Regulation X: Overview, definition, and example
What is Regulation X?
Regulation X is a rule issued by the Federal Reserve that governs borrowers involved in credit transactions related to the purchase of securities, specifically when the borrower is located outside the United States but the credit is extended by a U.S. lender. It works alongside Regulation T and Regulation U to control the use of credit in securities transactions and to prevent excessive leverage in the financial system. While Regulation T and U apply to lenders, Regulation X applies to the borrower directly.
Why is Regulation X important?
Regulation X is important because it ensures that U.S. credit rules for margin transactions can’t be avoided simply by borrowing from abroad. It prevents foreign borrowers from using U.S. credit to buy securities in ways that would violate Federal Reserve rules if done domestically. This helps maintain consistent credit standards across borders and protects the integrity of the U.S. financial system by closing a potential regulatory gap.
Understanding Regulation X through an example
A hedge fund based in London borrows money from a U.S. bank to buy stocks on a U.S. exchange. Even though the borrower is overseas, Regulation X requires the hedge fund to follow U.S. margin rules (like those in Regulation T). If the hedge fund uses the loan to buy securities without meeting the proper margin requirements, it would be in violation of Regulation X.
Example of how Regulation X may be referenced in a financing agreement
Here’s how Regulation X may appear in a credit or loan agreement:
"The Borrower represents and warrants that any credit extended under this Agreement shall be used in compliance with Regulation X of the Board of Governors of the Federal Reserve System and that such use will not violate any applicable margin requirements."
Conclusion
Regulation X ensures that borrowers outside the U.S. who obtain U.S.-sourced credit to buy securities still follow U.S. margin rules. It complements other Federal Reserve regulations and prevents regulatory arbitrage. Borrowers and lenders involved in cross-border securities financing should be aware of Regulation X to ensure lawful and compliant transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.