Securities lending involves the owner of a security, often a portfolio of securities, temporarily transferring them to an investor or financial firm. The process is done for a fee and the lender usually requires collateral, which can be cash or other securities, to secure the loan. The lender retains the ownership rights and will take any benefits like dividends or interest payments. Following agreed-upon timeframes, the securities are returned and the collateral is released.
1. How does securities lending work?
It starts when the owner (lender) of a security transfers it to a borrower. The borrower provides the lender with collateral, usually above the market value of the borrowed securities. The securities and collateral are then held by a custodian, to secure both parties. Following agreed-upon timeframes, the securities and collateral are returned to their respective owners.
2. Who can participate in securities lending?
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Securities lending is mostly run by institutional investors like pension funds, mutual funds, insurance companies, and exchange-traded funds. But some brokerage firms also offer programs for individual investors to lend out securities in their portfolios.
3. Why would an investor borrow securities?
There could be several reasons such as to take advantage of price differences between markets (arbitrage), to secure shares for short selling, or to cover a delivery obligation they’ve got.
4. What are the risks involved in securities lending?
Risks include borrower default, collateral reinvestment risk, and operational risk. There are however measures in place, like overcollateralization and indemnification, to mitigate these risks.
5. What is the benefit for lenders in securities lending?
Lenders earn extra income from the fees charged to the borrowers, which can help to improve the return on their portfolios. The income can offset other costs, like fund management fees.