Securities lending
Securities lending is a financial practice where securities are temporarily transferred from one party (the lender) to another (the borrower) in exchange for collateral and a fee. This practice is commonly used to facilitate short selling, enhance market liquidity, and generate additional income for long-term holders of securities.[1][2]
History[edit]
Securities lending has been a part of financial markets since the early days of stock trading. It became more formalized in the 1960s in the City of London and grew significantly as an industry in the 1980s. Over time, it evolved from a back-office operation to a common investment practice for large financial institutions.[3]
Process[edit]
In a typical securities lending transaction:
- The lender transfers securities to the borrower.
- The borrower provides collateral, which can be cash, securities, or a letter of credit.
- The borrower pays a fee to the lender for the loan.
- At the end of the loan term, the borrower returns the securities, and the lender returns the collateral.[4][5][6]
Market Participants[edit]
Key participants in securities lending include:
- Lenders: Typically large institutional investors such as mutual funds, pension plans, and insurance companies.
- Borrowers: Often banks, broker-dealers, and hedge funds.
- Lending agents: Facilitate transactions between lenders and borrowers.
- Custodians: Safekeep assets and may act as lending agents.[7]
Regulatory Cases and Controversies[edit]
FINRA Fines (2023)[edit]
In December 2023, the Financial Industry Regulatory Authority (FINRA) fined four companies - M1 Finance, Open to the Public Investing, SoFi, and SogoTrade - a total of $2.6 million for inadequate supervision of their securities lending programs. FINRA alleged that these companies failed to properly determine the suitability of the program for specific customers and did not offer appropriate compensation for borrowed securities.
2008 Financial Crisis[edit]
During the 2008 financial crisis, securities lending came under scrutiny due to excessive risk-taking in cash collateral reinvestment pools associated with securities lending businesses. This led to significant regulatory reforms and increased oversight of securities lending practices.
Risks[edit]
Securities lending involves several risks, including:
- Counterparty risk: The risk that the borrower may default on their obligation to return the securities.
- Collateral reinvestment risk: The risk of loss when reinvesting cash collateral.
- Operational risk: Risks associated with the day-to-day management of securities lending programs.[8]
References[edit]
- ↑ Securities Lending Primer. The National Association of Insurance Commissioners.
- ↑ Repo and Securities Lending. Federal Reserve Bank of New York.
- ↑ Securities Lending - Overview, Applications, Benefits. Corporate Finance Institute.
- ↑ What Is Securities Lending?. State Street Global Advisors.
- ↑ What is securities lending?. European Central Bank.
- ↑ AGENCY SECURITIES LENDING. BNY Mellon.
- ↑ Securities Lending: The Facts - May 2015. BlackRock.
- ↑ What are the risks associated with Securities Lending?. Sharegain.