Securities lending is a concept that has gained significant popularity in recent years, especially in Singapore. It refers to borrowing and lending securities between financial institutions, such as banks and broker-dealers. It allows them to take advantage of short-term market movements or meet their regulatory requirements for collateral.
Securities lending plays a crucial role in the smooth functioning of capital markets by providing liquidity and improving market efficiency. This article will discuss the fundamentals of securities lending in Singapore, highlighting its importance, participants, process, risks, and regulations governing it.
Importance of securities lending
Securities lending is a vital component of the financial market in Singapore. It plays a crucial role in providing liquidity to the capital markets, allowing for efficient price discovery and facilitating smooth market operations. By enabling institutions to borrow securities, securities lending promotes trading activities by providing short-term supply in the market. It helps investors who have taken long positions in various securities to finance their trades, reducing the cost of borrowing and potentially increasing their returns. Securities lending also facilitates short selling, essential for price discovery and market efficiency.
In addition to providing liquidity, securities lending has several other benefits. Institutions can earn additional income from idle assets by lending them out for a fee. It can benefit institutional investors who hold large portfolios that are not fully utilised. They can generate additional revenue streams by lending their securities to offset the costs of having these assets. Securities lending also promotes market stability by ensuring a sufficient supply of securities for settlement and reducing the risk of failed trades.
Participants in securities lending
The participants in the securities lending market include borrowers, lenders, agents, and custodians. Borrowers are usually institutions such as hedge funds, market makers, and other financial intermediaries that require securities for short selling or to meet collateral requirements. Lenders are typically large institutions with significant securities holdings, such as pension funds, insurance companies and mutual funds.
Securities lending agents act as intermediaries between borrowers and lenders, facilitating the borrowing and lending transactions. Custodians play a crucial role in managing the securities lending process, holding the securities on behalf of the lenders and ensuring their safekeeping. Visit home.saxo to see their securities lending options and how they can help you.
The securities lending process
The securities lending process involves four key steps: negotiations, agreement, collateralisation and return. In the negotiation stage, borrowers and lenders agree on the transaction terms, including the quantity, duration and fee for lending the securities. Once an agreement is reached, a written contract is drawn up outlining the terms and conditions of the transaction. Collateralisation involves the borrower providing collateral to the lender as security for borrowing the securities. It can be in cash or other assets, such as government bonds.
During the lending period, the borrower has ownership of the securities and is entitled to any income or dividends associated with them. However, they must return the securities at an agreed-upon date, usually with an additional fee. If the borrower fails to return the securities, the lender can request that their collateral be sold to cover any losses.
Risks involved in securities lending
Although securities lending offers several benefits, it also involves risks that should be carefully managed. The primary risk for lenders is the potential loss of their collateral if borrowers default on returning the securities. Other hazards include market and credit risks, where a borrower may fail to return the securities due to financial difficulties or adverse market conditions.
Counterparty risk is the risk that a borrower may default on their obligations to return the securities and their collateral. It can occur if the borrower becomes insolvent or unable to fulfil their contractual obligations. To mitigate this risk, lenders often require borrowers to provide collateral over the value of the borrowed securities.
Market risk refers to a lender’s potential loss due to adverse market conditions. If the value of the borrowed securities decreases significantly, the borrower may not be able to return equivalent securities and must provide additional collateral instead.
Credit risk arises from the potential failure of the borrower to return the borrowed securities due to financial difficulties or insolvency. To mitigate this risk, lenders may require borrowers to provide high-quality collateral and regularly monitor their creditworthiness.
Regulations governing securities lending
In Singapore, securities lending is regulated by the Monetary Authority of Singapore (MAS) under the Securities and Futures Act. The MAS requires all participants involved in securities lending to be licensed and regulated and has stringent risk management and reporting guidelines. Lenders must also comply with regulations on collateral requirements, ensuring that it is of good quality and easily convertible in case of default. The MAS also requires regular reporting on securities lending activities to promote transparency and monitor market stability.
The Securities Financing Transactions Regulation (SFTR) implemented by the European Union in 2020 also has a global impact on securities lending. The SFTR aims to increase transparency and mitigate systemic risks by requiring all securities lending transactions to be reported to trade repositories.