About Securities Lending
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
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)
- U.S. 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 traditional agency
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:
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