The US Agent Lending Disclosure Initiative is nearing completion. John Piccitto explains that this is of less concern to Europe than may be thought – many European players are better placed to comply than their US counterparts.
The hapless desk jockey in the credit department of a very large US broker/dealer, surprised by a telephone inquiry during a busy day, admitted that he had never heard of the Agency Lending Disclosure Initiative (ALDI). A quick explanation of the idea still rang no bells. Finally, he suggested asking the investor relations department. By contrast European industry players – in contrast to their obstreperous reactions of 12 months ago – have not only heard of the initiative, they are well on their way to figuring out how to cope with its implications.
Panic stations
In the wake of the MFJ Clearing default (2001), the US Securities and Exchange Commission (SEC), fearing another Peregrine or Drysdale, perhaps on the scale of the Savings and Loan scandal, began banging heads together. Something had to be done, urgently, about record-keeping among securities lending operatives so that a borrower knew exactly who the beneficial owner of a stock was. Just knowing the agent lender wasn't good enough anymore, because agent lenders had been known to back away from trouble.
In Europe, early reactions to the project ranged from indignant snorts to protracted whinges. Surely, nay-sayers objected, the proposed regulations implied a slur on the probity of agent lenders ("European lenders and borrowers are professionals and stand by their deals, ...not like those who backed away when Drysdale defaulted!") The idea of enhanced, or worse, compelled disclosure was feared as an engine of vastly increased head count, systems expansion (developing and processing files of information about lenders and loans) and a spike in billable legal time. It was condemned as an unnecessary replication of existing, though unused, facts on record.
Further acquaintance with the ALDI, partly through the articulate presence of representatives of the ALDI taskforce at industry conferences, has assuaged earlier misgivings, although that job is by no means complete. Perhaps the growing idea of transparency, in the context of the current corporate governance movement and in the wake of Basel II, has helped to make the inevitable seem more palatable. At any rate, among Europeans remaining objections to ALDI are now both less vehement and more specific.
Further, while the cost of data processing will be greater post-ALDI, especially the initial costs, most informants recognize that the data required is already in hand. IT and legal costs are likely to be one-offs. The most telling impact on agent lenders may be on the pooling arrangements that some use to apportion business among beneficial owners.
In its current (almost finalized) form, the Agent Lender Disclosure Initiative communicates between lender, agent and borrower information concerning the principal lender's identity as well as detailed information about individual transactions and the related collateral. When the ALD Taskforce's current plans become industry practice, standardized exchanges of data between agent lender and borrower will accompany every securities loan.
Through the Credit Pre-Qualification exchange, Incremental Add/Delete File and Borrower's Response [see boxes] the agent lender will transfer enough data about a proposed principal lender to a borrower's credit and treasury departments to enable a credit check on the principal lender, and a check of the impact of this loan and its source on issues of capital adequacy. As a result of this exercise, the principal lender is accepted or rejected. Then, during the ongoing period of the loan, the Daily Loan Data File [see box] will show standard trade ticket information and any changes to it, enabling continuous monitoring of credit and capital adequacy issues. In addition, a Master File, issued at least annually, and more frequently where requested, lists all the principal lenders and all their loans for a particular borrower, to facilitate reconciliation.
Credit Pre-Qualification Data
Data collected by borrowers before a securities loan is initiated
and maintained based on SEC books and records requirements
• Borrower Tax ID • Principal Lender ID
• Principal Lender IRS ID
• Lender name, address and contact person
• Classification of Principal Lender (hedge fund,
pension plan, etc.)
• Principal Lender’s Lendable Assets, Capitalization,
Assets under custody, and net asset value BACK
Incremental Add/Delete File
Sent by lender to ask borrower to approve a new principal lender,
or to delete a principal from the program. Among others, file
elements include:
• Borrower tax ID • Principal lender ID • Principal lender details – place of incorporation
and place of business • Ultimate parent of Principal Lender
• Optional information on Principal Lender’s
lendable assets, capitalization, assets under custody
at agent lender, and net asset value BACK
Borrower’s Response to
Lender’s Incremental Add/Delete File
• Date • Borrower Tax ID
• Principal Lender ID
• Approval
• Reason BACK
Daily Loan Data File
Standard loan data information, sent by lenders to borrowers for
regulatory capital computation and for credit
concentration limit testing
Trade ID
Open date
Sending Firm ID
Receiving Firm ID
Asset ID –
(CUSIP or ISIN)
Asset Identifier Code –
(CUSIP/CINS, ISIN, Quick or SEDOL)
Currency Code
LOC Collateral Amount
Securities Collateral Amount
Tri-Party Collateral Amount
Market Value
Mark to Markets
Securities Status
Collateral Status
Rebate Premium
Rate Net dividend to Lender
Rate Repeating Records –
The constant transmission of data files between borrower and agent lender was the focus of much of the initial resistance (both in the US and elsewhere) to the ALDI. In addition to its sheer volume, it was feared the data might allow the borrower to know who the underlying beneficial owner is, a matter of some concern to agent lenders who like to keep that sort of information to themselves. So Chinese walls were mooted, as well as non-disclosure agreements. The final decision is to send data about the principal lender to the borrower's credit and treasury departments only, and not to the securities lending desk. And no data will be communicated directly from the agent lender to the borrower. Instead, data will go through a sort of post office supplied by one of three providers, SunGard, DTCC or EquiLend.
