On November 18, 2021, the U.S. Securities and Exchange Commission proposed new Rule 10c-1, which, if adopted, would create a new reporting and disclosure framework for the securities lending market. Rule 10c-1 would require any person who loans a security on behalf of itself or another person (a “Lender”) to report to FINRA certain material terms of those loans and related information regarding the securities the person has on loan and available to lend. The proposal would also require that FINRA publish information concerning each transaction and aggregated information on securities on loan and available to lend.
The proposal represents the SEC’s response to its nearly 12 year old mandate under Section 984 of the Dodd-Frank Act to “increase the transparency of information available to brokers, dealers, and investors with respect to loan[ing] or borrowing securities.” Rule 10c-1 would create new industry obligations and newly defined terms and roles, and is an attempt to cast light on an opaque corner of the otherwise very transparent securities markets. The SEC notes that the value of securities on loan was approximately $1.5 trillion as of September 30, 2020.
Currently, the relative opacity of the securities lending market is addressed by private vendors who receive and transmit information regarding loaned securities to and from their subscribers. Because these vendors only have access to information provided by subscribers, the available data on this market is incomplete and fragmented. In the SEC’s view, the proposed requirements would serve the dual purpose of increasing transparency in the securities lending market to market participants and providing enhanced and comprehensive data to the SEC and FINRA for surveillance and analytics.
Does the proposed rule go too far? If approved, the proposal, including its reporting obligations, would have a sweeping and profound effect on the securities lending market and would create liability for those who do not comply with the new reporting construct. To the extent increased compliance costs reduce overall activity, the effects would be absorbed by a market that is not only a convenient source of extra revenue for firms and beneficial owners, but also beneficial to borrowers. The proposal also expands the scope of FINRA’s jurisdiction.
Proposed Rule 10c-1 would apply broadly to any person who loans any security on behalf of itself or another person. Notably, the SEC acknowledges that while “the majority of securities lending transactions involve broker-dealers, over which the SEC has direct regulatory oversight, a significant percentage of securities lending transactions occur away from broker-dealers.” Accordingly, the proposed rule would apply to entities over which the SEC does not typically exercise jurisdiction, such as pension plans, banks, and insurance companies, as well as to brokers. In addition, citing the ability to “ensure that a complete picture of transactions involving the loan of securities is provided,” the SEC is explicit in stating that the proposed requirements would apply to all securities, not just equity securities.
TRANSACTION REPORTING REQUIREMENTS
Rule 10c-1 would require Lenders to provide information about the terms of a securities lending transaction to FINRA within 15 minutes after a loan is effected or modified, and FINRA would need to make this information publicly available “as soon as practicable.” The SEC presumes that the securities lending market, with a generally high degree of automation, would not have trouble meeting a 15 minute reporting requirement. Under the proposal, a loan would be “effected” when it is agreed to by the parties and modified when the modifications are agreed to by the parties. This definition could be a point of uncertainty, given that terms being agreed to, and the actual execution of the loan transaction, are not necessarily always the same.
Rule 10c-1 would require Lenders to report the following “10c-1 Information” (both for initial transactions and any modifications to a loan if the modification results in a change to 10c-1 Information):
- Legal name of the issuer of the securities to be borrowed;
- Ticker symbol, ISIN, CUSIP, or FIGI;
- Time and date the loan was effected;
- Name of the platform or venue, if one is used;
- Amount of securities loaned;
- Rates, fees, charges and rebates for the loan, as applicable;
- Type of collateral provided for the loan and the percentage of the collateral provided to the value of the loaned securities;
- Termination date of the loan, if applicable; and
- Borrower type, e.g., broker, dealer, bank, customer, clearing agency, custodian.
In addition, Lenders would need to report the following information that would not be made public:
- The legal names of the parties to the loan;
- When the Lender is a broker-dealer, whether the security loaned to its customer is loaned from the broker-dealer’s inventory; and
- Whether the loan will be used to close out a fail to deliver pursuant to Rule 204 of Regulation SHO or otherwise. This requirement only applies if the Lender knows the loan is being used to close a fail to deliver.
AGGREGATE PUBLIC INFORMATION
In addition to making certain transaction-specific information about securities loan transactions public, as noted above, proposed Rule 10c-1 would require each Lender to provide FINRA, at the end of each business day, information concerning the aggregate amount of securities the Lender has on loan and available to lend. FINRA, in turn, would publish this information as soon as practicable, but not later than the next business day, on an aggregated basis.
