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Securities Lending & Borrowing Hub

Securities lending and borrowing (SLB) plays a vitally important role in the smooth functioning of today’s global capital markets. The size of the global securities lending industry (securities available for loan) is estimated to be in the region of €27 trillion as at the end of 2023.

Through the ISLA Securities Lending & Borrowing Hub, you’ll  gain an understanding of what securities lending and borrowing is, who the main participants are across the end-to-end value chain, as well as the main benefits to the wider capital markets ecosystem. The Hub also covers a range of related topics and frequently asked questions, including how risks arising from the activity are managed, as well deep diving into the regulatory framework in which the market operates. In this section, you will also find useful links to related content and further resources, including guides and a comprehensive glossary of terms.

 

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What is Securities Lending & Borrowing & Who are the Key Market Participants?

Securities lending and borrowing is where an investor temporarily lends securities to a borrower, in return for a fee. It is one of four different securities financing transaction (SFT) types, along with repurchase transactions (repos), buy-sell back transactions and margin or commodity lending.

Securities that are lent can be in the form of bonds issued by governments or corporates, as well as equities. In addition to the fee, the borrower provides the lender with collateral in the form of cash or other securities. This protects the lender from the risk of potential loss if the borrower becomes insolvent and is unable to return the lender’s securities. 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. To further protect both parties from market fluctuations during the life of the transaction, securities and collateral on loan are revalued on a daily basis and adjusted if needed. At the end of the transaction the borrower and lender return their respective securities and collateral to one another.  

Securities are frequently lent on an open basis and as such, can be recalled if the lender requires the securities back. These requirements form part of market standard legal agreements, and the processes are further supported by widely accepted best practices between market participants. 

This activity is often usually conducted by a lending agent, for example a custodial bank, a third-party lender or an in-house lending affiliate acting on behalf of the lender, often referred to as a beneficial owner. This is known as the supply-side. 

Agents are frequently used by lenders as securities lending tends to be a high volume and short term discretionary activity and does not form part of the main activity of institutional investors. However, some lenders may choose to lend directly (i.e., not appoint an agent) whilst others may choose to utilise multiple providers, lend assets through both a custodian and a third-party agent, or a combination of the above. Borrowers and end users of the lent securities are known as being on the demand-side.  

Borrowers are typically large financial institutions such as investment banks and broker dealers. These institutions borrow securities to support their own proprietary trading, market making and to facilitate short coverage for their clients such as alternative investment managers and hedge funds, who are referred to as underlying borrowers.  

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Supply

Demand

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Why do Organisations Lend & Borrow Securities?

Investors

Investors may lend out securities from a medium to long term investment portfolio to other market participants in order to earn additional income. As well as a flat fee for the loan of the securities, investors may earn interest from the reinvestment of the cash collateral provided in exchange for the loan.

The income generated from the activity can be passed on to investors in the form of reduced management fees or greater overall returns.

Intermediaries

Securities lending is largely a high volume and short term activity where lenders often utilise the service of agents to manage all aspects of the securities lending, collateral and reporting process. For this service, agent lenders or specialist providers receive a fee in the form of a percentage of the overall revenue generated from securities lending and may offer indemnities or insurance against certain risks, such as borrower default.

Borrowers

Banks need to borrow securities for several reasons:

To support buy and sell activities as part of their obligation as a market maker in securities markets. Under this function banks guarantee efficient and liquid markets. Banks usually commit to the buying and selling of certain securities at all times and thereby ensure market liquidity and efficiency. They can be required to make markets by their clients and even by governments (in the case of government bonds). Yet, banks do not tend to warehouse securities, so access to securities lending markets is critical so that they can make markets in securities they may not physically to ensure the timely delivery of securities.

Regulation requires that banks hold sufficient High Quality Liquid Assets (HQLA), such as government bonds, to ensure their financial health . Therefore, the securities lending market acts as a primary source for borrowing these assets.

Underlying borrowers such as Hedge funds and Alternative Investment funds often borrow securities to engage in short selling, a practice whereby an investor borrows securities to immediately sell them to a third party.

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Benefits of Securities Lending & Borrowing

Securities lending and borrowing plays an important role in today’s European and global markets. It is a fundamental means of mobilising securities quickly to ensure the efficient function, liquidity, stability, and resilience of financial markets, whilst providing low risk opportunities for investors to generate additional income for end-users.

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Benefits of
Securities Lending

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Why is Securities Lending & Borrowing Vital to the Global Economy?

Securities lending and borrowing allows long-term investors to put their long-only securities to work by lending them to other market participants. This efficient use of capital contributes to a more dynamic and productive capital market.

It helps banks to meet their market-making obligations, ensuring markets remain open and liquid. An efficient and liquid market offers several benefits for the overall financial system and the economy:

  • Lower Transaction Costs: In a liquid market, there are many buyers and sellers willing to trade at any given time. This competition helps keep bid-ask spreads (the difference between the buying and selling price) tight, which translates to lower transaction costs for investors.
  • Accurate Pricing: Efficiency means prices reflect all available information, leading to more accurate valuations of securities. This allows investors to make informed decisions and companies to raise capital at a fair cost.
  • Increased Investment Activity: Liquidity encourages participation in the market. Investors are more likely to buy and sell if they know they can easily enter and exit positions without significantly impacting the price. This increased activity can fuel economic growth.
  • Improved Capital Allocation: Efficient markets allocate capital more effectively. Companies with strong growth prospects can raise funds more readily, while struggling companies find it harder to do so. This helps direct capital towards its most productive use.
  • Reduced Volatility: Liquidity can help dampen price swings. With more buyers and sellers, sudden changes in sentiment are less likely to cause large price fluctuations. This creates a more stable environment for businesses and investors. Post-financial-crisis reforms have put many safeguards in place to protect investors, market participants and market infrastructures, and securities lending is one of the essential mechanisms by which high quality assets can be mobilised and transferred to meet such requirements.

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Additional Information & Frequently Asked Questions

What collateral is involved in the loan of a security?

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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.

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What fees are involved in securities lending and are they capped?

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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.

How is the securities lending market regulated?

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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.

Find out more about securities lending market regulations

Is there a legal framework that governs a securities loan?

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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.
Click here for more information on the GMSLA

What is the relationship between securities lending and short selling?

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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.

Click here to find out more information about Short Selling

What is the relationship between securities lending and sustainability?

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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”.

Click here to find out more about Securities Lending and Sustainability

What are the risks associated with securities lending and how are they managed?

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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.

Click here for information on the potential risks and their mitigants

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Securities Lending Market Data

Global Securities Lending Market

Global Equity Market

Global Government Bond Market

3.5 Tn

1.1 Tn

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