ALDI's jurisdiction
The issue of who will or will not be affected by the new US code of best practice is not yet clear. At the May 2005 ISLA/RMA conference in Athens, ALDI taskforce member Tred McIntire stated that: "The ALDI will affect US broker/dealers and anyone who lends directly to these broker/dealers. It will not affect companies that lend to UK branches of US broker/dealers, or to other entities not related to them."
Yet the head of equity finance at an international broker/dealer says international compliance is inevitable: "If a non-US regulated entity is borrowing securities from a US regulated entity, [our] global headquarters will comply with the US regulations and advise all subordinate groups of US compliance rules."
And a London fund manager says that is irrelevant: "It is very unusual for a UK lender to lend or borrow securities to or from a US entity. If Merrill Lynch or Morgan Stanley wanted to borrow securities, they would have to borrow in the name of their UK subsidiary," who would be signed up via a GMSLA document with him, under UK law.
However, in reaction to what seems to be inevitable international compliance, the ALDI taskforce has recently added elements to the data files for foreign government ID numbers and country of issue codes.
Progressive Europe
The thing is, Europe is better placed to comply than the US. Many European institutions already abide by regulatory practices similar to ALDI. Wayne Burlingham, head of securities lending at HSBC Bank in London, points out that the essence of the ALDI had been put forward already by the SFA (Notice 511) in 1999, and in the 'Stock Lending and Borrowing Code of Guidance' issued by the Bank of England.
The head of securities lending at a large London institutional lender says that he currently "tells all borrowers who the beneficial owners are when shares are loaned. We follow UK best practice guidelines, so that borrowers can manage the underlying exposure of their lending counterparties. We will always comply with the know-your-customer guidelines." And the head of marketing at another UK institution says that the initiative will not mean too much change for his company because it already looks to the primary lender, though some agent lenders provide better data than others.
Christopher Fay, SecFinex CEO, agrees. He pointed out at the May 2005 ISLA/RMA conference in Athens that "many borrowers in Europe have for many years had to know the underlying principal at point of trade."
Even the Swiss, famous for bank secrecy for generations, have come on board. The disgorging of information about the underlying principal by an agent is no longer a problem, because several Swiss banks have decided to act as a principal in all securities lending transactions.
"The banks have to react positively with the marketplace," says a director of one of the major Geneva institutions. Confining lending activities to borrowers who are rated A+ or better, the bank includes in its borrower base such entities as broker/dealers, investment banks and trading companies. But the source says it has tightened up its credit approval process considerably in recent years.
An official at another Swiss bank in Zurich explains that "at present the bank lends as a principal, because Swiss Bank Secrecy laws were a burden on securities lending arrangements." This includes risk for both securities and collateral. The credit approval process has been tightened, since the bank must decide who to lend to and against which borrower the bank will take principal risk for its transactions.
The problem is pooling
The biggest challenge for institutional lenders will be adapting pooling programmes to ALDI. Many lend securities from a pool and either do not disclose the names of the beneficial owners unless they are asked, or else switch the attribution of the loan around the pool of beneficial owners during the life of the transaction. As they reallocate shares to successive beneficial owners, the borrower may come into violation of his own credit or capital adequacy policies through no action (or fault) of his own.
But even here the Europeans are ahead. "There are more direct lenders in the UK than in the US," says industry stalwart Roy Zimmerhansl, examining the differences. "For direct lenders, ALDI requirements are a non-issue as they already allocate in a transparent way. And US custodians typically have more clients than Europeans and do more pooled lending activity."
Credit and communication
So who will feel an extra burden from the ALDI? Zimmerhansl says it is essentially a technology issue for custodians and a credit one for the borrowers: "I would be stunned if most European lenders could cope with producing the amount of data that will be required by the ALDI on a daily basis. ALDI does nothing for the custodian at all and as the Europeans have not been involved with the initiative, it has not been a priority issue for them. I am not aware of any European custodian that broadcasts a full underlying client breakdown to borrowers on a daily basis."
Yet others argue that any technology changes will be one-offs, initial investments that will simply become integrated with the rest of the agent lenders' infrastructure. Less debatable is Zimmerhansl's opinion on borrowers. The head of marketing at a UK institution says that the ALDI will mean more credit work for borrowers, who will now have to cross reference new data with their own. He also says that the borrower will be compelled to show that the data is being used, though this is probably not a bad thing on either end of a securities lending deal.
At his presentation of the ALDI programme at the ISLA/RMA conference, taskforce member Tred McIntire said that small borrowers may suffer the most. More documentation will be required and it may be difficult to meet all the requirements, he said. The point was taken up by Christopher Fay, focusing on the burden of transmitting the proposed Daily Loan Data File: "Building a post trade matching process seems to be a way of ensuring that big players who can afford big IT spends will be given a significant advantage over smaller guys." On a side point, Fay pointed out that "Unless the underlying principal is disclosed – at least on a coded basis – at the time of trade, then the risk still exists."
Other than these issues, the impact of the ALDI in Europe will be an interesting example of one regulatory practice driving out another fairly similar practice. While the best practices regulations resulting from the initiative will apply – at least at first – only to financial entities governed by the US SEC, the idea will fall on fertile ground elsewhere in the world. Through the recent inclusion of data fields, non-US borrowers, agents and lenders may participate. But more importantly, they already share some of the ideas and practices that underlie the US-based initiative.