The proposal would allow Lenders (including lending agents that are not broker-dealers) to enter into a written agreement with a broker-dealer to serve as the Lender’s reporting agent, pursuant to which the broker-dealer would agree to report the 10c-1 Information to FINRA on the Lender’s behalf. These arrangements would place the responsibility to report 10c-1 Information on the reporting agent. The SEC thinks that these arrangements will ease burdens on Lenders, including lending agents, that do not have and do not want to establish connectivity to FINRA.
If a beneficial owner does not employ a lending agent or reporting agent, the beneficial owner would be responsible for providing the 10c-1 Information to FINRA. In the case of retail investors, for any securities lent by a broker-dealer that are fully paid, the broker-dealer is acting as the lending agent and is responsible for reporting 10c-1 Information. If a lending agent enters into a written agreement with a reporting agent and provides the reporting agent with timely access to the 10c-1 Information, and the reporting agent fails to provide 10c-1 Information to FINRA, the reporting agent would be in violation of proposed Rule 10c-1. In the event a lending agent does not provide timely 10c-1 Information to the reporting agent, the lending agent would be in violation of the rule. Lenders who opt for reporting agent arrangements, and the broker-dealers that provide reporting agent services, should pay close attention to the terms of these eventual contracts, which will need to specify the responsibility for provision and reporting of, and access to, timely 10c-1 Information in addition to carefully considering liability and indemnity provisions.
Given the scope of information required, the proposal is sure to increase compliance burdens on those affected, most notably broker-dealers, but also beneficial owners, lending agents, and potentially clearing agencies. Other than for large institutional Lenders, broker-dealers will likely be expected to serve in the reporting agent role so beneficial owners themselves will not need to establish connectivity to report to FINRA. The SEC notes, however, that certain clearing agencies act as intermediary on behalf of beneficial owners to lend the beneficial owner’s securities. In these cases, the clearing agency would be acting as a lending agent and required to report 10c-1 Information to FINRA.
The proposal would require FINRA to implement rules regarding the format and manner used to administer the collection and distribution of 10c-1 Information. FINRA will likely mirror many of its existing TRACE reporting requirements for fixed income securities. Market participants will have an opportunity to comment on the eventual proposed construct. But query what sway, if any, non-broker-dealers will have in affecting the final outcome.
Finally, the proposal will affect third party data providers that currently disseminate private information on securities lending. Under the proposal, FINRA will disseminate both transaction-specific information and aggregate information regarding securities on loan and available to lend. With comprehensive data publicly available, market participants may no longer see as much value in data from private providers. Those existing data providers will need to find a way to differentiate themselves, likely through speed of delivery and ease of access.
The SEC’s mandate under Dodd-Frank is to “promulgate rules that are designed to increase the transparency of information available to brokers, dealers, and investors with respect to loan[ing] or borrowing securities.” While certain aspects of the proposal appear aimed to achieve this goal, such as public dissemination of transaction data like volume and price and aggregate market data, the proposal appears to go beyond the mandate in requiring Lenders to provide certain confidential non-public information. Specifically, it is difficult to see how transparency is furthered by the proposed requirements that Lenders report to FINRA the identities of the parties, whether the loan will be used to close a fail to deliver, and in the case of broker-dealers, whether such securities are loaned from the broker-dealer’s inventory. While this information would give FINRA and the SEC a more detailed view into the actions of market participants, its value to transparency is low if it is not publicly disseminated.
The broad scope of the proposal may be intended, in part, to help the SEC and FINRA gain insight into the inner workings of the securities lending market, including in relation to volatility seen in the market during the “meme stock” events in January 2021 and later. The SEC staff report on equity and options market conditions during that time noted excessive short interest as a contributing factor in the volatility of GameStop shares, where short interest at times exceeded 100% of shares outstanding as a result of the same shares being lent multiple times by successive purchasers. The same report also noted that the SEC observed spikes in fails to deliver for GameStop. The confidential data required by the proposal relating to inventory and fails to deliver may be intended to improve the SEC’s surveillance capabilities and strengthen its oversight in these areas.
In proposing this sweeping rule, the SEC also proffered 97 specific questions for which it requested public feedback during the public comment period that expired January 7, 2022. Given the size of the market, the number and scope of participants affected, and the compliance and operational questions raised by the proposal, affected market participants have given the SEC plenty to consider with a voluminous comment file. We will continue to monitor developments in this area, including any final adoption.
Lender, when used in the proposal, refers to “any persons 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”).”
Rule 10c-1 states that Lenders must report to a registered national securities association (“RNSA”). FINRA is currently the only RNSA.