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An overview of securities lending

IN SHORT: Retirement funds can earn extra income from their existing portfolio through securities lending.

Securities lending is a practice that can benefit retirement funds; with very limited risks. Retirement funds generally buy securities (such as shares) and hold them for a prolonged time on behalf of members with a view to generating a capital (price) and income (dividend) return over time.

Shares are rarely “traded” in the sense of monitoring the market daily to make a quick profit. Instead, retirement funds take a long-term view of investments.

What is securities lending? 

However, there are those market participants that trade daily, betting on either a rise or fall in prices. They’re called traders. They take a short-term view of the market and bet on short-term rises and decreases in the price of shares.

Certain types of asset managers, such as hedge funds, also take a stance on whether a share will rise or fall. A hedge funds’ stance on a share may be a little longer than those of day traders.

A hedge fund manager may hold the view that company A’s shares will decline over a three-month period. To profit from this decline, the hedge fund manager (also called an investor or borrower) will need to borrow shares from someone legally owning them, sell the shares and return them on a future date. This is called securities lending. There are companies that specialise in administering the lending of securities. They do this as either an agent or a principal – that means they borrow the securities from a retirement fund and on-lends them to investors (i.e., the hedge fund manager)

Lending securities, like any other asset, entails the risk that the borrower will default and be unable to return the assets. However, this is extremely rare, and the lender holds collateral over the securities lent out. In practice, the borrower pays a fee to the owner (i.e., the retirement fund) of the shares for borrowing them. The borrower will also need to put up security or collateral, usually in the form of cash, to ensure the shares are returned on the agreed future date.

Securities lending can be a lucrative source of income for a retirement fund that doesn’t trade shares regularly.

Who typically borrows shares in South Africa?

Short selling, or the practice of borrowing shares, selling them and betting that the price of the share will decline, is usually done through a contract for differences (CFD) in South Africa. The counterparty to a CFD is a reputable institution, such as a registered bank. In order to honour the CFD, these financial institutions must borrow shares of different companies from time to time.

Questions to ask when choosing a securities lending service:

Fees: A provider offering securities lending services will charge a fee (margin) of the value of the underlying securities to be lent out. Ask the service provider for detailed fee structures before contracting with them.

Reputable: Ensure the securities lending service is a reputable and registered company licensed by the Financial Sector Conduct Authority (FSCA). You can do a search on the FSCA’s website.