Institutional investors, including pension and mutual funds, have historically viewed securities lending as a relatively low-risk method to increase the returns on their securities portfolios. In a typical securities lending transaction, one party (the securities lender) loans specific securities to the other party (the securities borrower) in exchange for collateral. To the extent that non-cash collateral is used, the securities lender receives a loan fee under the transaction. However, to the extent that cash collateral is used, the securities lender pays a cash collateral fee (also know as a rebate fee) to the securities borrower. Thus, an implicit element of cash collateralized securities loans is the reinvestment of the cash collateral by the securities lender or by an agent of the securities lender.1

Many securities lenders that used cash collateral reinvestment programs experienced sizable losses during the recent financial crisis, largely as a result of the declining values of their reinvested collateral. In large measure as a result of those losses, regulators have increased their focus on the securities lending markets.

In September 2009, the Securities and Exchange Commission (the “SEC”) hosted a roundtable to discuss various issues relating to securities lending.2 Key themes that emerged during the roundtable were those of investor protection, better disclosure, and increased transparency. To date, however, the SEC has not proposed any new rules.

In contrast, on January 5, 2010 and as part of its continuing process of developing a consolidated rulebook, the Financial Industry Regulatory Authority, Inc. (“FINRA”) published Regulatory Notice 10-03, in which it proposed three rules relating to securities lending.