Securities lending is loaning security to an investor or institution, usually in the form of stock. The borrower uses the security as collateral for various financial transactions, including short selling, derivatives transactions, or other activities.
To meet the requirements for short selling
To short-sell security, an investor must first locate shares to borrow. The securities lending process facilitates this by allowing investors to borrow the shares they need from other investors willing to lend them. It is essential because it allows investors to take advantage of market downward price movements without owning the underlying security.
To generate additional revenue
Securities lending can be an excellent option for investors seeking additional income. Investors can earn interest on the loaned amount by loaning out their securities. This extra income can help offset some of the costs associated with investing, such as brokerage fees and taxes.
To facilitate the creation of new products
Many financial products, such as Exchange-Traded Funds (ETFs) and index futures, rely on the process of securities lending to function. For example, when an ETF is created, it typically buys many different stocks to track a particular index. To do this, the ETF needs to be able to borrow these stocks from other investors. Without securities lending, many of these products would not be possible.
To provide liquidity in the markets
Securities lending provides much-needed liquidity in the financial markets by allowing investors to borrow and lend securities regularly. This activity helps keep markets functioning smoothly by making it easier for investors to buy and sell securities.
To help ensure price discovery
Securities lending is essential for price discovery because it allows investors to trade securities they may not otherwise be able to access. By making it possible for investors to borrow and lend securities, securities lending helps to ensure that prices are accurate and reflect the actual value of the underlying security.
To reduce counterparty risk
In many financial transactions, there is a risk that one of the parties will not be able to fulfil their obligations, known as counterparty risk. By allowing investors to borrow securities from each other, securities lending can help to reduce this type of risk.
To lower the cost of borrowing
For investors that need to borrow securities to complete a trade, securities lending can be a cheaper alternative to traditional borrowing methods because the interest rates on securities loans are typically lower than those charged by brokerages or banks.
To access hard-to-borrow securities
Some securities are complicated to borrow, which is often the case with small-cap stocks or illiquid securities. Securities lending can give investors access to these types of securities by making it possible for them to borrow them from other investors.
In Singapore, the securities lending process is regulated by the Monetary Authority of Singapore (MAS). It helps ensure that all parties involved in a securities loan are protected and that the process is conducted fairly.
How to do securities lending
Determine what you want to borrow
The first step in securities lending is identifying the security you wish to borrow. You can search for security on a financial website or broker platform.
Find a lender
Once you have determined what you wish to borrow, you will need to find a lender. You can do this by contacting your broker or searching for a lending platform online. Many different platforms are available, so it is important to compare fees and terms before choosing one.
Once you have found a lender, you must negotiate the loan’s terms, which includes deciding on an interest rate and how long the loan will last. It is essential to get these terms in writing before proceeding.
Complete the loan
Once the terms have been agreed upon, you can complete the loan. The borrower will typically transfer the security to the lender’s account and agree to pay interest on the loan. The loan period can differ depending on the agreement between the parties, but it is typically 30 days.
Return the security
At the end of the loan period, the borrower will need to return the security to the lender by transferring the security back to the lender’s account. Once the security has been returned, the loan is complete.