What is Securities Lending?
- Investment strategy in which investors make short-term loans of their securities to generate incremental revenues from their portfolios
- Loan results in a transfer of title/ownership to the borrower who is obligated to return the same type and amount of securities
- Loaned securities are collateralized, typically 102 or 105%, reducing the lender's credit exposure to the borrower
Who are the players?
Lenders
- Mutual Funds and investment companies
- Corporate & Government pensions and Sovereign Wealth Funds
- Endowments and foundations
- Insurance companies
- Off-shore investment funds (Ireland & Luxembourg)
Borrowers
- Broker/dealers – prime brokerage units
- Bank and/or broker/dealer proprietary trading desks
- Hedge funds
Facilitators
- Custodial agent lenders
- Third-party agent lenders
- Broker/dealers acting as principal borrowers (exclusive principal deal)
Routes to Market
- Discretionary - stock by stock 'agency' lending, best efforts basis
- Exclusive – guaranteed fee payment for a portfolio or segment of a portfolio (can be executed directly with a broker/dealer or through an agent who also manages all ongoing program administration and indemnification)
Why Lend Securities?
- Lenders are interested in achieving an incremental return on their portfolios
- Increase overall performance for portfolio managers, increase alpha
- Offset expenses associated with maintaining a portfolio
- Maximize opportunities to leverage a portfolio
- Finance fund-specific projects
- Retain all economic ownership benefits, except right to vote shares
Why Borrow Securities?
Borrowers are typically global banks and broker/dealers with proprietary trading desks and prime brokerage units supporting hedge fund activities. Reasons to borrow:
- Operational needs - covering shorts and preventing fails
- Risk, tax, dividend, merger, index and convertible bond arbitrage
- Pairs trading and market making
- Various cross-border strategies
- Financing inventory and managing balance sheets
What type of collateral can be used?
Typically, collateral consists of:
- Cash (USD, GBP and Euro primarily)
- US government or agency securities or G1O debt and Supernationals
- Other U.S. and/or foreign securities as allowed by the lending institution
- Letters of credit
What drives the securities lending market?
- Capital markets growing
- More institutions lending
- Express support from central banks
- Deregulation of international markets
- Growth of hedge fund activity
What does the transaction look like?
In a typical securities lending transaction, the beneficial owner of the assets will lend securities to a borrower. The borrower must provide collateral in an amount equal to the market value of the security plus margin, 102% to 105%. At termination of the loan the borrower must return a like quantity of the same security.
The diagram below describes a basic securities lending transaction where cash is accepted as collateral and the collateral is re-invested into a short-term money market investment vehicle.
What determines the potential revenue?
In a discretionary program, fees are negotiated on a trade-by-trade basis. At eSecLending, price is effectively established for portfolios, or segments thereof, through a competitive blind auction process. Revenue can be affected by many factors. These include:
- Availability of security in open market
- Value of portfolio
- Asset class
- Duration of loan
- Size of individual holdings
- Type of investment strategy
- Market / geographic diversification
- Dividend yield of security
- Tax status of underlying lender
What are the risks?
When properly planned and executed, securities lending is a low-risk investment strategy. Since all investment activities involve some risks, lenders should consider the following with respect to their securities lending activities:
