Securities Lending & Borrowing Hub

A lender will receive collateral from the borrower, generally in the form of cash or other securities. This protects the lender from the risk of potential loss in the event that the borrower is unable to return the securities to the lender at the maturity of the securities lending transaction. The value of the collateral provided by the borrower is normally greater than the value of the borrowed securities, providing additional protection for the lender.

The fees involved in securities lending are negotiated between the lender and the borrower, and there isn’t a standard fee structure or cap. The terms of securities lending transactions are typically outlined in a legal agreement between the parties involved. Fees are usually negotiated on a bi-lateral basis between trading parties.

The borrower will generally pay a fee to the lender to borrow the securities, which is a percentage of the value of the loaned securities. In case of receiving cash collateral from the borrower, the lender may re-invest the cash in the money market and pay a rebate rate to the borrower which is determined as a spread below the prevailing money market reference rate used, such as €STR, depending on the demand for the underlying security.

Other fees and terms can be negotiated between the parties when they set up the securities lending agreement. For example, fees may be adjusted based on the type of securities, the term of the loan, and market conditions.

The securities lending market is dynamic, and fees can be influenced by factors such as the demand for specific securities, the availability of supply, prevailing market interest rates, and the creditworthiness of the borrower. Participants in securities lending transactions should carefully review and negotiate the fee structure to ensure transparency and fairness in the arrangement. Fee splits will arise where the income generated from the loan is divided between the lender and the agent lender i.e., the intermediary facilitating the transaction.

Securities lending is primarily an over the counter (OTC) activity and a well supervised practice that contributes to the overall health and functioning of global financial markets. It is mostly conducted by prudentially regulated entities and regulated indirectly via various pieces of legislation globally, including MiFID and SFTR in Europe and 10C-1 in the US.

In 2015, the Financial Stability Board (FSB) published recommendations for improving oversight and data collection in the global securities financing market. These recommendations aimed to enhance transparency and reduce systemic risk. In Europe, the Securities Finance Transaction Regulation (SFTR) 2015/2365/EU was introduced, and, in the US, the SEC 10C-1 rule was introduced.

SFTR targets all SFTs including securities and commodities lending and borrowing transactions, repurchase transactions, buy-sell/sell-buy back transactions, and margin lending and borrowing transactions. SFTR mandates detailed reporting of securities financing transactions to repositories, enabling regulators to monitor risks related to these activities more effectively.

10c-1 was also introduced to address the lack of transparency in the securities lending and borrowing market.

Beyond the transparency reporting frameworks, several other pieces of legislation touch upon and indirectly regulate the securities lending market.

This activity occurs globally across many markets and is typically carried out under an industry standard master agreement such as the Global Master Securities Lending Agreement (GMSLA), which was developed and is maintained by ISLA.

Under industry standard securities lending agreements such as the GMSLA:

• Legal ownership of the securities transfers from the lender to the borrower. The economic ownership however remains with the lender as they are obligated to take the securities back at the end of the transaction.
• The lender and the borrower have the right to terminate the loan.
• Upon termination, the borrower will return equivalent securities to the lender and the lender will simultaneously return collateral to the borrower.

Short selling is a practice whereby an investor borrows securities to immediately sell them to a third party with the intention to buy them back, at a later point in time, once the price has decreased.

Covered short selling involves borrowing securities, or having an intention to borrow securities via a locate before making a sale. Naked short selling occurs when the investor has not borrowed securities or shown an intention to borrow securities prior to the execution of the short sale. Naked or uncovered short selling is banned in most jurisdictions globally.

There is often a misconception that the short-term nature of securities lending, can align with a long-term sustainable investment strategy. Policy makers are sometimes concerned that activities within capital markets are inducing companies to prioritise short-term profit at the expense of the long-term success of businesses, which requires consideration of threats such as climate change. In Europe, ESMA was mandated to review the evidence and report on whether practices within capital markets are generating undue short-term pressure in the real economy, including in relation to securities lending. ESMA did not find any concrete evidence for a causal connection between securities lending and undue short-term market pressures and clearly stated that “short-selling and securities lending are key for price discovery and market liquidity”. They did not recommend any changes to policy in this area as a result of their findings.

In the absence of clearly defined sustainability legislation targeting investment tools such as securities lending, both institutional and retail investors may take a stricter approach to engagement in the activity, which could ultimately hinder growth in EU markets, as well as hinder liquidity in sustainable securities.

Recognising that securities lending plays an important role in the market and provides investors with additional income, the UK FCA has, for example, usefully clarified “we do not consider securities lending as being incompatible with ESG, as securities lending arrangements can be tailored to meet the ESG objectives of the lending and borrowing parties”.

The collateralised nature of securities lending, combined with robust daily mark to market procedures and tried and tested legal frameworks, make securities lending a relatively low risk activity. However, there are risks that market participants should be aware of when undertaking securities lending. These should be understood, quantified and mitigated wherever possible.

Risks include; counterparty risk, collateral risk, settlement risk, operational risk and market risk. With the proper oversight, all theses risks can and are effectively mitigated by market participants.