What Is a Securities Lending Agreement

In investment banking, the term “securities lending” is also used to describe a service offered to large investors that can allow the investment bank to lend its shares to other people. This is often done with investors of all sizes who have pledged their shares to borrow money to buy more shares, but large investors such as pension funds often choose to do so with their undistributed shares because they receive interest income. With these types of agreements, the investor always receives all the dividends as usual, the only thing he usually cannot do is choose his shares. Securities lending is a common practice in insurance companies. Insurers can make long-term investments to reconcile them with insurance liabilities. Thus, securities are not actively traded. It offers insurance companies the opportunity to lend the securities and earn fees to increase returns. Securities lending is generally carried out between brokers and/or dealers and not between individual investors. To complete the transaction, a securities lending agreement, called a loan agreement, must be concluded. This defines the terms of the loan, including the term, the lender`s fees and the type of guarantee.

The goal of our securities lending is to help financial markets function smoothly. This is especially important with our expanded Asset Purchase Program (APP). The Eurosystem – the ECB and the 19 national central banks of the euro area – buys large quantities of securities from banks to counter the risk of excessive inflation. Large-scale asset purchases by a central bank are likely to gradually lead to a decrease in the number of securities available on the market. Lending our securities on the market allows them to continue to be used by others for their transactions. In securities lending, securities are classified for lending based on their availability. Highly liquid securities are considered “light”; These products are easy to find on the market if someone decides to borrow them to sell them short. Illiquid securities in the market are classified as “hard”. Due to various regulations, a short selling transaction in the United States and other countries must be preceded to locate the security and quantity one might wish to sell short to avoid naked short selling. However, the credit intermediary may draw up a list of securities for which such location is not required.

This list is called an easy-to-borrow list (abbreviated as ETB) and is also called general insurance. Such a list is drawn up by broker-dealers on the basis of “reasonable assurance”[8] that the securities on the list will be readily available at the client`s request. However, if a warranty on the list cannot be delivered as promised (an “absence” would occur), the reasonable grounds assumption does not apply. In order to better justify such assumptions, the ETB list must not be older than 24 hours. Sometimes security is only needed temporarily, whether it`s just for a day or for a few weeks. If this is the case, it is often cheaper, faster and/or less risky to borrow a security than to buy it directly. There are a number of reasons to hold securities temporarily: unlike a buy/sell transaction, a securities lending transaction has a life cycle that begins with the settlement of the transaction and continues until the final return. During this life cycle, various life cycle events occur: A securities lending agreement governs the terms of a securities loan. The agreement covers the type of guarantee – cash, securities or LOC – with a value of at least 100% of the borrowed security. The borrower of the title pays a loan fee, which is usually paid monthly to the lender.

In addition, the borrower is contractually obliged to return the borrowed guarantee either on a predetermined date or at the request of the lender. Securities lending also deals with hedging, arbitrage and default-oriented borrowing. In all of these scenarios, the benefit to the securities lender is either to generate a low return on the securities currently held in its portfolio, or potentially to meet cash financing needs. When collateral is transferred under the loan agreement, all rights pass to the borrower. These include voting rights, the right to dividends and the right to other distributions. Often, the borrower sends equal payments to dividends and other returns to the lender. Typical securities lending requires clearing brokers that facilitate the transaction between the borrowing and lending parties. The borrower pays the lender a fee for the shares, which is divided between the lending party and the clearing agent. All investment strategies involve risk, including securities lending. As a lender, the main risk is that the value of the collateral falls below the cost of the collateral lent.

Another risk for the lender could be that the borrower becomes insolvent and cannot repay the borrowed collateral. Securities lending is important for short selling, where an investor borrows securities to sell immediately. The borrower hopes to profit by selling the security and buying it back later at a lower price. Since the property has been temporarily transferred to the borrower, the borrower is required to pay all dividends to the lender. In these transactions, the lender is compensated in the form of agreed fees and also receives the guarantee at the end of the transaction. This allows the lender to increase its returns by receiving these fees. The borrower benefits from the opportunity to make a profit by short selling the securities. Securities lending is an important way to eliminate “failed” trades and allow hedge funds and other investment vehicles to sell stocks short. [3] In 2011, FINRA issued a warning to investors about equity-based lending programs. [9] In the warning, FINRA advised investors to ask several questions, including: 1) What happens to my shares after I pledge them as collateral? (FINRA states that securities must never be sold to finance loans); 2) Has the lender checked the finances? (FINRA noted that any major listed broker/bank that reports must have verified financial data available to investors); and (3) Is the institution managing the loan and accounts fully licensed and in good standing? The chart below shows what happens during a typical securities lending transaction.

Bond A is lent to the borrower who provides a cash guarantee. Then, these cash guarantees received are lent or “reinvested” with the borrower in exchange for securities guarantees. When Obligation A is returned to the lender, all other parts of the transaction are also cancelled and the borrower also pays the agreed fee in cash to the lender. The terms of the loan are governed by a “securities lending agreement”[1] which requires the borrower to provide the lender with collateral in the form of cash or tangible securities worth at least the borrowed securities plus the agreed margin. Cash other than cash refers to the subset of collateral that is not pure liquidity, including equities, government bonds, convertible bonds, corporate bonds and other financial products. However, to make a short sale, a party must first be able to sell the security. This is usually achieved through securities lending. One party would borrow a security, provide collateral, sell the security, and then buy it back in the future (hopefully at a lower price) and return the security to the lender. The guarantee provided by the borrower usually corresponds to the guarantee. From the lender`s perspective, the benefits of securities lending include the opportunity to earn additional income from the fees charged to the borrower to borrow the collateral. It could also be seen as a form of diversification.

Empirical evidence shows that securities lending helps to provide liquidity in OTC markets. It facilitates various transactions that allow investors or institutions to hedge, take a tailor-made position or in arbitrage situations. Until early 2009, securities lending was only an over-the-counter market, so the size of this industry was difficult to estimate exactly. According to the isla industry group, the balance of credit securities exceeded £1 trillion worldwide in 2007. [4] In July 2015, the value was $1.72 trillion (with a total of $13.22 trillion available as loans) – similar to the level before the 2008 financial crisis. [5] In a sample transaction, a large institutional asset manager with a position in a particular stock allows these securities to be transferred from a financial intermediary, typically an investment bank, principal dealer or other broker-dealer, acting on behalf of one or more clients. . .