To which items should custodial credit risk be applied in securities lending arrangements?

Custodial credit risk in securities lending arrangements pertains to the possibility that a counterparty, such as a lending agent or borrower, may fail to fulfill their obligations regarding the custody of assets. In this context, both collateral and the underlying securities are relevant.

When securities are lent, the lending party typically receives collateral to mitigate the risk associated with the arrangement. If the borrower fails to return the borrowed securities, the lender has the collateral as a safeguard. Therefore, the custodial credit risk must be assessed regarding the collateral received, including the creditworthiness and custody status of that collateral.

Additionally, the underlying securities themselves are subject to custodial credit risk. If the entity that holds the securities (the custodian) fails, there could be risks related to the actual ownership and accessibility of those securities.

Since both collateral and underlying securities represent different aspects of custodial credit risk within these arrangements, identifying both as applicable ensures a comprehensive understanding of the risks involved. Thus, the correct response encompasses both items as significant considerations in evaluating custodial credit risk in securities lending arrangements.