MFA encouraged FINRA to limit its proposed rules to implement an enhanced securities loan reporting framework to what is mandated by the final SEC Securities Lending Rule in a comment letter submitted yesterday. The Securities Lending Rule mandates that FINRA propose new rules governing the reporting of securities loans.
To protect investors and markets, MFA is challenging the Securities Lending Rule in court. The lawsuit argues that the SEC did not consider the interconnected nature of its rulemaking when adopting the Securities Lending and Short Selling rules. The level of transparency required under the Securities Lending Rule goes against the SEC’s own findings that disclosure of individual transactions will harm investors and negatively impact market-wide liquidity and efficiency.
Securities lending enables short selling which is crucial for well-functioning markets. It aids in price discovery, enhances liquidity, improves market efficiency, and provides an important source of income to investors who lend their securities, including pensions, foundations, and endowments.
The Securities Lending Rule already mandates the publication of granular transaction-by-transaction information that will harm investors taking short positions in markets. However, the FINRA proposal goes even further, requiring the reporting and publishing of data far beyond what is mandated by the SEC. FINRA is proposing to publish loan data, confidential information, and loan modifications that exceed the requirements of the Securities Lending Rule. It has also proposed an entirely new set of ‘modifiers and indicators’ that the SEC did not mandate.
Publishing detailed information will deter participation in capital markets and degrade market quality by exposing the identities and strategies of short sellers. This outcome contradicts the SEC’s goal of its Securities Lending Reporting Rule, “to minimize the risk of chilling the short sale market.”
“The FINRA securities loan reporting proposal will harm markets and investors by deterring short selling and promoting herding behavior that will increase volatility. The U.S. capital markets drive economic growth and benefit all Americans. This success should not be jeopardized by an ill-conceived proposal that exposes confidential position and trading information and discourages market participation,” said Bryan Corbett, MFA President and CEO.
MFA’s letter highlights the danger of publishing detailed securities lending data:
[The SEC] has also recognized the dangers of being too transparent about short positions, such as potentially revealing the trading strategies of short sellers and encouraging retaliation against short sellers. Yet, this is exactly what the Proposed [securities loan reporting] rules would do. Even if the published data is anonymized, it still will disclose confidential position and trading information. This will further facilitate the ability for other market participants to reverse-engineer individual transactions, thereby disclosing firms’ proprietary trading strategies and exposing the market to manipulative short squeezes like those that occurred in GameStop and other “meme stocks” in early 2021.
MFA’s letter emphasizes that FINRA’s proposal to publish daily aggregate transaction activity by borrower type directly contradicts its SEC mandate:
MFA acknowledges that under [the Securities Lending Rule], covered persons must report, for publication by FINRA, “[w]hether the borrower is a broker or dealer, a customer (if the person lending securities is a broker or dealer), a clearing agency, a bank, a custodian, or other person.” However, by also deconstructing its daily publication of aggregate transaction activity data by these borrower categories, the information FINRA publishes could (particularly for thinly-traded securities) effectively disclose individual loan amounts—which the Commission expressly determined, in its final rulemaking, should be delayed by 20 business days. The Commission recognized in its adopting release for [the Securities Lending Rule] that “customer” loans, especially, are “tightly linked to short selling positions” and so loans identified this way “could give a strong indication of aggregate short interest.” The Commission determined to delay the dissemination of loan amount/volume information by 20 business days so as not to “significantly expand market participants’ abilities to discern short selling strategies.” Thus, FINRA’s proposal to publish, on the next business day, aggregate transaction activity by borrower type, is directly at odds with the Commission’s stated position in the adopting release for [the Securities Lending Rule].
Read the full comment letter here.
Source: MFA
