Securities lending
Encyclopedia
In finance
, securities lending or stock lending refers to the lending of securities
by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral
, in the form of cash, government securities, or a Letter of Credit
of value equal to or greater than the loaned securities. The agreement is a contract enforceable under relevant law, which is often specified in the agreement.
As payment for the loan, the parties negotiate a fee, quoted as an annualized percentage of the value of the loaned securities. If the agreed form of collateral is cash, then the fee may be quoted as a "rebate", meaning that the lender will earn all of the interest which accrues on the cash collateral, and will "rebate" an agreed rate of interest to the borrower.
market, so the size of this industry was difficult to estimate accurately. According to the industry group ISLA
, in the year 2007 the balance of securities on loan globally exceeded £1 trillion.
on a daily basis so that it exceeds the value of the loan by at least 2%. The institutional manager would have access to the cash for overnight investment and maintains a long position in the stock.
When a security is loaned, the title
of the security transfers to the borrower. This means that the borrower has the advantages of holding the security, as they become the full legal and beneficial owner of it. Specifically, the borrower will receive all coupon and/or dividend payments, and any other rights such as voting rights. In most cases, these dividends or coupons must be passed back to the lender in the form of what is referred to as a "manufactured dividend".
The initial driver for the securities lending business was to cover settlement failure. If one party fails to deliver stock to you it can mean that you are unable to deliver stock that you have already sold to another party. In order to avoid the costs and penalties that can arise from settlement failure, stock could be borrowed at a fee, and delivered to the second party. When your initial stock finally arrived (or was obtained from another source) lender would receive back the same number of shares in the security they lent.
The principal reason for borrowing a security is to cover a short position. As you are obliged to deliver the security, you will have to borrow it. At the end of the agreement you will have to return an equivalent security to the lender. Equivalent in this context means fungible, i.e. the securities have to be completely interchangeable. Compare this with lending a ten euro note. You do not expect exactly the same note back, as any ten euro note will do.
Securities lending & borrowing is often required, by matter of law, to engage in short selling. In fact, recent regulation in the United States required that, before short sales were executed for 19 specific financial stocks, the sellers first pre-borrow shares in those issues.
This caused securities lending volumes in these 19 issues to double. The SEC is currently evaluating whether to extend such a rule to the wider market.
. According to a June 2004 survey, their members had euro 5.99 billion worth of securities available for lending. In the US, the Risk Management Association publishes quarterly surveys among its (US based) members. In June 2005, these had USD 5,770 million worth of securities available.
Typical borrowers include hedge fund
s and the proprietary trading desks of investment banks.
through the purchase of options which are then structured into the loan to permit a reduction (though not elimination) of risk of loss at loan settlement or maturity. Institutionally-managed consumer securities-based loans where there is no transfer of title have come to replace nonrecourse transfer-of-title loans as consumers have become more securities conscious in recent years.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, securities lending or stock lending refers to the lending of securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
, in the form of cash, government securities, or a Letter of Credit
Letter of credit
A standard, commercial letter of credit is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking....
of value equal to or greater than the loaned securities. The agreement is a contract enforceable under relevant law, which is often specified in the agreement.
As payment for the loan, the parties negotiate a fee, quoted as an annualized percentage of the value of the loaned securities. If the agreed form of collateral is cash, then the fee may be quoted as a "rebate", meaning that the lender will earn all of the interest which accrues on the cash collateral, and will "rebate" an agreed rate of interest to the borrower.
Market size
Until the start of 2009 Securities Lending was only an over-the-counterOver-the-counter (finance)
Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....
market, so the size of this industry was difficult to estimate accurately. According to the industry group ISLA
International Securities Lending Association
The International Securities Lending Association is an independent trade association established in 1989 to represent the interests of the securities lending industry...
, in the year 2007 the balance of securities on loan globally exceeded £1 trillion.
An example
In an example transaction, a large institutional money manager with a position in a particular stock would allow those securities to be borrowed by a securities lender. The securities lender (investment bank) would then allow a short seller to borrow the stock and sell it. The short seller would like to buy the stock back at a lower price (which would create a profit). Once the shares are borrowed and sold, it generates cash from selling the stock. That cash would become collateral for the borrow. The cash value of the collateral would be marked-to-marketMark to market
Mark-to-market or fair value accounting refers to accounting for the fair value of an asset or liability based on the current market price of the asset or liability, or for similar assets and liabilities, or based on another objectively assessed "fair" value...
on a daily basis so that it exceeds the value of the loan by at least 2%. The institutional manager would have access to the cash for overnight investment and maintains a long position in the stock.
