Industry unsure of SEC’s new short-selling transparency rule

At some point in the next two years, market participants that engage in securities lending will need to begin reporting their transactions to the US Securities and Exchange Commission along with a wealth of additional information designed to create greater transparency around stock loans and short selling.

But they won’t need to report everything the SEC originally proposed.

Under the rule, 10C-1a, which the SEC finalised last month, a lender or intermediary will need to report three types of core data: the material terms of a loan, including the security being loaned; any subsequent modifications to the loan; and confidential information – such as the parties involved – about the loan. They will report that data to a registered national securities association – in this case, the Financial Industry Regulatory Authority (Finra).

The SEC had sought to increase transparency and reduce market inefficiencies by creating something of a consolidated tape for securities loans. It would be similar to what exists in most cash equities markets and in the Trace feed for bond transactions.

However, in response to feedback from industry participants on the initial version of its proposed rule (10C-1), the SEC has dropped a provision that would have required participants to report securities loan deals within 15 minutes of the transaction taking place. Rather, all transactions will be reported on an end-of-day basis. After that, Finra will make aggregated transaction data available the next morning. It will make specific loan-level information available 20 days after the transaction occurs.

The move represents a significant increase in transparency around securities lending and short-sale positions.

As noted in NYSE’s comment letter in response to the SEC’s original proposed rule: “Today, Finra collects cash equity security short position information from its member firms twice a month, but this aggregate and significantly delayed data is insufficient for market participants or regulators to understand how supply and demand are changing for stock loans in an actionable fashion. Overall, investors would benefit from more timely, complete, and visible data regarding securities lending transactions in individual securities.”

Peter Gargone, founder and CEO of n-Tier Financial Services, a provider of a technology platform for managing and mapping complex data problems, notes that the market already has some reporting requirements around naked short selling, but those “lack transparency”, he says. “We do expect the new rule to help address that.”

By and large, securities lending is a bilaterally traded, over-the-counter market with relatively little transparency. Now, for the first time, we’ll see how much trading takes place bilaterally/OTC versus on centralised marketplaces

Madhu Subbu, Clear Street

Short selling only accounts for one segment of stock lending and borrowing, which is also used to cover failed trades and obtain stocks for market-making. Most comment letters responding to the original proposal were broadly supportive of its transparency efforts, but took issue with aspects they thought were unnecessary, might prove overly costly or present a technical challenge.

A large number of responses came from retail investors across a broad array of professions. Some provided well-thought-out arguments in favour of increased transparency, though many simply copied and pasted their comment from the text of a Reddit post titled “Don’t let Citadel get away with this”. The gist was that a lack of transparency allowed short sellers to take advantage of retail investors by driving down the value of a company’s stock at the expense of ordinary investors and their pension funds.

This response was elicited by investment manager Citadel’s broad opposition to Rule 10C-1, which argued that the rule would “transform the proposed securities lending disclosure regime into a transaction-by-transaction short sale public reporting regime.” This, Citadel claimed, would increase the costs of establishing short positions, facilitate the “copycatting of investment and trading strategies”, and impair price discovery, liquidity and market efficiency, creating “material negative consequences” for institutional and retail investors alike.

In contrast, NYSE’s comment argued that the rule would guard against this exact behaviour by keeping information about the parties involved in a transaction confidential, and that the investment strategies of market participants would be “appropriately protected” by reporting transactions on an unattributed basis.

Balancing act

Kevin McNulty, global head of regtech solutions at securities lending platform operator EquiLend, believes the SEC has “walked a fine line” between giving the public more information on the securities lending markets and not giving so much detail that it could be used by one investor to harm another.

“If they had required too much disclosure, it would be possible to work out individuals’ trading positions and create the opportunity for a short squeeze. … So, too much information in this area might be unhelpful for market integrity,” says McNulty.

Most sources spoken to for this story agree the rule would increase transparency to the extent that all investors will gain greater insight into the external factors impacting their investments – though not enough to reveal specific traders’ positions or strategies.

“The stock loan market has an impact on other markets,” says Madhu Subbu, managing director and head of securities finance technology at prime broker Clear Street. “It’s a useful signal for retail markets to understand what’s going on. For example, short interest is a signal for the wider cash equities market. It may tell you something about the health of a company, or the opinions that different people have about a company. So, the more transparency you have, the better that signal will be.”

The data to be reported includes the issuer’s name for the securities being borrowed and the securities’ ticker symbol; the time and date of the loan; the name of the platform executed on; the amount of securities loaned, rates, fees, charges and rebates; the type of collateral provided; the termination date of the loan; and the borrower type. In addition, data to be reported but not made public includes the parties to the loan, whether a broker-dealer making a loan is using its own inventory, and whether the loan is to close out a fail-to-deliver in or outside the scope of Reg SHO. In addition, Finra will assign each loan a unique identifier.

“By and large, securities lending is a bilaterally traded, over-the-counter market with relatively little transparency,” says Subbu. “Now, for the first time, we’ll see how much trading takes place bilaterally/OTC versus on centralised marketplaces.”

That “now” is still some way off. Clear Street’s best guess is that it will fully come into force sometime in 2025. Subbu notes that the final rule needs to be published in the Federal Register. Then, Finra has four months to finalise the details, and participants need to start reporting on the first day after 24 months from the effective date. Finally, Finra will start reporting the data within 90 days of that.

