Regulatory Deep Dive

As we enter the second half of 2011, the various governments and regulators continue to write regulation with the goal of managing risk and enhancing transparency for securities lending programs. As lenders and borrowers return to the market, they face potential new legislation and a change in supply and demand side dynamics, resulting in less predictability for lenders. In addition, beneficial owners, although not directly impacted, are indirectly feeling the effects of regulatory change. Below are a few of the key regulations J.P. Morgan has been actively following and the impacts we foresee to the industry as a result of their implementation.

European Commission on Short Selling

The European Commission on Short Selling discussions continued between the European Parliament, Council and Commission to try and produce an agreement on rules governing short selling in Europe. Disagreement remains on uncovered short selling of shares, bonds and CDS, plus the powers to be given to ESMA (European Securities and Markets Authority) to monitor and control short selling, versus those of individual member states. Further meetings are not expected until September.

Dodd-Frank

Of the major regulation impacting the industry, Dodd-Frank has been at the forefront. Consultations around rule makings regarding Securities Lending are still taking place, but below are a few specific titles of Dodd-Frank we have been monitoring closely.

• Title IX, which focuses on increased transparency for both lenders and borrowers, has yet to be fully established. J.P. Morgan has been an active player in the industry task force, speaking to the SEC about the initiative and helping regulators understand what the current transparency standards are in the market and how changes to standards affect the industry.  
• J.P. Morgan has also been actively involved in Title II discussions that focus on the Orderly Liquidation Authority (OLA). As part of a larger industry group, J.P. Morgan spoke with the FDIC about the OLA clarification issues and specific business impact questions.   
• Finally, J.P. Morgan has been closely following Title VII, which details legislation around the clearing of derivatives and rules of remaining OTC derivatives. Title VII could potentially increase demand for high-grade collateral to post at exchanges, again affecting the supply and demand side dynamics of the industry.

Basel III

While the implementation and impact of Basel III are still a number of years away, many firms are already operating under Basel II/III guidelines, which have yet to be formalized. The overall impact of Basel III is still being assessed but additional capital constraints on borrowers may impact the demand side of the Securities Lending business.

FATCA and U.S. Tax Changes

Foreign Account Tax Compliance Act (FATCA) takes effect January 1, 2013. As a result, major changes have been announced in the U.S. market relating to the tax treatment of U.S. source income. The goal of the legislation is to require non-U.S. financial institutions and non-U.S. entities owned by U.S. persons to provide information identifying U.S. persons invested in non-U.S. bank and security accounts to the IRS. As J.P. Morgan’s accounts are all correctly documented, and because of the manner in which J.P. Morgan conducts its U.S. lending (i.e., “on loan tracker”) there should be no impact as a result of these changes; however we continue to monitor developments until the regulations are finalized.

UCITS IV & V

The implications of UCITS IV and V are still being assessed as we await developments to see how legislations will affect the funds landscape and therefore the investment strategies of lenders. It is possible that the legislation could result in a consolidation of funds through UCITS mergers and changes in Investment Management companies.