Securities lending is a practice where investors lend out their securities to other investors or financial institutions for a specified period in exchange for a fee. Securities lending allows short-sellers to borrow securities in order to sell them, with the hope of buying them back at a lower price, thereby profiting from the price difference when the markets move.
Why do people participate in securities lending?
In securities lending, there are two main parties: the lender and the borrower of the securities. They participate in securities lending for several different reasons.
Why lenders participate in securities lending
Firstly, for investors who hold securities in the long term, securities lending provides them with the opportunity to earn extra income from their investments without having to sell them outright. This is because securities lending takes place for a fee paid by borrowers to lenders.
Another reason why lenders participate in lending their securities is to improve liquidity in the markets. By lending securities to other investors, lenders increase the supply of securities available for trading, which can help lower borrowing costs and make it easier for other investors to participate in trading the same market.
Why borrowers participate in securities lending
For borrowers, many participate in securities lending so they can short-sell securities. This is when an investor believes that a stock is overvalued and expects its price to decline in the future. They borrow stocks to sell in the market. When the stock price goes down, they buy back the stock to return to the lender. From this, they attempt to make a profit from the price difference between the time of selling and buying. Another reason borrowers participate in securities lending is simply to obtain securities that are difficult to locate in the market.
Is securities lending regulated in Singapore?
Yes, securities lending in Singapore is regulated.
Singapore is a global financial hub, and the country’s central bank and financial regulatory authority, the Monetary Authority of Singapore (MAS), oversees the local securities lending industry. MAS regulates the activities of securities lending agents and providers, such as financial advisors, banks, and brokers. It also facilitates the lending and borrowing of securities between parties.
The regulations set by MAS ensure the securities lending activities are conducted in a fair and transparent manner. The rules also require securities lending agents to maintain adequate records and to disclose information to their clients when required. Overall, this can give you a much greater peace of mind when borrowing and lending securities, and it also ensures the integrity of the securities lending market remains intact.
Risks of securities lending and risk mitigation
However, despite the country’s regulations, it is important to note that this is not an activity that comes without risks. There are risks for both borrowers and lenders, and they are as follows:
Risks for lenders
The biggest risk for lenders is that their borrowers may default on the loan, resulting in the loss of the securities they loan. In some cases, the lender may ask their borrower to provide collateral – in the form of assets – to the lender to mitigate this risk. However, there is still the possibility that the collateral may not fully cover the value of the loaned securities.
Similarly, another risk lenders run is that their borrowers may sell the borrowed securities and be unable to return them when the loan matures. This can result in the lender having to purchase replacement securities on the open market, potentially at a higher price than the original securities were lent for.
Risks for borrowers
For the borrowers, the primary risk of securities lending is that the value of the borrowed securities may decline during the loan period. If this takes place, the borrower may be required to provide additional collateral or return the securities before they have a chance to sell them. This results in a loss.
There is also the risk that the lender may recall their securities before the borrower is ready to return them. In this case, the borrower will have to purchase replacement securities on the open market, which may potentially cause them to incur a loss.
How to mitigate these risks
To mitigate these risks, it is crucial that both lender and borrower only conduct trading in a lawful manner, through the facilitation of a professional and regulated provider. It is also a necessity for these providers to run thorough background checks on both borrower and lender to minimise the chances of foul play. Finally, both lenders and borrowers should carefully review the terms of any lending agreement before entering into one.
How to participate in securities lending…
If you are looking to participate in securities lending, the route looks different depending on whether you are going to be a lender or a borrower. Though the first step for both is to create a brokerage account or an account at a custodian bank, the next steps are as follows:
Once you have opened a securities lending account, you can choose which securities you want to lend. Typically, you lend securities that are in high demand and have a low default risk. When you decide on the securities, you will want to find a borrower who is looking to borrow some of your securities.
You will need to agree on the terms of the lending agreement with the borrower, including the duration of the loan, the collateral that they will provide, and other issues concerning fees. When you have agreed on the lending terms, you will transfer the securities to the borrower, while the borrower provides you with collateral to secure the loan.
Even though you are not the one using the securities to participate in the market, you will have to monitor the loan to ensure the borrower complies with the terms of the lending agreement. You will also need to log any corporate actions that may affect the value of the securities, so you are prepared to recall them if urgent scenarios.
As a borrower, once you have opened a borrowing account, you can choose which securities you want to borrow. Afterwards, you agree on the lending terms with the lender, and you are free to exchange collateral with the securities. You will also have to pay a fee to the lender for the service.
You can use the borrowed securities for any investment venture. Most borrowers use them for short-selling. When you have entered into the market, you should be aware of when your loan agreement is due and make sure not to exceed what is stated in the contract. Make sure you comply with the terms of the lending agreement, as you may incur legal repercussions otherwise.
When you loan agreement term is over, you will need to buy back the securities from the market regardless of whether you are doing so at a loss or profit. This is because you need to return them to the lender. If you fail to do this, your securities lender can take legal action against you and pocket your collateral.
In summation, securities lending is a practice where investors lend out their securities for a fee, primarily to short sellers who need to borrow securities to sell them short. While it can provide extra income and improve liquidity, it’s important for participants to understand and manage the associated risks. The MAS regulates securities lending in the country, which includes facilitating the lending and borrowing of securities between parties and to ensure the activities of securities lending agents are transparent and ethical. If you are interested in participating in buying and selling securities, you can simply sign up for an account with a licensed provider.