Securities lending is commonly used by institutional investors, including hedge funds, mutual funds, pension funds, and other asset managers. These investors often have large amounts of securities, and they lend out some of these securities to earn an additional income based on the demand of market participants for certain stocks and assets.
However, retail traders can also participate in securities lending. It is less common, due to the significant amount of capital and infrastructure required, but more and more brokers and banks have started up securities lending programmes for their clients in recent years. These brokers allow clients to pool their securities together with other investors to loan them out to borrowers. The broker facilitates the lending process, and clients can earn revenue in the form of applicable dividends.
In this article, we will go through what securities lending is, how it works, and how individual traders can apply to become a lender. We will also go through some risks of securities lending, and how traders can mitigate these risks.
What is securities lending?
Securities lending is a service, provided often by brokers, for their clients to make securities on their accounts available for lending to other market participants. Some examples of these securities are stocks, ETFs, and bonds. The reason for that is because sometimes, the market has a high demand for certain instruments, and by contributing to their supply, traders can earn extra revenue in the form of applicable dividends.
How does securities lending work?
Securities lending is straightforward. Say, you are a client with shares of ABC Company. The stock is in high demand on the market, and market participants are paying substantial interest per year to borrow these shares. If you have a securities lending account, you can loan your shares out to these market participants, and you can split the interest with your broker. This means you can earn an extra revenue of a certain percentage of interest a year when you loan out your shares of ABC Company.
The extra revenue that you generate from being a securities lender will be deposited into your client account each month. The whole time, the broker acts as the facilitator in the transactions, so that the client does not have to worry about anything beyond activating the service. However, market demand can be arbitrary, and those with certain assets may find it easier to appeal to other market participants and earn a high interest.
How to become a securities lender as an individual trader
If you are an individual investor looking to become a securities lender, it may be more challenging than trying to become one as an institutional trader. This is because securities lending generally requires a significant amount of capital and operational infrastructure. Institutional traders have the backing of their institution – such as a hedge fund, finance firm, or bank – to provide the capital and the resources required to become a securities lender. As an individual investor, you are largely on your own.
Yet, there are a few ways that individual investors can participate in securities lending.
Working with a broker
Many brokers offer securities lending for their clients. If you want to be a lender, you can sign up for an account with the broker and fulfil the minimal balance requirements and other eligibility criteria. These brokers take care of the lending process for their clients, and they pool together the funds of multiple clients to meet the needs of market participants.
For example, Saxo Bank offers securities lending for clients who want to earn extra revenue while avoiding custody fees. Saxo’s clients can lend securities out to third parties in a safe and secure manner through the regulated and established investment bank, and they can receive payments in the form of applicable dividends. Saxo offers five plans for their clients – Bronze, Silver, Gold, Platinum, and Diamond – with differing transaction fees, custody fee rates, minimum account funding requirements, and cash rebate rates. Their clients can switch plans anytime, should their investment objectives change.
Joining a securities lending programme
Some securities lending programmes allow individual investors to pool their securities together to loan out. This helps each investor reap the benefits of securities lending without requiring a lot of capital per person.
Many brokers offer these programmes, as well as custodian banks that hold and safe securities on behalf of institutional investors. On top of this, there are also securities lending agents, who are intermediaries that facilitate securities lending transactions. These agents work with both institutional and individual investors, and they take care of the lending process in exchange for a fee or interest payment.
How to make the most of being a securities lender
Regardless of how you become a securities lender, there are some key factors to note if you intend on making the most of your opportunities and reaping as much benefit from these programmes as you can. Below are some of them.
Do your research on the market
Before you participate in securities lending as a borrower or a lender, you should learn about the mechanics of securities lending, such as what it is and how it works. You should also learn about the risks that come with this activity and how you can mitigate or minimise them. Additionally, you should learn about the participants in the market and the kinds of people you can work with, and the kind of assets that are in high demand from market participants.
Choose the right broker for you
When choosing a broker, you should make sure you research the minimum account balance required, the custody fees you will be charged, eligibility requirements, and the reputation of the broker. Remember to read through the securities lending terms that the broker will have on their website and choose a plan that works best for you.
Closely monitor your securities lending activities
When you are participating in a securities lending programme, you should keep a close eye on your activities and your funds, such as the securities you have lent or borrowed, and the fees you have accrued. These include commission rebates, custody fees, transaction fees, and more.
Set up risk management strategies
Finally, you should always be aware of the risks involved in securities lending and take steps to manage these risks. By working with a reputable broker, you can save yourself headspace from worrying about the security of your funds. Nevertheless, you should monitor your collateral to ensure it remains sufficient and diversify your lending activities across borrowers to reduce the risk of any one borrower defaulting on the loan.
The bottom line
In general, investors can become securities lenders to earn additional income on their securities holdings by loaning out their securities to borrowers. Depending on market participant demand, these securities can be loaned out with a high interest rate, generating substantial revenue for lenders that can offset the cost of holding securities, such as custody fees.
Nevertheless, it is essential that lenders understand the risks that come with securities lending, such as the chances of borrowers defaulting. To minimise the risk of securities lending, traders should work with reputable brokers with a strong history of providing lending services to clients. They should also understand the mechanics of securities lending and do sufficient market research to understand market demand.