And of the data being reported, how much value could be derived from the public data remains a matter of debate. In its comment letter, the Securities Industry and Financial Markets Association laid out a list of data fields that it deemed not relevant, not comparable and not meaningful. However, others still believe that in the right hands, the data will prove valuable.

“This data will be a big source of signal for cash equities and options,” says Subbu. “If people trading those markets have access to data about activity in the stock loans market, they can tell when something’s up. It’s a new source of alpha. That’s a big deal.”

There are other potential industry-wide benefits, though it may also increase pressure on margins, borrowing rates and lending fees, which may not be good for lenders and brokers but is good news for customers, because it makes the process more transparent and competitive.

“End-users will be able to see the wholesale-to-retail spread – industry-wide – so they’ll be able to start measuring and benchmarking themselves against that,” says Subbu.

In the right hands, it could prove valuable. But to untrained eyes, the data may be misleading or misinterpreted. For example, Subbu notes that borrowing rates vary based on the quality of collateral offered by the borrower. And while the rate will be public data, that nuance that determines the rate will not be captured in the data.

EquiLend’s McNulty questions the value of the data to those without specialist market knowledge to interpret it. “There’s definitely more information there, but how useful that is to a retail investor looking to engage in short selling … we’ll see over time,” he says.

Delayed data

One of the biggest changes from the original proposal was abandoning the requirement that loan transactions be reported within 15 minutes.

“The SEC dropped the quite controversial 15-minute reporting requirement in favour of end-of-day reporting, so the markets are generally quite relieved,” says McNulty.

The unpopularity of the original 15-minute proposal was twofold. First, that much data delivered so soon might risk revealing traders’ strategies. Additionally, some industry participants believed the technical challenge for compliance would be great, which some say felt like the regulator trying to force a real-time market structure onto a mostly OTC market that simply isn’t suited to that model.

“The 15-minute reporting requirement would have been hard because the regulation was seeking to push into areas not really set up for real-time reporting,” says n-Tier’s Gargone. “So, it would have placed obligations on systems not designed to be real time in nature, and it would have forced firms to rebuild systems and processes.”

And even those like EquiLend and IHS Markit (now part of S&P Global), which believed that 15-minute reporting would ultimately be beneficial, noted that it posed “considerable challenges and risks”.

In its comment letter, IHS Markit stated that most lenders would be unable to meet that requirement without “substantial technology development and cost,” adding that this would disadvantage smaller lenders and those without an existing relationship with Finra. Additionally, the note stated that the added costs may prompt asset owners to withdraw from lending activities, resulting in less liquidity, and that since most loans occur around market open and close, “there might not be enough significance in the intraday data to justify the high implementation and ongoing costs”.

Further to that point, even a seemingly simple term like “end of day” presents a challenge in the securities lending market. For instance, Subbu notes, an agent lender would need to allocate loans, but that’s a process that would take longer than the market close of the equities markets – a key difference between cash markets and borrowing/lending markets, along with the nuances of securities loans versus buying or selling stock or options.

The value is not in the raw data, but combining it with other datasets. It’s more about analytics than the data itself

Kevin McNulty, EquiLend

“In the absence of a normal ‘market’, you have to figure out what ‘end of day’ means,” McNulty adds. “Finra will have to write those rules. And it’s important for Finra, too, because they need to publish some of that data early the next day and they will need time to process that.”

Finra may also need to define other aspects of the data required, and how it is reported. For example, McNulty says defining how much of a security is available to lend is quite complex. For a beneficial owner, deciding what is technically available and what the owner is willing to loan could be tricky to differentiate.

However, despite the challenges and complexities, there are inroads to be made. Gargone, for example, sees opportunities for firms to leverage the vendor’s data aggregation technologies to meet their reporting requirements.

“We’re already doing the same stuff for Trace reporting, and the SEC’s Rule 606 [reports on how trades are routed on clients’ behalf],” he says. “This is our specialty.”

EquiLend also sees opportunities to use its technical experience to exploit the rule and help market participants meet their new obligations.

“We’re looking to provide a [10C-1a] solution to clients, because there is interest from firms in helping them with that reporting requirement,” says McNulty. This may be part of a broader distributed ledger-based securities finance solution currently being developed by EquiLend called 1Source that would be a golden source of all securities lending transactions in the market. The vendor hopes to go live with this next year, within a timeframe that would allow it to serve as the golden source of data for 10C-1 reporting. In addition, McNulty says the vendor can add value to its existing datasets.

“For data providers like us, it’s good because there’s more data that we can take in. And for us, the value is not in the raw data, but combining it with other datasets. It’s more about analytics than the data itself. So, we’re quite excited,” says McNulty.

And Clear Street’s Subbu can barely contain his excitement about the potential for the data that will be provided.

“We can’t wait to get our hands on the data, because we’ll find alpha in it and it will make pricing better for our customers,” he says.

“The sophisticated players are already thinking about this. There are other sources you can get this data from, but this [SEC] data will be concrete data. And the sophisticated players are already putting it together with other information to build up a full picture of the supply chain.”

Ultimately, the data may not give retail investors the fully level playing field they believe can exist against the likes of Citadel, but it goes a long way towards ensuring parity of publicly available data, as well as giving regulators greater transparency into firms’ activities in this space.