Document Properties
- Type of Publication: Guideline
- Date: September 1996
- No: B-4
- Audiences: P&C
This guideline sets out prudential considerations relating to the lending
of securities by federally regulated Canadian-incorporated property and
casualty insurance companies. Securities under the control of Chief Agents
of Canadian branches of foreign insurance companies can be used in
securities lending programs but securities vested in trust by branches are
not available for securities lending.
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. Companies 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.
Companies 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
Companies 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 company's policy on acceptable collateral should be consistent with the
company's overall investment policies as established by the board of
directors. Accordingly, companies 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 US dollars:
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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.
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 companies 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
Companies should ensure that they have appropriate internal controls,
procedures and records in place. Controls should include a list of
approved borrowers, consistent with the company's lending policies that
are based on generally accepted credit worthiness standards with specified
lending limits for each borrower. The list should be:
The company'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 company'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 company should receive regular,
comprehensive and timely reports summarizing the company's securities
lending activities to allow the manager to judge whether the activities
are being properly administered.
Use of
an Agent
A company must employ an agent for the administration of its securities
lending program. The company'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 company should be clearly set out and agreed to in writing.
Other
Considerations
Companies should enter into a legally binding master agreement with each
borrower establishing the basis for all security loans between the two
parties. Since an agent must be involved, there should be a master
agreement between company and agent as well as a master agreement between
borrower and agent. The agreements should set out the rights and
obligations of all parties including the right to immediate set-off for
the company (or agent acting for the company) in the event of the
borrower's failure to return the securities as specified in contractual
arrangements.
Companies should ensure that they are in compliance with the Protection of Assets (Insurance Companies)
Regulations.