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What is Securities Lending? An Informative Guide

Experts estimate that there is around $74 trillion in assets under management invested with wealth management firms worldwide.

If you have placed some of your assets into investment vehicles, chances are that you’re already familiar with a lot of the terminology that goes with investment.

However, securities lending is something you may not have come across before.

Read on as we explain what securities lending is, and whether it might be a good idea for your portfolio.

What Is Securities Lending?

As the name suggests, securities lending involves transferring ownership of financial instruments on a temporary basis. These instruments can be stocks, bonds, or derivatives.

The security is loaned by one investor or firm to another in exchange for collateral. The title to the security passes to the borrower for the duration of the loan period.

Securities lending is sometimes referred to as a stock loan.

How Does Securities Lending Work?

Securities lending transactions rarely take place between two individual investors. Rather, it is money managers, investment funds, brokers, and other financial organizations that carry out the majority of these kinds of transactions.

Securities loans must be finalized through a loan agreement. This is similar to a cash loan in many respects.

The agreement document will contain all the relevant details of the arrangement, including the fee to be paid to the lender, the duration of the loan, and the type of collateral to be used.

Collateral for Stock Loans

Regulations provide that borrowers should give lenders collateral which has a value of at least 100% of the value of the loaned stock. It will usually be a few percent more than this.

An important consideration in terms of the collateral to be used is the volatility of the loaned securities.

Volatility is a term used in financial trading which refers to the likelihood of price changes in a given instrument. The more volatile an instrument is, the more likely it is to increase or decrease in price.

Volatility is a major consideration for investors when gauging the appropriate securities to buy for their risk appetite. The more risk an investor wants to take on, the more volatile his or her investment picks should be.

Volatility is relevant to securities lending because a loaned security that is very volatile might have a significantly different value when a borrower gets it back then when they loaned it out.

To protect against such movements, a higher percentage for the collateral payment is usually required.

Is Securities Lending a Good Idea for Your Portfolio?

Firstly, it is important to understand that securities lending is not something that is typically undertaken by retail investors, or individuals with a moderate amount of investable assets.

While the basic premise of securities lending is simple enough, the technical approach that is required to make it profitable can be very complex indeed.

Fees are charged on the basis of an asset’s riskiness. Assessing this riskiness takes in-depth research and mathematical analysis.

Because margins are narrow, securities lending must be undertaken at scale to be profitable. This is why only specialist organizations generally offer it as a service.

However, if you want to take advantage of securities lending as a small investor, there is a way you can; stock loan financing.

The Advantages of Stock Loan Financing

While securities lending is generally only used by firms and organizations, there are ways in which retail investors can use it to boost their portfolio.

Depending on how your portfolio is doing and what your goals are for the future, stock loan financing could be a very smart move for your money.

Stock loan financing allows you to transfer stock to a finance provider temporarily in return for a cash payment. You pay back this money with interest over time, and your stock is then returned to you.

If you need liquidity to fund further investment, this could be the answer.

The Relationship Between Securities Lending & Short Selling

Securities lending is most often used to facilitate short selling. If an investor wishes to take a short position in a given security, he or she will have to temporarily borrow the security in order to sell it and buy it back.

How Does Short Selling Work?

If an investor thinks that certain security or index is likely to lose value in the future, he or she can short sell it in order to capitalize on this movement.

To perform a short sale, an investor must sell a borrowed security and then buy it back. Their goal is for the later purchase price to be lower than the earlier sale price.

This difference becomes their profit on the transaction if it goes as planned. If the price of the security rises while they hold it, however, their investment will make a loss.

The specifics of this arrangement are all set out before the initial borrowing takes place. The investor sells a security at a given price on a given day and agrees to buy it back at an agreed later date for the price that it commands at that time.

Generally, lending in this scenario will be carried out by a brokerage firm. They charge fees for the transaction, and these fees will be payable at the end of the transaction regardless of how successful or unsuccessful the venture was for the investor.

Growing Your Portfolio Through Securities Lending

As you can see, securities lending can have many benefits. Many of the firms and financial vehicles that use it do so with a high degree of success.

Did you find this post useful? If so, be sure to check out some of our others! We regularly post content on everything to do with investing.