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from the better treatment for regulatory capital. Under
Fig 13: A Cost Comparison of Three Scenarios - Current; Proposed Regulation; and ECAI
the previous 2010 GMSLA agreement, if the borrower
is a financial institution, its claim on the lender for
¹Difference in standardised RWA of the return of excess title-transfer collateral after a
Current
$200mm per billion notional [It is estimated] that the liquidation of collateral is a risk-weighted asset (RWA)
$1Bn $1Bn
Risk Weight 5% 50,000,000 2,500,000,000 savings possible by the for regulatory capital purposes, which requires an
²Difference in Standardised Cost of Capital allocation of capital and therefore has an impact on the
EAD 25% 250,000,000 12,500,000,000
of 20bsp per billion notional reduction of the cost borrower’s balance sheet.
RWA (RW x EAD) 1.25% 12,500,000 625,000,000
Capital at 10% 0.125% 1,250,000 62,500,00 of capital from a 100%
risk weight to a 20% risk segregated account with a third-party custodian, such
Cost of Capital at 10% 0.0125% 125,000 6,250,000 Under the Pledge GMSLA, collateral is transferred to a
weight could be up to 2 as a tri-party provider, in the name of the borrower
Basel III Using Unrated Risk Weights at 100% Basel III Using ECAI Risk Weights at 20% (the “Secured Account”). This makes it the subject
$1Bn $1Bn $1Bn $1Bn million USD per notional 1 of the security interest in favour of the lender but
Risk Weight 100% 1,000,000,000 50,000,000,000 Risk Weight 20% 200,000,000 10,000,000,000 segregates it from the lender’s assets and protects
EAD 25% 250,000,000 12,500,000,000 EAD 25% 250,000,000 12,500,000,000 billion USD of exposure it from the risk of non-return on insolvency of the
RWA (RW x EAD) 25% 250,000,000¹ 12,500,000,000 RWA (RW x EAD) 5% 50,000,000¹ 2,500,000,000 lender. As either the value of the collateral, or the
Capital at 10% 2.5% 25,000,000 1,250,000,000 Capital at 10% 0.5% 5,000,000 250,000,000
value of the loaned securities fluctuates, transfers are
Cost of Capital at 10% 0.25% 2,500,000² 125,000,000 Cost of Capital at 10% 0.05% 500,000² 25,000,000
made in and out of the Secured Account. However, if
Addressing the Challenge the collateral is given by way of security, the borrower
Such a dramatic increase in the cost of doing business penalises saving which may result in other unintended retains a property interest in the collateral assets
for those impacted by the forthcoming regulations and negative macroeconomic effects. The securities financing industry is certainly adaptive. and is not exposed to the same risk of non-return of
could result in a collapse in securities financing There are two ways in which the industry is already excess collateral by the lender. Therefore its return
activity, with potentially severe consequences across The array of funds that benefit from securities finance adapting to address the oncoming challenge of Basel does not carry such a risk weighting. The security
the capital markets. Hence it is imperative that the represent the vast majority of savings across the IV today; a revised legal approach to collateralisation; collateral arrangement is an attractive prospect for
industry finds solutions to the challenges that the developed world. Without access to a functioning and the development of specialised Central Clearing borrowers in particular.
Basel IV rules will pose. market which is liquid, and where price discovery Counterparts. Both have been under development
can take place, the funds that act as agents for our for several years and are now becoming more widely
collective savings will find their ability to function accepted. They will not solve the issue in its entirety - Custodians and Sub-Custodians
The Implications for the Capital Markets efficiently is severely hampered. And given the but they are making a difference.
importance of savings for the real economy, these In order to successfully understand and mitigate the
Any dramatic increase in the cost of conducting effects must be given due consideration. impact of anything it makes logical sense to first measure
securities financing activities is likely to result in a Pledge GMSLA and manage it. The world of credit risk and capital
significant curtailment in activity across the sector. A The key challenge for the securities financing industry management are no exceptions and the involvement of
reduction in securities lending will result in the drying is therefore to come up with a solution that can assess In November 2018 ISLA published the first market custodians and sub-custodians in the pledge solution
up of market liquidity for securities, which will reduce the creditworthiness of the tens of thousands of standard agreement to support the pledging of security, does not remove the risk completely – it moves it and
transparency and increase trading costs. As financing counterparts involved in the securities financing industry the Global Master Securities Lending Agreement can also potentially reduce the capital at risk.
and repo costs escalate, higher trading costs will that is acceptable to regulators. (Security Interest over Collateral) (the “Pledge
ultimately be paid for by pension and mutual funds, GSMLA”). This agreement provided for borrowers to Prudent credit risk and capital managers will have
thereby reducing their returns. In addition, a fall in As the vast majority of these counterparts are high transfer collateral to lenders by way of security interest an understanding and knowledge of all of their
securities financing activity will further reduce the quality in terms of creditworthiness, one can sensibly rather than an absolute transfer of title. The principal counterparts and of the complex financial network of
returns for funds given they derive an income stream argue they should therefore attract the lowest motivation behind the Pledge GMSLA is to enable interconnectedness and interdependencies that they
directly from lending out securities. This, in effect, standardised risk weight at 20%. borrowers to benefit from the cost savings available are part of.

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