Following concerns expressed in a recent staff report by the Federal Reserve Bank of New York about securities lending, BlackRock reiterates that its securities lending infrastructure has already brought together best investment practices and prudent risk management that address the regulators’ concerns.
In its May 2015 report titled “Securities Lending: The Facts”, BlackRock elaborates how it addresses the various concerns expressed by the NY Fed.
Concerns over cash and non-cash collateral
BlackRock points out that since the 2008 Financial Crisis, significant regulatory reforms have been implemented for securities lending by various authorities including Financial Stability Board, European Commission, and Securities and Exchange Commission. However, the BlackRock’s report notes several common misunderstandings have arisen regarding securities lending practices and associated risks, including potential conflicts of interest, use of cash collateral and cash reinvestment vehicles, borrower default indemnification. The BlackRock report also notes many misunderstandings specific to BlackRock’s involvement with securities lending have also been expressed in the staff report.
However, BlackRock believes it is imperative for policy makers to have all the facts. ValueWalk recently detailed how BlackRock has pushed back against regulators and indicated the regulators may not fully understand how securities lending works.
In its May 2015 white paper, BlackRock highlighted how each of the concerns raised in the Federal Reserve Bank of New York‘s staff report is addressed.
For instance, expressing concern over potential conflicts of interest, the staff report indicated that as a securities lending agent, self-dealing is potentially occurring. However, BlackRock responded by citing it doesn’t arrange transactions between lenders for which it acts as securities lending agent and entities for which it acts as investment manager.
The staff report also touched upon ‘use of cash collateral and reinvestment vehicles’ and indicated cash collateral reinvestment pools are subject to ‘run risk’. The following captures BlackRock’s pictorial representation of cash and non-cash collateral transaction:
Responding to the concern expressed in the report over ‘cash reinvestment vehicles’, BlackRock highlighted significant reforms have been implemented to address cash reinvestment vehicles:
Risk from borrower default indemnification
The Federal Reserve Bank of New York‘s staff report also expressed concern that borrower default indemnification represents a material balance sheet risk to lending agents. Responding to the concern, the asset manager clarifies that where ‘borrower default indemnification’ is provided, the lender is not indemnified for investment results, such as cash reinvestment. Moreover, borrower default indemnification is triggered only when both the following conditions are fulfilled, viz.: the counterparty defaults on the loan and the collateral is insufficient to cover the cost of replacing the securities.
The asset manager also highlighted how it has built a proprietary securities lending infrastructure which brings together best investment practices and prudent risk management. To highlight the robustness of its securities lending practices and systems, BlackRock also touched upon features of its independent risk management, robust assessment of borrowers, collateral standards, prudent collateral management and integrated investment process.