Legalities
Securities Lending is legal and clearly regulated in most of the world's major securities markets. Most markets mandate that the borrowing of securities be conducted only for specifically permitted purposes, which generally include;- to facilitate settlement of a trade,
- to facilitate delivery of a short sale,
- to finance the security, or
- to facilitate a loan to another borrower who is motivated by one of these permitted purposes.
When a security is loaned, the title
Title (property)
Title is a legal term for a bundle of rights in a piece of property in which a party may own either a legal interest or an equitable interest. The rights in the bundle may be separated and held by different parties. It may also refer to a formal document that serves as evidence of ownership...
of the security transfers to the borrower. This means that the borrower has the advantages of holding the security, as they become the full legal and beneficial owner of it. Specifically, the borrower will receive all coupon and/or dividend payments, and any other rights such as voting rights. In most cases, these dividends or coupons must be passed back to the lender in the form of what is referred to as a "manufactured dividend".
The initial driver for the securities lending business was to cover settlement failure. If one party fails to deliver stock to you it can mean that you are unable to deliver stock that you have already sold to another party. In order to avoid the costs and penalties that can arise from settlement failure, stock could be borrowed at a fee, and delivered to the second party. When your initial stock finally arrived (or was obtained from another source) lender would receive back the same number of shares in the security they lent.
The principal reason for borrowing a security is to cover a short position. As you are obliged to deliver the security, you will have to borrow it. At the end of the agreement you will have to return an equivalent security to the lender. Equivalent in this context means fungible, i.e. the securities have to be completely interchangeable. Compare this with lending a ten euro note. You do not expect exactly the same note back, as any ten euro note will do.
Securities lending & borrowing is often required, by matter of law, to engage in short selling. In fact, recent regulation in the United States required that, before short sales were executed for 19 specific financial stocks, the sellers first pre-borrow shares in those issues.
This caused securities lending volumes in these 19 issues to double. The SEC is currently evaluating whether to extend such a rule to the wider market.
Securities lenders
Securities lenders, often simply called sec lenders, are institutions which have access to 'lendable' securities. This can be asset managers, who have many securities under management, custodian banks holding securities for third parties or third party lenders who access securities automatically via the asset holder's custodian. The international trade organization for the securities lending industry is the International Securities Lending AssociationInternational Securities Lending Association
The International Securities Lending Association is an independent trade association established in 1989 to represent the interests of the securities lending industry...
. According to a June 2004 survey, their members had euro 5.99 billion worth of securities available for lending. In the US, the Risk Management Association publishes quarterly surveys among its (US based) members. In June 2005, these had USD 5,770 million worth of securities available.
Typical borrowers include hedge fund
Hedge fund
A hedge fund is a private pool of capital actively managed by an investment adviser. Hedge funds are only open for investment to a limited number of accredited or qualified investors who meet criteria set by regulators. These investors can be institutions, such as pension funds, university...
s and the proprietary trading desks of investment banks.
Term in investment banking
In investment banking, the term "securities lending" is also used to describe a service offered to large investors who can allow the investment bank to lend out their shares to other people. This is often done to investors of all sizes who have pledged their shares to borrow money to buy more shares, but large investors like pension funds often choose to do this to their unpledged shares because they will receive interest income. In these types of agreements, the investor still receives any dividends as normal, the only thing they cannot generally do is to vote their shares.Term in private securities-collateralized lending
The term "securities lending" is sometimes used erroneously in the same context as a "stock loan" or individual "securities-collateralized loan". The former refers to the actual lending typically of banks or brokerage to other institutions to cover short sales or for other temporary purposes. The latter is used in private or institutional securities-backed loan arrangements across a wide spectrum of securities. Loans of the latter type can be those where the underlying securities are hedgedHedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
through the purchase of options which are then structured into the loan to permit a reduction (though not elimination) of risk of loss at loan settlement or maturity. Institutionally-managed consumer securities-based loans where there is no transfer of title have come to replace nonrecourse transfer-of-title loans as consumers have become more securities conscious in recent years.