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An Inside Look On Securities Borrowing And Lending
In the Spotlight | 13 April 2012
By: Louis Kent Lee
Articles (199) Profile

Ever seen a bearish market and felt you should have shorted it but were taken aback by the policy that requires you to buy back the share on the same day? What about earning additional returns while you’re holding onto your stocks? It’s Possible? And how do you do that? In a bid to find out more about how we can achieve this, Shares Investment did an exclusive web interview recently with Phillip Securities, a reputable financial institution, to unveil “Securities Borrowing and Lending”, which will answer the questions mentioned above earlier.

Shares Investment: What is Securities Borrowing and Lending?

Phillip Securities: In essence, Securities borrowing and lending is a temporary loan of securities between the lender and the borrower. This is done so as to allow the borrower, who expects the price of a stock to fall to hold a short position for a longer duration. On the other hand, the lender receives a fee which could potentially enhance his portfolio yield with relatively low risk.

SI: What is the main factor that makes investors explore Securities Lending?

PS: Securities Lending allows an investor to potentially earn extra income by lending the securities in their portfolio. This lending fee acts as an additional source of income which could potentially help to improve the yield of the securities at relatively low risk. Furthermore, there will be no disruption to an investor’s trading activities as their stocks can be sold anytime, even if they are on loan.

SI: What are the lending rates like and how are they determined?

PS: Different institutions offer different rates. To better benefit our clients who are lending out their securities, we adopt a flexible rate system, which varies between 0.25 percent and 5 percent. The rate will also be determined by the supply and demand of that particular security. For example, if stock A is a banking blue chip stock that is readily available and the supply in the market outstrips demand, the rate that is paid to the lender will be lower compared to say stock B, whose demand actually outstrips that of its supply. Also, every loan is unique and therefore, interest rate can only be confirmed at time of loan.

SI: If others are using my shares to short the market, wouldn’t it cause a downward pressure on its share price?

PS: In the short-term, lending of a security may create a downward pressure on its share price due to the short selling of shares. This happens when investors hold a bearish view of the security and would like to sell first and buy back later at a lower price. Other reasons for securities borrowing also include hedging, arbitraging or market-making purposes. However, what is sold must ultimately be bought back. As such, securities lending will not really aid in depressing share prices in the long run. In fact, securities lending adds liquidity and reduces volatility to the security concerned through the process of price discovery and transparency; hence, creating an efficient market. Lastly, it also aids in the efficiency of trade settlement.

SI: What if I want to sell my shares?

PS: Most Securities Lending Programme do not impose a minimum lock-in period for your loans. You may sell your shares anytime, even if they are being loaned out.

SI: What will happen to the borrower in this case?

PS: Different institutions have different ways of managing their inventory, usually using a reserve ratio requirement. Due to this, the institution will ensure delivery of your stocks even if they are on loan. Furthermore, the institution reserves the right to recall the stocks from their borrowers and then return them to their lenders.

SI: Will I still be entitled to my economic benefits such as dividends, bonus shares and rights issue of the shares?

PS: Yes, although Securities Lending involves a transfer of title, the lender does not lose possession of the shares as his beneficial ownership remains. The lender is still entitled to all economic benefits, with the exception of voting rights.

SI: Could you elaborate on some of the risks encircling Securities Lending?

PS: One possible risk to a lender is counterparty risk. However, this risk is mitigated as lenders only need to look to Phillip Securities, a reputable financial institution as the borrower. Furthermore, Phillip Securities collects at least 105% of the market value of the loan from their borrowers, marked to market on a daily basis.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

Please click here for more information about this author.


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