Short Sale Locate Architecture

Any US broker-dealer (and now many foreign banks as well) is required to have a locate for every short sale transaction. When this rule was initially introduced, it was aimed to curb naked short selling and to prevent delivery fails. However, with the introduction of RegSHO [1] and Threshold securities list [2], and, especially after the crisis of 2008, the regulators are now fiercely enforcing these rules.

It is very important for a broker-dealer to come up with an architecture that is not only fully compliant with the regulations, but also allows the in-depth discussions this with the regulators during the exam or any other inquiry.

As with many other securities lending related apps, there is more art in it than science, and each broker-dealer handles it differently.

There are three components that any well thought-out Short Sale Locate system must include:

• Updated inventory

• Impossible to borrow list

• Easy to borrow list

Inventory

Short Sale Inventory usually includes parts: internal and external.

Internal inventory will have the list of securities and their associated positions including all of today’s pending settlements. Ideally, it needs to be fed from a Settlements system into a Short Sale system real time but, if this is not practical, it should be calculated taken any excess borrow positions, long positions that have not been lent out, and any pending receives or delivers.

External inventory should be calculated according to your own rules based on all the securities provided to your company from the lenders as a part of their availability feeds and, if external inventory is used to provide a locate, this locate should be tagged with the counterparty where the potential borrow might take place.

Impossible to Borrow

The impossible to borrow list will by default include all securities that are on the Threshold list in the U.S. or on the Short Sale Restricted Securities list of the primary market where the security is traded. Unfortunately, there are not many places where the latter is consolidated for all markets.

The idea of the ITB list is that if the locate is requested for a security on this list, it is automatically denied without any manual intervention.

Easy to Borrow

The easy to borrow list will include all securities that are deemed borrowable based on your Short Sale inventory and will usually include only GC (general collateral) securities with no liquidity or market sourcing issues.

The purpose of the ETB list is to automatically approve a locate requested for a security on this list.

When designing a Short Sale Locate system, you should also consider the following ...

• Clientele

• Can be used by internal desks only

• Can include your securities lending counterparts

• Can include any client as long as there is a way to lend the securities to them, either directly or to client’s Prime Broker or Custodian

• Integration

• Can be fully Integrated with your securities lending system or left stand-alone

• Can include the ability for clients to pre-borrow or convert locates into borrows

• Can include a module to charge for every locate and the amounts to charge are to be associated with your clients’ agreements/schedules

• Reporting

• The most important part of the entire system

• Robust daily archived reports to include as much information as possible about every locate

• If used internally, a report showing all short sales at the broker-dealer vs locate given reconciled daily

Although, based on the above, it seems quite simple to build or use a robust Short Sale Locate system, there are many issues that are only easy to avoid if proper planning is used.

Ready to build? Revamping your old system? Contact us for a full evaluation.

#securitieslending #RegSHO #shortsale #locate