporting agent to transmit information to an RNSA; and whether there are other methods by which the SEC could improve securities lending market transparency.
Information to Be Reported to an RNSA
Under the Proposed Rule, lenders and lending agents would be required to provide certain enumerated categories of information to an RNSA (e.g., transaction data, loan modification data, confidential data, securities available to loan and securities on loan). As discussed in further detail below, the Proposed Rule would prescribe whether such data is treated as confidential or may be made publicly available by the RNSA, as well as the timeframe in which the information must be provided to the RNSA. For the transaction data, loan modification data and confidential data categories, all information must be reported to an RNSA within 15 minutes after the loan was executed or modified.
Transaction Data
If applicable, transaction data required to be provided to an RNSA would include loan-level data and material terms of transactions.11
As soon as practicable following receipt, the RNSA would be required to assign each loan a unique transaction identifier and make such information publicly available.
Loan Modification Data
If applicable, the Proposed Rule would require lenders or lending agents to provide the following categories of information to an RNSA, if the modification results in a change to information required to be provided to an RNSA:
(i) The date and time of the modification;
(ii) A description of the modification; and
(iii) The unique transaction identifier of the original loan.
As soon as practicable following receipt, the RNSA must make this information public.
Confidential Data
While much of the data provided to an RNSA would be required to be made publicly available, the SEC noted that it may not be appropriate for an RNSA to make publicly available all data provided to it by a lender or lending agent. Specifically, if applicable, the Proposed Rule would require lenders or lending agents to provide the following information to an RNSA (and the RNSA would be required to keep such information confidential, subject to provisions of applicable law):
(i) The legal name of the party and identification number, if applicable;
(ii) The role of the party in the transaction;
(iii) If the lender is a broker-dealer, information about whether the security is being loaned to the customer from the lender’s inventory; and
(iv) If the information provider has such knowledge, that the loan is being used to close a fail-to-deliver outside of Rule 204 of Regulation SHO.
Securities Available to Loan; Securities on Loan
In relevant part, the Proposed Rule would require lending agents to provide certain information to an RNSA by the end of each business day.
All lenders would be required to provide (either directly to an RNSA or to a reporting agent that would provide such information) and to identify the person on whose behalf it is providing the information:
(i) The legal name of the security issuer, and the LEI of the issuer, if the issuer has an active LEI;
(ii) The ticker symbol, ISIN, CUSIP or FIGI of the security, if assigned, or other identifier;
(iii) The total amount of each security that is not subject to legal or other restrictions that prevent it from being lent (referred to in the Release as “available to lend”); and
(iv) The total amount of each security that contractually has been booked and settled (referred to in the Release as “security on loan”).12
The Proposed Rule would require an RNSA to make available to the public only aggregated information required under Proposed Rule 10c-1(e)(1) and (2). The RNSA would be required (subject to the provisions of applicable law) to keep confidential identifying information about lending agents, reporting agents and other persons using reporting agents. If information under Proposed Rule 10c-1(e)(1) and (2) is not subject to confidential treatment, the RNSA would be required to make such information publicly available as soon as practicable, but not later than the next business day.
The SEC requests comment in response to several questions related to information to be reported to RNSAs, including: whether the proposed reporting of loan-level information provides sufficient transparency; whether additional specificity regarding the timeframe under which information provided under Proposed Rule 10c-1(e) should be provided; whether any other data related to securities loans should be provided to RNSAs to improve market transparency, or if existing categories of data proposed to be provided to RNSAs should be removed; whether data under Proposed Rule 10c-1(d)(2) and (3) should be made publicly available; and whether information an RNSA is required to make publicly available under Proposed Rule 10c-1(e) should be made publicly available.
Additional Requirements Related to RNSAs
The Proposed Rule also would impose certain additional requirements on RNSAs, including (among others) to: retain and make available to the SEC certain data collected pursuant to the Proposed Rule; establish, maintain and enforce written policies and procedures reasonably designed to maintain the security and confidentiality of confidential information provided under Proposed Rule 10c-1(d) and (e)(3); and permit the collection of “reasonable fees."
Non-Applicability to Repurchase Agreements
The Proposed Rule does not apply to repurchase agreements (repos). As noted in the Release, a securities loan collateralized by cash is economically very similar to a repo.13 The Release discusses the potential risk that market participants may substitute repos for securities loans in order to circumvent the reporting requirements of the Proposed Rule. The Release acknowledges that there is a well-developed practice for effectuating short sales of bonds through a repo instead of a securities loan, although it states that the SEC is “unaware of short sales of equities currently being facilitated by repo contracts.” The Release does not indicate that the SEC would modify the scope of the Proposed Rule to address this risk, nor does it seek comment on this issue, but it does state that “the comprehensiveness of the data, and hence the benefits that accrue due to the comprehensive nature of the data, would be diminished if the proposal induces market participants to substitute [repos] for securities lending agreements."
Footnotes
1) Reporting of Securities Loans, SEC Rel. No. 34-93613 (Nov. 18, 2021).
2) Currently, Form N-CEN requires certain disclosure related to an investment company’s securities lending activities, and Form N-PORT requires disclosure related to borrowers of loaned securities and collateral received. See Release at n. 4; however, the disclosure required by the Proposed Rule is far more extensive.
3) For purposes of the Proposed Rule, the term “security” is defined by reference to Section 3(a)(10) of the Exchange Act. The Proposed Rule does not limit the types of securities that would be subject to reporting.
4) Release at n.9.
5) Id.
6) References in this OnPoint to “an RNSA” or to “RNSAs” are intended to refer to any eligible RNSA in existence at the time of any final rulemaking, and currently refers only to FINRA.
7) Rule 10c-1(a)(2)(i).
8) Rule 10c-1(a)(2)(ii).
9) Rule 10c-1(a)(2)(iii).
10) Rule 10c-1(a)(2)(iv). This would include information such as the time that the information was provided to a reporting agent by a lender/lending agent, and the time that the information was provided by the reporting agent to the RNSA.
11) Loan-level data includes: the legal name of the security issuer, and the Legal Entity Identifier (“LEI”) of the issuer, if the issuer has an active LEI; the ticker symbol, ISIN, CUSIP or FIGI of the security, if assigned, or other identifier; the date and time the loan was effected; and (for a loan executed on a platform or venue) the name of the platform or venue.
Material terms of securities loan transactions include: the amount of the security loaned; (for a loan not collateralized by cash) the securities lending fee or rate, or any other fee or charges; the type of collateral used to secure the loan of securities; (for a loan collateralized by cash) the rebate rate or any other fee or charges; the percentage of collateral to value of loaned securities required to secure such loan; the termination date of the loan, if applicable; and whether the borrower is a broker or dealer, a customer (if the person lending securities is a broker or dealer), a clearing agency, a bank, a custodian or other person.
12) The specific information required to be disclosed in (iii) and (iv) of the text would vary based on whether the lending agent is a broker or dealer.
13) Release at 147.
*Law Clerk
