Securities lending
Securities lending is a form of financial trading normally participated in by businesses who are looking to enhance yields from their securities portfolio. The basic principle behind securities lending is quite simple: businesses holding securities and assets make them available to wholesale borrowers who can sell or re-loan the securities on the promise that at the end of the lending period the securities are returned. Typically, the lender of the securities receives a lending fee from the borrower of the securities, and the lender can also stipulate that the borrower commits to collateral for the life of the lending period. Collateral for the securities can be in the form of other securities acceptable to the lender, cash or a letter of credit.
Importantly, upon return of the securities to the lender it is the volume of securities themselves that must be returned in full not the value of the securities at the time lending took place - this is the basis of the international securities lending industry.
The securities lending industry
Securities lending is big business the world over. Owners of securities see lending their securities as a low-risk low-return strategy for enhancing yields from their portfolio. Lenders typically include life companies, insurance companies and pension companies who see lending in this way as a method of growing their assets. Borrowers typically comprise of dealers and investors such as investment banks, hedge funds and stockbrokers. They use securities as a way to buy and sell for profit or as a method of meeting other financial commitments.
As an example of how a borrower uses securities to make a profit consider a big business lender making 15,000 shares of stock available to borrowers. A borrower may make an agreement with the lender to borrow the 15,000 shares with a view to trading them on the stock market. The borrower pays the lender a lending fee and issues collateral in the form of securities that are not currently being traded by the borrower. These securities could however be traded on behalf of the big business if such an agreement was acceptable to both parties.
The borrower could then speculate by selling all 15,000 shares at a given value in anticipation of buying back those shares at a lower price as governed by share value on the stock market. If the borrower is shrewd they could end up making a substantial profit on the securities before having to return the securities to the original owner as part of the lending deal. Whatever profit is made by the borrower is not relinquished to the original big business lender as part of the lending agreement.
Lending of securities knows few international boundaries. Lenders and borrowers are governed by the laws of the country in which they reside, and many subscribe to codes of conduct and practice acceptable to the international securities industry at large.