Why securities lending

While the securities are on loan the borrower transfers collateral in the form of other securities such as shares, bonds or cash to the lender. The value of the collateral is equal to or greater than the value of the securities being borrowed. Exchange traded fund providers are particularly interested in the practice because ETFs — like pension funds and sovereign wealth funds, which are also big securities lenders — tend to be long-term owners.

Lending out their securities, which would otherwise be untraded, gives them an opportunity to generate additional earnings that can help keep management fees down and improve returns for investors.

Securities lending is controversial for several reasons. One concern is that when the securities are on loan their ownership title transfers to the borrower along with any voting rights. This means that if the ultimate owner wants to exert an influence on a company by attending its AGM and voting on executive pay, for example, or seeks to engage with its leadership over climate change issues, it has to wait until its securities have been returned.

Critics claim that short sellers effectively manipulate pricing. By borrowing shares in a company in order to sell them the critics argue it can create downward pressure. Proponents of short selling say it helps to provide liquidity and price discovery and that buyers will enter the market once the price of a security falls to an attractive level.

The practice of securities lending has also raised concerns because it introduces counterparty risk. One potential risk is that the short seller miscalculates and the security it has shorted rallies very strongly driving the short seller to default. This would be a risk, however, only if the value of the collateral was not enough to cover the cost of buying back the lent out securities. Another risk arises when the lender, for example an ETF provider , is given cash collateral which it invests in money market securities to earn interest on the cash.

This introduces the risk that the value of those securities could fall. During the financial crisis some funds lost money from their securities lending programmes.

However, Morningstar, a data provider, has said that those losses were mainly driven by reinvesting cash collateral too aggressively. Since then global regulators have mandated or recommended more conservative rules that reduce risk, particularly in cash collateral transactions. There are also mandated or recommended limits on the proportion of securities that can be lent out. Agency lending: pension fund selects one or more agents to take care of lending their portfolio, splitting the revenue with the agent, who in most cases will be the global custodian.

The combination of custody and securities lending at one provider reduces the administrative burden and is therefore a good solution for medium sized pension funds. Market auctions. The pension fund puts its portfolios up for auction, whereby a selected agent takes care of the operational duties, but the decision making process remains with the pension fund.

This method provides more lending channels and portfolios are lent in their entirety to the highest bidder. Securities lending administration is carried out by the third party lending specialist and in some cases, the custodian retains management of the day to day securities lending and management. Added value for pension funds? In summary, Securities Lending can add additional income to portfolios within the boundaries of acceptable risk. It reduces the overall cost budget and adds performance.

It is increasingly import that pension funds understand the importance of their role within the Securities Lending market, in adding liquidity and enhancing portfolio returns. The scheme is reducing its equity allocation by 7. The plans are hard to compare as the signatories, which include 13 pension funds, use different methods to measure carbon emissions. Site powered by Webvision Cloud. Skip to main content Skip to navigation.

Why securities lending adds value to your portfolio. No comments. Topics Netherlands Securities Services. Related articles. News Dutch pension fund investments in mortgages surge TZ Pension funds have swapped part of their government bond portfolios for housing loans.

News Philips pension fund dials down risk in run-up to DC switch TZ The scheme is reducing its equity allocation by 7. Load more articles. Exchanging one security for another at the same time can be technically challenging, so securities lending is often done in two steps. First, the security in demand is lent to the borrower, who transfers cash collateral to the lender. Second, the cash collateral is lent back to the borrower, who exchanges it for securities collateral.

The end result is cash-neutral: the borrower is left with only the securities they need and the lender with only the securities collateral. The diagram below shows what happens in a typical securities lending transaction. Bond A is lent to the borrower, who provides cash collateral. When Bond A is returned to the lender, all the other parts of the transaction are reversed too and the borrower also pays the agreed fee in cash to the lender.

Borrowers pay a fee, which can vary a lot depending on which security is being borrowed, who is lending to whom, how long for and so on. Finally, borrowers sometimes face legal and administrative costs when they wish to start borrowing from a new lender. We are always working to improve this website for our users. To do this, we use the anonymous data provided by cookies. Learn more about how we use cookies. See what has changed in our privacy policy.

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