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Owners of securities frequently lend those
securities to other parties who may sell them short or deliver them to
another party to satisfy some other obligation. Securities may be loaned
for a fixed period of time, or the loans may be open-ended. In return for
lending its securities, the lender receives a fee, which 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. For example, if
Treasury bond
futures are maturing, the cheapest to deliver Treasury bond will demand a
higher fee than other Treasury bonds. Parties who are short the future
will want to borrow that bond and deliver it against the future.
A securities loan is typically collateralized.
This reduces the lender's credit exposure to
the borrower. 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.
Many custodians run securities lending
programs for their custody clients. Under such programs, the custodian
earns income for the client by lending out the securities the custodian is
holding for the client.
If securities lending is collateralized with cash, the transaction is
economically equivalent to a repo, although there
are legal differences that may be relevant in the event of a default. Rather than be motivated by the
borrowing party's need for a particular security, such transactions may be
motivated by the lender's need for cash. In this sense, the transaction is
economically a cash loan collateralized by the loaned security. Just as a
bond dealer might finance its inventory with repos, so might it do so
through securities lending.
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 collateral
Assets held to secure an obligation.
custody
The safekeeping of securities and related services.
hypothecation The posting of collateral.
repurchase agreement An agreement to sell and later repurchase securities at
specific prices.
short
sale Sale of a borrowed security.
soft
dollars A sometimes controversial inducement brokers offer
investment managers to place trades through them.
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Ads by Contingency Analysis
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Steiner (1997)
covers the repo and securities lending markets primarily from the
broker-dealer standpoint. Fabozzi (1996)
is a standard text on securities lending primarily for
institutional investors who might be interested in lending out
their investments.
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