Close this search box.

What is securities lending?

Table of Contents

Securities lending is a common practice in Singapore among retail traders and financial professionals such as hedge fund managers. It allows lenders to earn additional income for their portfolio, while providing borrowers with the opportunity to temporarily obtain securities they may not otherwise have access to.

The Monetary Authority of Singapore (MAS), the country’s central bank and financial regulator, oversees securities lending activities to ensure the market is fair and transparent. This means that market participants are required to follow rules and guidelines set by the MAS to participate in trading. Typically, these include requirements for the disclosure of information, operational procedures, and risk management practices.

In this article, we will explore what securities lending is and how it works for both borrowers and lenders. We will also explain what it is about this practice that appeals to so many financial markets participants. Finally, we go through some of the benefits and risks of securities lending. If you are planning to be a lender or a borrower but you are unsure of what it means to be one, you can read on to learn more.

What is securities lending?

Securities lending is the practice of temporarily transferring ownership of a security from one party, the lender, to another party, the borrower. The borrower pays a fee to use the borrowed securities for a variety of purposes, such as short selling, hedging, or obtaining exposure to a particular security or sector in financial markets.

On the other hand, the lender lends securities to borrowers for a fee. Typically, the lender of securities is a financial institution, such as a bank, broker, or securities firm. The borrower is often a short seller or a hedge fund manager who needs securities temporarily to complete their transactions and make investments.

The borrower and lender come together to sign a contract, which is called a loan agreement. This contract will contain details such as the type of securities exchanged, the amount of securities, the loan period, and other details such as lending fees and collateral.

How securities lending works

Knowing why people participate in securities lending, we can look at how it works. Details will vary depending on the financial institution you work with, but for the most part, if you are a borrower, these are the steps you will need to take:

Identify a lender

You must first identify a securities lender. This depends on the desired securities you want to borrow, which can range from stocks and currencies to commodities and other forms of assets. You should find a licensed securities lender, as this can give you a greater peace of mind, and a good example is Saxo Bank Group.

Negotiate borrowing terms

Next, you will need to negotiate the suitable borrowing terms for you, with the lender. This includes interest rates, collateral requirements, and the length of the loan.

Provide collateral

The next step you should take is provide collateral to secure the loan. This collateral is typically in the form of cash or other securities, and this gives the lender peace of mind and minimises the possibility of you, as a borrower, defaulting on the loan. Providing collateral is essential in securities lending, and this is something borrowers should consider carefully.

Complete the loan agreement

Once you have agreed upon the terms and conditions of your loan, you will need to complete a loan agreement with the lender. Having complete documentation is another vital step. You need to make sure you understand what the terms detail, and if need be, you should consult with a lawyer or financial expert to help you understand what you are agreeing to.

Receive the borrowed securities

Once you have completed the loan agreement and signed off on the documents, the lender will deliver the securities to you. You are then free to use it for your desired purpose, such as for hedging, short selling, or other activities.

Return the borrowed securities

When you reach the end of the loan term, you will need to return an equal number of securities to the lender. If you fail to do this, the lender may take legal action against you, or delay the end of the loan term with hefty interest rates.

Why participate in securities lending?

Investors participate in securities lending because it can impact the returns of their investments. For example, securities lending can generate additional revenue for the lender, and they can pass on this revenue to the investor in the form of higher returns. This is due to increased liquidity for the borrower, as they can afford to short sell assets and find opportunities in bearish markets.

For lenders, participating in securities lending can lead to additional income, an enhanced portfolio, and an improved market liquidity. This is because securities lending allows lenders to receive lending fees from borrowers, which can be a great supplementary form of income. Lenders can also offset any of their potential losses with securities lending, and they can improve portfolio returns by lending out securities that are in high demand. Finally, by lending securities to short sellers so they can complete their trades, they increase market liquidity, which can be helpful for all traders.

Risks of securities lending

However, as all forms of financial transactions go, there is risk involved in securities lending for both the lender and the borrower.

Investors should therefore carefully consider the terms and conditions of securities lending programmes offered by their investment managers. They can do this by weighing the potential benefits and carefully considering the risks posed by securities lending before deciding to participate.

Below, we explain three of the most common risks that traders encounter:

Counterparty risk

The first risk is counterparty risk, which is the possibility that the borrower may default on their obligation to return the borrowed securities, leading to a loss for the lender. For the lender, this means carefully considering the profile of the borrower and conducting accurate risk assessment to reduce this risk. It also means never lending any securities you cannot afford to lose.

Market risk

The next risk is market risk, which is the possibility that the securities can decline during the loan period. This will lead to a result in a loss for the lender. While unavoidable and unpreventable, lenders can mitigate this risk somewhat, with better analysis of where the market is heading.

Operational risk

Finally, there is a small risk for both the borrower and the lender, which is the possibility of errors occurring during the settlement process. This can potentially result in a loss for either party, depending on the error. Luckily, Singaporean financial institutions have advanced technology and tend not to make too many mistakes when conducting transactions.

The bottom line

Overall, securities lending is an important tool for market participants in Singapore. It is subject to strict regulation, overseen by the MAS, to ensure its smooth operation and stability in the market. Traders who participate in securities lending should pay attention to loan terms and read the fine print to make sure they are agreeing to acceptable terms and agreements. They should also make sure not to borrow a greater number of securities than they can afford to return, as they may face legal action or high interest rates if they fail to pay back their loan at the end of their term.

Related Posts