Document Properties
- Type of Publication: Guideline
- Date: September 1996
- No: B-4
- Audiences: Banks / FBBs / T&L / Co-op
This guideline sets out prudential considerations relating to the lending
of securities by federally regulated banks, authorized foreign banks in
respect of their business in Canada (foreign bank branches - FBBs), trust
and loan companies and cooperative credit associations ("financial
institutions").
Introduction
Traditionally, security loans have been short term transactions designed
to assist the liquidity of securities markets by enabling dealers/brokers
to cover failed deliveries or short sales. However, some security loans
may also have been undertaken for longer terms in which liquidity is a
secondary consideration. Financial institutions should be fully cognizant
of the additional risks stemming from such longer term transactions and
should ensure that they have the systems and controls in place to identify
and control these risks.
Financial institutions should ensure that securities lending activities
are conducted in a safe and prudent manner and they should seek
appropriate professional advice to ensure that controls and procedures are
comprehensive and sound.
Collateral
Financial institutions should at all times hold adequate collateral to
protect themselves against the risks associated with securities lending.
The amount of collateral taken for securities lending should reflect best
practices in local markets. In Canada, the current market practice is to
obtain collateral of at least 102 per cent of the market value of the securities lent. Management is
expected to ensure that the margin of collateral in excess of market value
of securities lent is appropriate at all times. This margin should provide
adequate protection against volatility and liquidity problems that may
arise for securities lent and for securities held as collateral. Both
loaned and collateral securities should be "marked to market" at least
daily. Shortfalls in the amount of collateral should be rectified
immediately.
A financial institution's policy on acceptable collateral should be
consistent with the financial institution's overall investment policies as
established by the board of directors. Accordingly, financial institutions
should only take securities as collateral that are acceptable as a direct
investment.
For securities lending within North America, eligible collateral should be
readily marketable and would normally be restricted to the following
assets, denominated in Canadian or U.S. dollars:
-
cash;
-
widely-traded debt instruments having a rating of single A (or the
equivalent) or higher from a recognized, widely followed North
American credit rating agency;
-
commercial paper rated A-1 or R-1 or the equivalent by a recognized,
widely followed North American credit rating agency;
-
acceptances of banks and trust and loan companies whose short-term
deposits are rated A-1 or R-1 or the equivalent by a recognized,
widely followed North American credit rating agency; and
-
high quality common and preferred shares.
Eligible collateral also includes:
-
unconditional, irrevocable letters of credit that comply with the
standards of the International Chamber of Commerce and which are
issued by banks and trust and loan companies whose short-term deposits
are rated A-1 or R-1 or the equivalent by a recognized, widely
followed North American credit rating agency; and
-
unconditional and irrevocable guarantees of banks and trust and loan
companies whose short-term deposits are rated A-1 or R-1 or the
equivalent by a recognized, widely followed North American credit
rating agency.
Convertible preferred shares and convertible debt instruments may be taken
as collateral when they are immediately convertible into the underlying
security lent.
Securities lending activities in Organization for Economic Co-operation
and Development (OECD) countries other than Canada and the U.S. should be
in accordance with the above criteria, but financial institutions may also
accept collateral denominated in the currency of the country in which the
lending occurs, and debt instruments issued by that country's central
government.
Controls
and Records
Financial institutions should ensure that they have appropriate internal
controls, procedures and records in place. Controls should include a list
of approved borrowers, consistent with the financial institution's lending
policies that are based on generally accepted credit worthiness standards
with specified lending limits for each borrower. The list should be:
The financial institution's board of directors (or a committee designated
by the board and reporting to the board)
should, at least annually, review and approve:
-
the general credit worthiness standards used in establishing the list
of approved borrowers which should be consistent with the financial
institution's overall lending policies as established by the board;
and
-
overall and individual securities lending limits. These limits should
take into account other exposures established by the board.
External or internal auditors should verify at appropriate intervals:
-
that the list of borrowers conforms to the criteria established by the
board (or a committee designated by the board and reporting to the
board);
-
that securities accepted as collateral are consistent with the overall
investment policies established by the board of directors; and
-
the existence of securities lent and taken as collateral.
A designated senior manager of the financial institution should receive
regular, comprehensive and timely reports summarizing the financial
institution's securities lending activities to allow the manager to judge
whether the activities are being properly administered.
Use of
an Agent
A financial institution may employ an agent for the administration of its
securities lending program. The financial institution's board of directors
(or a committee designated by the board and reporting to the board) should
approve the choice of an agent. The agent selected should be an
institution that can demonstrate an ability to perform the required duties
in a competent and responsible manner. Administrative and reporting
arrangements satisfactory to the financial institution should be clearly
set out and agreed to in writing.
Other
Considerations
A financial institution should enter into a legally binding master
agreement with each borrower establishing the basis for all security loans
between the two parties. When an agent is involved, there should be a
master agreement between the financial institution and agent as well as a
master agreement between borrower and agent. The agreement(s) should set
out the rights and obligations of all parties including the right to
immediate set-off for the financial institution (or agent acting for the
financial institution) in the event of the borrower's failure to return
the securities as specified in contractual arrangements.
Financial institutions should ensure that they are in compliance with
applicable Protection of Assets
Regulations.