Trading and securities lending in Singapore enables institutional investors to temporarily transfer their holdings of specific securities to other investors who wish to use them for particular purposes. In this way, the securities lending market helps ensure the efficient and smooth functioning of the overall capital markets.
This article provides a basic overview of the securities lending market, including its key players and mechanics. It also discusses some of the benefits institutional investors can derive from participating in this market.
What is securities lending?
Securities lending is the act of temporarily transferring securities from one party to another. The transaction is made with an agreement that the securities will be returned later, typically with additional compensation. Securities lending can be used for many purposes, including short selling, hedging, and collateralization.
There are two main types of securities lending: intramarket and intermarket. Intramarket securities lending occurs when two parties agree to trade within the same market. For example, if Party A holds shares of Company XYZ and wishes to borrow against them, Party A may lend the shares to Party B in return for cash or other assets. The loan period is typically short, lasting only a few days or weeks. Once the loan period is up, Party A must return the shares to Party B, plus any agreed-upon interest or other compensation.
Intermarket securities lending, on the other hand, occurs when one party loans securities to another party who wishes to trade in a different market. For example, if Party A holds shares of Company XYZ and wishes to borrow against them, Party A may lend the shares to Party B, who wishes to trade them in the market for Company ABC stocks. The loan period is typically much longer in intermarket securities lending transactions, often lasting several months. Again, at the end of the loan period, Party A must return the shares to Party B, plus any agreed-upon interest or other compensation.
What are its benefits for investors?
The benefits of securities lending for investors include the following:
- The ability to generate additional income from their portfolios: When investors loan out their securities, they typically receive compensation, such as an interest payment. It can help offset any losses the investor may incur on their investment during the period when the securities are lent out.
- The ability to hedge against potential losses: By temporarily transferring securities to another party, investors can reduce their exposure to potential losses if the price of those securities falls during the loan period.
- The ability to participate in short selling: Securities lending enables investors to participate in short selling transactions without owning the underlying securities. It can be beneficial for both parties involved in the transaction, as the investor who loans the securities can earn interest income. In contrast, the party who borrows the securities can profit from a decline in the price of those securities.
What are the mechanics of securities lending?
Three key players in the securities lending market are borrowers, lenders, and intermediaries. Borrowers are typically financial institutions that wish to use the borrowed securities for short selling or other purposes. Lenders are typically institutional investors, such as pension funds or insurance companies, who temporarily lend out their securities. Intermediaries are typically banks or other financial institutions facilitating securities lending transactions between borrowers and lenders.
In a typical securities lending transaction, a borrower approaches an intermediary and requests to borrow specific security from a specific lender. The intermediary then contacts the lender and requests that they loan the security to the borrower. If the lender agrees to loan the security, the intermediary will transfer the security to the borrower. The borrower will then agree to return the security at a later date, plus any agreed-upon interest or other compensation.
What are some of the risks associated with securities lending?
There are many risks associated with securities lending, including counterparty risk, credit risk, and liquidity risk.
Counterparty risk is the risk that either the borrower or the lender will default on their obligations under the securities lending agreement. This might occur if the borrower cannot return the borrowed securities when required or the lender cannot pay the agreed-upon interest payments.
Credit risk is the risk that the value of the securities loaned will decline during the loan period. This might occur if the underlying security price falls or the borrower’s creditworthiness deteriorates.
Liquidity risk is when the lender cannot find a buyer for their securities when they need to unwind their position. This can occur if there is a sudden decrease in demand for the securities being lent or a general deterioration in market conditions.
How can investors mitigate risks associated with securities lending?
There are many ways that investors can mitigate risks associated with securities lending, including diversifying their portfolios, monitoring market conditions, and working with experienced intermediaries.
