Securities lending Totally Explained

Everything about Securities Lending totally explained

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, under U.S. law, 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. 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

Securities Lending is an over-the-counter market, so the size of this industry is difficult to estimate accurately. According to the industry group ISLA, in the year 2007, the balance of securities on loan exceeds $2 trillion globally .

An example

In an example transaction, a lending firm such as a large institutional money manager with a significant position in a particular stock would agree to transfer a requested amount of stock to an investment bank or hedge fund wishing to cover a short position. In exchange for the stock transfer, the bank or fund would transfer 105% of the stock value in cash as collateral. The cash value of the collateral would be marked-to-market on a daily basis to maintain 105%. The bank or fund would therefore have the ability to cover a temporary short position without impacting the price of the stock on the market, as the stock transfer was off-market. The institutional manager would have access to the cash for overnight investment. Theoretically, they'd also have access to inside information regarding trading strategies from the various firms they work with based on the positions maintained off-market.

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 of the security transfers to the borrower. This means that the borrower has the advantages of holding the security, just as though they owned 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're unable to deliver stock that you've 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're obliged to deliver the security, you'll have to borrow it. At the end of the agreement you'll have to return an equivalent security to the lender. Equivalent in this context means fungible, for example the securities have to be completely interchangeable. Compare this with lending a ten euro note. You don't expect exactly the same note back, as any ten euro note will do.

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 Association. 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. Large security lenders are:

ABN AMRO (New York, London, Hong Kong)

Bank of America (New York)

Bank of New York (New York)

Barclays Global Investors (San Francisco, London, Tokyo)

Citibank (New York)

Credit Suisse (New York, London)

Charles Schwab Corporation (San Francisco)

Dresdner Bank (Frankfurt)

Deutsche Bank (New York))

Fortis Bank (New York, Amsterdam, London, Hong Kong)

Goldman Sachs (New York, London, UK)

JPMorgan Chase (New York)

Lehman Brothers (New York)

Morgan Stanley (New York)

Mellon Bank (Pittsburgh)

Penson Financial Services (New York, Dallas)

Robeco (Rotterdam, the Netherlands)

RBC Dexia (London, Luxembourg, Toronto)

State Street Corporation (Boston, London)

The Northern Trust Company (Chicago)

UBS (Zürich, Switzerland, London)

Wachovia Global Securities Lending (New Jersey) Typical borrowers include hedge funds and the propriety trading desks of investment banks.

The Term as Used 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 that'll receive interest income. In these types of agreements, the investor still receives any dividends as normal, the only thing they can't generally do is to vote their shares.

The Term as Used in Private Stock-collateralized Lending

The term Securities Lending is sometimes used without further definition as a synonym for "stock loan", although the term is also widely used to describe stock-collateralized loan arrangements where the underlying securities are hedged in one or another manner (options, trading, hedge fund, fund, line of credit, etc.) for the express purpose of allowing quasi-conversion of the variable asset into a relatively stable asset against which a nonrecourse debt loan can be placed. These are sometimes referred to as "hedged portfolio stock loans" or "securities based lending."

Market Transparency

Transparency has been increased in the securities lending market by organisations such as Data Explorers Limited and SunGard Astec Analytics

, who monitor these formerly “over the counter” only transactions and try to provide clarity in a previously opaque world.

References

Further Information

Get more info on 'Securities Lending'.

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