Securities lending

Securities lending is a transaction whereby the seller/borrower is paid to transfer securities to a buyer/lender. On conclusion of the agreement, the seller/borrower simultaneously commits to buy back the securities at an agreed price on expiry of the agreement. For legal/technical reasons securities lending is defined in the contracts as sale and buy-back of securities, but in reality these are collateralised loans. The counterparty in this transaction lends against securities as collateral. Institutions can enhance the yield on their securities portfolio by lending them to the wholesale market (custodians, dealers, and short sellers). Collateralisation can take lace in the form of cash (in which case the cash flows are the same as a repo transaction) or of other securities acceptable to the lender. Securities lending can reduce custodial costs or enhance annual returns by a full percentage point or more in some markets at some times, although revenue from this source is usually much smaller. Improvements in securities settlement procedures and systems to facilitate securities lending have tended to reduce lending premiums over time. The fee is quoted as basis points per annum of the original market value of loaned securities. The fee depends upon how scarce a loaned security is in the marketplace. Securities lending allows a broker-dealer in possession of a particular security to earn enhanced returns on the security through finance charges. Their collateral may be cash, other securities or a letter of credit. The lender retains the market risk of loaned securities. This is because the borrower is obligated to ultimately return the securities -not the original market value of the securities-to the lender. If the loaned securities pay dividends, coupons or partial redemptions during the loan, these are returned to the lending party. If cash is used as collateral, interest is credited at the repo rate. The securities lending fee is then deducted as a "rebate" from the interest.