A securities lending involves a transaction in which the lender issues a security to a borrower for a limited time, in exchange for a fee. The parties agree on the fee, cited as an annual percentage of the issued securities.
Whenever cash is involved as a collateral, the fee is sometimes mentioned in the form of a rebate, which pertains to the lender gaining from the interest applicable.
Unlike the traditional forms of borrowing which entail the borrower returning the securities to the lender, but only those of the same type and quality. Lenders are usually large securities dealers, banks, funds and major shareholders. Generally, the lender requires a loan guarantee in the form of cash or other securities.
Securities lending transactions are used to comply with short sale delivery obligations incurred. Lent securities may also be used for refinancing purposes, hence the securities lending especially in the bond market is a widespread practice.
This lending avenue is well regulated in most of the securities markets of the world. They also authorize the borrowing of securities for particular purposes such as enabling the finalization of a trade, together with the delivery of a short sale, and the financing of a security.
Once a security is issued, the title of the security shifts to the borrower, hence the borrower can hold the security as if he/she owns it. In essence, the borrower takes receipt of all coupon or dividend payments, including voting rights whenever applicable. Typically, the dividends and coupons are returned to the lender as the so-called manufactured dividend.
The lending of securities may have different tax benefits that result from the specialized treatment of income and capital gains from equity investments.
The securities lending business commenced inspired by the need to address settlement failure, as a result of actions of one party that fails to deliver stock. And as a way of avoiding costs and penalties of having been unable to deliver stock that is already sold to another party, stock could then be borrowed at a fee, for onward transmission to the purchasing party.
Securities lenders, also known as sec lenders are normally entities that enjoy access to lendable securities. Asset managers, derive securities from those under their management, while custodian banks keep securities for third parties.
In investment banking, securities lending can refer to a service provided to large investors by issuing their shares to others, the investors often opt to do this because they can earn interest income. During the course of such agreements, the investor still takes receipt of dividends as usual, but they are not in a position to vote their shares.