Disclosure of Equities Securities Lending – February 2009 4. Possible Approaches to Improving Disclosure

As noted above, to meet the Reserve Bank's objectives, data are required on both the transaction-level flow and the aggregate outstanding stock of securities loans. This section considers the possible approaches to collecting these data.

4.1 Real-time tagging

In consultation, the importance to the system operator of transaction-level flow data on securities-lending transactions was widely accepted, as was the use of tagging to collect these data. Suitably aggregated, these data could be used to calculate the gross flow of settlement activity in the market or the proportion of settlement fails attributable to loan-related transactions. Transaction-level data could also form the basis for constructing data on aggregate loans outstanding, both including and excluding on-lending activity.

The main option considered for the collection of transaction-level data was the tagging of securities-lending transactions as they are submitted to the securities settlement system, CHESS. In principle, if each settlement instruction were tagged as either a new loan, a borrow, an inward return or an outward return, transaction-level data could be aggregated across participants, at the end of each settlement day, generating the net flow of equities securities lending for each line of security. In combination with an initial ‘snapshot’ of on-loan positions, the system operator could then calculate the stock of aggregate outstanding on-loan positions. With this level of tagging, it would be possible to produce two separate aggregations – one including on-lending, and one excluding the effect of on-lending – which could then be published by the system operator either the next day or with a short lag.

Being collected from the actual transaction data, this approach would capture the transactions of both settlement participants and their clients. Furthermore, once the procedures were established, tagging could be highly automated, thereby reducing the reporting burden on participants. Enforcement by ASX would also be relatively straightforward, as the reporting party would be directly bound by ASTC Settlement Rules and, in turn, its clients would be bound by the need to tag the transaction properly if it was to settle. ASX and industry participants indicated that systems could be adapted to accommodate tagging without incurring large costs – it could be achieved in a couple of different ways, neither of which would require fundamental re-engineering of the CHESS software at ASX or at the level of a settlement participant's interface to the system.

The consultation process, however, drew out a number of difficulties with this approach. The first was that in order to be able to use the data on the flow of lending transactions to construct a stock of on-loan positions, the information collected on each transaction would need to be fairly detailed. In particular, transactions would have to be separately identified as loans, borrows, inward loan returns, or outward loan returns. This level of tagging was seen by some participants as too complex, particularly where a settlement participant is reliant on receiving accurate information from clients. Furthermore, to enforce accurate reporting, the tagging field would need to be a ‘matching field’ in the instruction template: that is, a field which both parties to a trade are required to populate accurately or else the trade will not settle. The more complex the tagging regime, the higher the potential for non-matching transactions and hence the possibility of more frequent settlement failures, at least during a transitionary phase as participants adjust to the new regime.

Finally, while the transaction-level data could be aggregated to estimate a stock of outstanding loans, they will not capture all loan transactions. In particular, internalised trades – loan transactions between two clients of the same settlement participant that are settled across the books of that participant – are not submitted to ASTC for settlement.

While data on internalised transactions are not important for the system operator in managing the settlement process, they are important if a ‘true’ outstanding on-loan position is to be constructed from transaction-level data. The constructed series would, therefore, diverge from the ‘true’ position over time, requiring that periodic reporting of lenders’ outstanding on-loan positions be carried out via direct reporting to re-anchor the series.

4.2 Two-part disclosure: real-time tagging and direct reporting

An alternative approach, discussed with industry participants, would be to collect data on the stock of loans outstanding via direct reporting, rather than to build up the stock position using transaction-level data. Under this approach, institutions engaged in securities lending or borrowing activity would report their outstanding on-loan and borrowed positions in each ASX security. The data would then be aggregated across reporting institutions, with the outstanding on-loan position in each security (both including and excluding on-lending activity) published on the next business day or with a short lag.^[1]

The main advantage of this approach is that it would directly capture the outstanding loan positions in each security, thereby avoiding potential errors and omissions in constructing the series from tagged settlement data associated with the inability to capture internalised transactions.

Furthermore, since the transaction-level data would not be used to construct a stock series for lending, the tagging regime could be simplified. This would reduce costs of compliance while still providing sufficient information to the system operator to manage potential settlement issues. Simplified tagging would also increase the likelihood of accurate reporting, reducing the likelihood that settlement failures would increase due to transactions not matching.

A final advantage is that, since many institutions currently provide similar data to DataExplorers, a commercial provider of data services to the securities-lending and fund-management industries, the additional burden of such disclosure for these participants should be relatively low.

The main issue with this approach relates to reporting by lenders/borrowers that are not settlement participants. While settlement participants would be required to provide data under ASTC Settlement Rules, participants were of the view that it would be difficult to compel their clients, particularly those located offshore, to report. In the case of tagging, clients have a clear incentive to comply, since incomplete or inaccurate tagging will lead to settlement mismatches and settlement fails. No similar incentive exists in the case of direct reporting and we understand that existing contractual arrangements between settlement participants and their clients would not cover such a reporting obligation. Of course, this could change over time.

Clients may also be reluctant to provide data on such activity to their settlement participants for confidentiality reasons and, even if the data could be obtained, the settlement participant has no means of validating such data.

4.3 Discussion

Having considered the alternative approaches discussed above and consulted extensively with industry participants, the Reserve Bank is of the view that a two-part regime for disclosure – combining real-time tagging of settlement instructions with direct reporting of outstanding on-loan and borrowed positions – would best meet its objectives, without imposing unnecessary costs on industry participants. It would allow a simplified tagging arrangement to be put in place to meet the needs of the system operator in understanding and managing risks in the settlement process, while also providing an efficient means for public disclosure of aggregate on-loan positions.

The principal disadvantage of this approach noted above was the potential difficulty in obtaining information from participants in the securities-lending market that are not settlement participants and, in particular, offshore clients of settlement participants. This issue has been discussed at length with industry participants during the consultation process, with the conclusion reached that a regime underpinned by the Financial Stability Standard, enforced via ASTC Settlement Rules, could only formally require settlement participants to provide the relevant information. To supplement these data, the Reserve Bank would work with ASX and industry participants to secure commitments to provide similar data from non-settlement participants with a material presence in the Australian securities-lending market. The Reserve Bank is confident that a commitment could be obtained from non-settlement participant members of ASLA, and ASLA has agreed to engage other international securities lending associations to promote reporting by offshore market participants.

In the event that insufficient coverage is obtained using this approach, two alternative routes could be considered. One possibility would be to re-examine the implementation of a more complex tagging regime, which would facilitate the construction of the data on outstanding loan positions from transaction-level data. Another would be for the Parliament to introduce explicit requirements in legislation.

Footnote

The aggregate outstanding on-loan position including on-lending activity would be the sum of all on-loan positions across participants. The aggregate outstanding on-loan position excluding on-lending activity would first subtract all borrowed positions from on-loan positions and then sum all positive net on-loan positions across participants. [1]