By David Adonri, Highcap Securities
To recap the first part of this 2 – piece series, margin lending and securities lending are two sides of the same coin. In the previous edition, it was stated that margin facility is a well established short term cash liquidity enhancer for investors and an important credit outlet for banks. It was further stated that the profitability of investment in financial assets and their derivatives can be magnified through the use of margin and securities lending. In the concluding part of this series, attention will now be devoted to the benefits of securities lending to the lender and borrower.
Securities Lending is another leveraging resource which investors can use to maximize their returns. It provides liquidity to markets, can generate additional interest income for long-term stockholders or owners and facilitate additional income to short sellers.
Securities lending is the practice of loaning securities thereby temporarily transferring them from their holder (lender) to another party (borrower), with the borrower returning the securities to the lender either on demand or at the end of an agreed period. Securities lending requires the borrower to provide a collateral, whether cash, other securities or a letter of credit of a value equal to or greater than that of the borrowed securities, in order to protect the lender against counterparty credit risk. The transaction is often facilitated by a brokerage firm. Loan fees and interest are charged for the facility and these can vary depending on the difficulty of sourcing the securities in question.
When a security is loaned, the rights, title and ownership are also transferred via an equitable mortgage charge to the borrower. The rights include voting rights, the right to dividend and the right to other distributions. Often, the borrower returns the dividend and other benefits back to the lender. A Securities Lending Agreement (SLA) must be signed before the securities are borrowed by an investor. The SLA sets forth the terms of the loan including duration, interest rate, lender’s fee and the nature of the collateral. Global Master Securities Lending Agreement (GMSLA) and it’s Nigerian addendum is the standard contract document that binds the lender and the borrower under the Nigerian Exchange Limited (NGX). As payment for the loan, the parties negotiate a fee (shared between the Lender and the brokerage firm), quoted as an annualized percentage of the value of the borrowed securities. If the agreed form of collateral is cash, then, the fee may be quoted as a short rebate, meaning that the lender will earn all the interest that accrues from placement of the cash collateral and will rebate an agreed rate of interest to the borrower.
Initial driver of securities lending was to cover settlement failure and prevent defaults. Principal reason now is to cover a short position. As you are obliged to deliver the security, following a short sale, you will have to borrow it. Short sellers must either possess the securities they are selling short or have a right to obtain them in order to cover the short sale. Short selling or shorting is the practice of selling securities the seller does not currently have, and subsequently repurchasing them (covering). Securities lending is important to short selling, in which an investor borrows securities to immediately sell them. The borrower hopes to profit by selling the securities and buying them back later at a lower price. However, if the price falls, the borrower incur losses. Naked short selling, that is, without a borrowing backup is not allowed on NGX. While the securities lender benefits from the fees and interest which allows him to enhance his returns, the borrower benefits through the possibility of making profits by shorting the securities.
Currently, margin trading is a rare event in Nigeria but capital market operators are pushing for its activation. Hopefully, stakeholders in the finance industry will understand it’s necessity and endeavour to do the needful. Securities lending is already gathering momentum. It’s impact will become stronger when more investors are enlightened on it’s usefulness.