Securities Lending

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Securities lending is the temporary transfer of shares or bonds from one party to another, in return for a fee and collateral, with an agreement to return equivalent securities later.

Large investors, such as pension funds, insurers and index funds, hold securities for long periods. They can earn extra income by lending them out. Borrowers are usually banks, brokers and hedge funds.

Borrowers use securities for several purposes, most commonly short selling, where they sell borrowed shares hoping to buy them back later at a lower price. Securities are also borrowed to settle trades, support market-making and for certain hedging strategies.

For example, a pension fund lends shares worth 10,000,000 to a broker. The broker provides collateral worth slightly more, often cash or government bonds, and pays a lending fee. The pension fund receives any dividends paid during the loan in the form of equivalent payments.

Securities lending improves market liquidity and supports price discovery, but it carries risks, including the borrower failing to return the securities and losses on reinvested cash collateral. Lenders also give up the right to vote the shares while they are on loan, unless they recall them.

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