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Securities lending made simple

Securities lending is a transaction between two parties: a lender (the owner of some securities, such as an index mutual fund) and a borrower (often a bank or a broker).

September 23, 2022

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Key takeaways

Definition of securities lending

Securities lending is a transaction between two parties: a lender (the owner of some securities, such as an index mutual fund) and a borrower (often a bank or a broker).

In the deal, the lender transfers the ownership rights of securities (stocks, bonds, etc.) to the borrower. In exchange, the borrower agrees to give back exactly the same type and number of securities borrowed, plus some additional fees and interest. The borrower also has to put up collateral, which can be cash or other securities they own.

When the borrower gives the securities back to the lender, the lender again has full ownership rights over them.

Why lend securities? Why borrow securities?

The main reason for lending is simple: the lender gets income from the borrower. Lending out securities for a short period gives a fund who owns stocks in, for example, a tech giant, the opportunity to generate fees and interest on stocks that they plan to hold in their portfolio long-term. This revenue goes into the net asset value (NAV) of the fund, which can increase investors’ returns.

So why borrow? Banks and brokers use securities loans, for example, to fulfill delivery obligations, support market-making activities, or implement investment strategies through derivatives transactions.

Credit Suisse Asset Management Index Solutions and securities lending

The fund range  of Credit Suisse Asset Management Index Solutions has both funds that allow securities lending and funds that do not.

Index mutual funds are a mix of both – some permit securities lending, while others don’t. The fund name will tell you right away: if it’s “blue”, then no lending is permitted. 

Our ETFs do not allow securities lending. This is what the word “blue” in their names means – see the guide to our fund names. 

The reason some funds do not allow securities lending is simple – during the period securities are held by the borrower, we are unable to exercise the rights attached to them, like voting rights. It also limits our ability to engage in dialogue with senior management of portfolio companies, through which we can exert influence to improve their business and governance practices.

Securities lending and safety

Securities lending transactions are subject to numerous regulations. In Switzerland, for example, securities lending for investment funds is governed primarily by the FINMA Ordinance on Collective Investment Schemes (CISO-FINMA). Thanks to comprehensive safety mechanisms and regulators engaged in various jurisdictions, the risks involved with securities lending are low.

For funds that allow securities lending, the borrower is required to provide highly liquid collateral with a high credit rating. The collateral must be worth at least the market value of the securities lent out at any time and is typically worth 105% or more. 

In addition, contracts for securities lending typically state that the fund management company has the right to recall securities lent out at any time without notice. Once the securities have been returned, the fund management company can exercise all subsidiary rights again, in particular voting rights.

Should the borrower not return the securities lent out per the contract, the fund management company may sell the collateral in favor of the funds as it already acquired ownership of the collateral when it was transferred. This helps to protect the value of the fund’s total assets.

Potential risks

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Source: Credit Suisse, unless otherwise specified.
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