The practice of lending shares of stocks, derivative contracts and commodities (or other securities) to other firms or investors is called securities lending. The practice requires the borrower to put up a form of collateral, such as a letter of credit, cash or another type of security, and is usually facilitated by a brokerage firm. While it’s on loan the ownership and title of the security are transferred to the borrower.
Securities lending enables short selling, can generate extra interest income for long-term securities holders and can provide liquidity to markets. The practice is also a means for investors to hedge their portfolios and offers investors more ways to earn money from their securities.
Is Securities Lending a New Thing?
Securities lending has been practiced for more than 40 years, with the first formal equity lending transactions undertaken in the early 1960s in London – although it didn’t fully take off as an industry until the 1980s. Although it began as something of a back office operation, the practice has now evolved into a common investment process that can potentially increase returns for large financial institutions.
Why Borrow a Security Rather than Buy It?
There are several reasons that investors may choose to borrow rather than buy a security. For example, if an investor has purchased some securities that haven’t arrived on time, they may need to borrow at short notice as a way of obtaining the missing securities.
Furthermore, there are many different strategies in financial markets that rely on the temporary borrowing of a security. In this way, borrowing may be used for arbitrage or trading purposes.

What Are the Risks Associated with Securities Lending?
Experienced traders like Domen Zavrl know that all investment strategies carry inherent risks, and securities lending is no different. The main risk of the practice is the borrower becoming insolvent or the value of the provided capital dropping below the cost to replace the borrowed securities.
Other potential risks associated with securities lending are the securities being delivered to the borrower before the receipt of the collateral, and the lender suffering a loss upon the reinvestment of the cash collateral. It’s important for lenders to be aware that the lender’s legal agreement doesn’t provide complete protection should the borrower default. Furthermore, stockholders lose their voting rights on the loan stock, which is transferred to the borrower for the period during which they hold the shares.
For more information about securities lending, take a look at the embedded PDF.

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