Securities lending

In finance, securities lending or stock lending refers to the lending of securities by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral, in the form of cash or non-cash securities, of value equal to or greater than the loaned securities plus agreed upon margin. Non-cash refers to the subset of collateral that is not pure cash, including equities, government bonds, convertible bonds, corporate bonds, and other products. The agreement is a contract enforceable under relevant law, which is often specified in the agreement.

As payment for the loan, the parties negotiate a fee, quoted as an annualized percentage of the value of the loaned securities. If the agreed form of collateral is cash, then the fee may be quoted as a "short rebate", meaning that the lender will earn all of the interest which accrues on the cash collateral, and will "rebate" an agreed rate of interest to the borrower. Key lenders of securities include mutual funds, insurance companies, pension plans and other large investment portfolios.

Securities lending is an important means of eliminating "failed" transactions as well as enabling hedge funds and other investment vehicles to sell shares short.

Until the start of 2009 Securities Lending was only an over-the-counter market, so the size of this industry was difficult to estimate accurately. According to the industry group ISLA, in the year 2007 the balance of securities on loan globally exceeded £1 trillion. In July 2015, the value was $1.72 trillion (with a total of $13.22 trillion available on loan) -similar to pre-crisis levels.

In an example transaction, a large institutional money manager with a position in a particular stock would allow those securities to be borrowed by a financial intermediary, typically an investment bank, prime broker or other broker-dealer, acting on behalf of one or more clients; after borrowing the stock, these clients could sell it short. The short seller would like to buy the stock back at a lower price (which would create a profit). Once the shares are borrowed and sold, it generates cash from selling the stock. That cash would become collateral for the lender. The cash value of the collateral would be marked-to-market on a daily basis so that it exceeds the value of the loan by at least 2%. NB: 2% is the standard margin rate in the US, whereas 5% is more usual in Europe.

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