Operation of Standard Form of Australian Master Securities Lending Agreement

Operation of Standard Form of Australian Master Securities Lending Agreement

In a securities lending transaction, one party (“the lender”), makes securities available to another party (“the borrower”), subject to an undertaking by the borrower to return those securities or equivalent securities either on demand or at the end of the agreed term.

Part and parcel of the brokers’ securities lending businesses is the use of a standardised form of agreement known as the Australian Master Securities Lending Agreement (ASLA). Generally speaking, most ASLA’s incorporate the same key terms and these key terms are described in detail by Finkelstein J in CMG Equity Investments Pty Ltd –v- Australia and New Zealand Banking Group Ltd [2008] 65 ACSR 650.

Historically, ASLAs had been used between institutional lenders (like insurance companies, investment managers and superannuation funds) to increase returns across their portfolio, on the one hand, and institutional borrowers (like large institutional brokers, investment banks and hedge funds) to enable them to take short positions on stock that they believe would reduce in value. A short position is the sale of shares when the seller does not have the shares to sell. In order to meet their obligations to deliver the shares to the buyer, they borrow the stock.

An ASLA enables and regulates this practice of securities lending by establishing a framework in which a broker typically makes a cash advance to clients in return for clients transferring to the broker in respect of each cash advance a pre-approved parcel of securities as collateral for that cash advance.

The client is required to maintain a pre-agreed margin between the value of the securities transferred to the broker and the cash advance made by the broker. In the real estate industry this is called the LVR – the loan to value ratio – and under an ASLA, the agreed margin has to be maintained at all times.

Where the value of the cash advanced to the client compared to the value of the securities transferred to the financier falls below a pre-determined margin, the broker may make a “margin call” at which time the client must repay that portion of the cash advance or deliver further securities in order to maintain the pre-determined margin ratio. If the client is unable to do so, then the broker can “close out” which means, put simply, sell securities to the value required to reduce the loan so that the agreed “margin” or LVR is re-established.

Often a “close out” entitles the broker to sell all of the securities to pay out the loan and the change is given to the borrower. Try that in a falling market when (almost) everyone else is also doing it.

The standard form ASLA describes the parties as “lender” and “borrower” and uses the terms “lend” and “borrow” and to the uninformed reader, it suggests that an ASLA is designed to facilitate loan transactions. However, this does not reflect the true position of an ASLA. Under an ASLA, the broker obtains absolute unencumbered title to the securities transferred by the client. An examination of the introductory provisions of the standard form ASLA indicates that it states that:

“…all right title and interest in the [transferred securities] will pass absolutely…free and clear of any liens, claims, charges or encumbrances or any other interest of the Transferring Party…”

A close examination of the standard form ASLA also reveals other terms which are consistent with this statement of intent.

An example of this is at the end of the term of a loan or when the agreement is terminated. In those circumstances, the “borrowers” have to repay the cash advanced and the broker has to deliver to the client “equivalent securities”.

The terminology of the agreement indicates that the broker is not bound to redeliver the same securities which were originally transferred. “Equivalent securities” are defined to mean securities of an identical type having the same value and description as those transferred to the broker at the beginning of the agreement but they don’t have to be exactly the same securities that were originally transferred.

So for example, if the ASLA was initially in respect of Woolworths shares then at the end of the agreement Woolworths shares would have to be retransferred back to the client but not the exact same Woolworths shares as were initially the subject of the transfer of title.