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NAIC Capital Markets Bureau
Last Updated 9/18/17
Issue: Securities lending is a recognized and established activity in financial markets that helps provide liquidity to markets and extra returns to investors who lend securities. The securities lending market involves lending of securities by institutional investors, such as insurance companies, to mostly banks and broker-dealers. It requires that the borrower post collateral in the form of cash or security.
Overview: According to FSOC's 2015 annual report, the average daily value of securities lending transactions at the end of 2014 remained at the same level as the previous year at $1.9 trillion worldwide, with the value of U.S. securities on loan at about 50% of the total or approximately $900 billion. The composition of assets being lent, both globally and in the United States, remained consistent with 2013, with government bonds and equities continuing to comprise the overwhelming majority of securities lent in 2014.
In its November 18, 2012 consultation paper, Strengthening the Oversight and Regulation of Shadow Banking, the Financial Stability Board (FSB) examined the complex and rapidly evolving securities lending markets. While the FSB acknowledges the benefits to the financial markets, aspects of securities lending are an issue of concern, particularly their procyclical nature, their lack of transparency, and the ways they may help to transmit negative market events in one part of the globe to another.
Insurance companies engage in securities lending to enhance returns on their investment portfolios, loaning out securities that are not actively traded. Securities lending is intended to be a low-risk investment strategy, providing the lender a modest income through fees charged to borrowers. Additional income may be generated by investing the cash collateral posted by the transactions' borrowers. The securities lending agreement spells out the term of the loan, the fee that the lender receives and the amount and type of collateral to be posted, among other items. The collateral is generally between 102% and 105% of the fair value of the securities loaned. Upon investing the posted collateral, insurance companies must consider credit and liquidity risks, as well as the asset/liability management risks of the potential investments. Insurance companies must also follow the appropriate statutory accounting rules related to securities lending transactions, which are included in the NAIC Accounting Practices and Procedures Manual. Insurance companies' individual investment policies should address the types and duration of investments that can be made with the cash collateral.
In general, securities lending transactions have a term of less than one year; however, terms can vary across different agreements. And, in most cases, the borrower may return the borrowed security and request its cash collateral back on relatively short notice, without penalty.
According to guidance in SSAP No. 103, "Collateral which may be sold or repledged by the transferor or its agent is reflected on balance sheet, along with the obligation to return the asset. Collateral received which may not be sold or repledged by the transferor or its agent [i.e. must be held and returned] is off-balance sheet." Note that for both on- and off-balance sheet reinvested collateral, summary information is required to allow for identifying potential liquidity constraints related to any potential duration mismatches.
At year-end 2015, insurers reported $79.6 billion in securities associated with securities lent, representing an increase from about $76 billion at year-end 2014. In comparison, insurers reported about $80 billion in securities associated with securities lent in 2013. Note that for year-end 2015, approximately $77.7 billion of the securities associated with securities lent were bonds; $1.9 billion were common equity (of which 94% was unaffiliated; the remainder in mutual funds) and $18 million were short-term investments (as reported in Schedule DA).
As of year-end 2015, about 40% of bonds associated with securities lent had maturities of up to five years, followed by 30% maturing between six and 10 years. This compares similarly to the maturities of insurers' reinvested collateral.
Furthermore, during the same period the insurance industry had $55 billion in reinvested collateral for securities lending, a relatively small exposure that was approximately 1% of the insurance industry's total cash and invested assets of $5.8 trillion as of year-end 2015. Insurer exposure to reinvested collateral from securities lending activity has been on a declining trend over at least the past few years; it was down from about $59 billion in 2014 and $61 billion at year-end 2013.
Life insurance companies accounted for 90% of securities lending activity (measured by total reinvested collateral), followed by property/casualty (P/C) companies at 6%.
Status: Since 2010, securities lending transactions are subject to more defined valuation rules and disclosure requirements. A new Schedule DL has been implemented that includes a detailed listing of the invested collateral, including separate categories for bonds, preferred stock and common stock. These reporting changes provide more transparency whether insurers are overcollateralized or undercollateralized.
To eliminate any misinterpretation of "restricted" and "unrestricted" collateral — including whether the securities lending transactions should be recorded on the balance sheet — the accounting rules within SSAP No. 91R were clarified such that if the collateral "can be sold or pledged by custom or contract by the reporting entity or its agent," then the reinvested collateral would be recorded on the balance sheet, which is more consistent with U.S. general accepted accounting principles (GAAP).