Unlocking Portfolio Potential with Securities Lending
A well-managed securities lending program can be a valuable portfolio management tool, and can enable funds to receive an additional source of income that can add incremental risk-adjusted returns to a fund’s overall investment return objective.
What is Securities Lending?
A securities lending transaction involves the temporary transfer of securities from one party (the lender) to another party (the borrower). Frequently, a securities lending agent (the agent) is employed by the lender to facilitate the transaction. Securities lending enables funds enrolled in the securities lending program to potentially generate an additional source of income.
The borrower pays a fee to the lender for borrowing the securities. Sometimes, if cash is transferred as collateral, the borrower may expect interest to be paid on the cash (a rebate). In this case, instead of a borrow fee, the lender will earn the interest differential between what is earned by investing the cash in money markets and the rebate due to the borrower. The agent will typically retain a portion of the borrow fees, or interest differential, as a fee for their service. In SPDR's securities lending program, cash in not accepted as collateral.
Figure 1: How the Securities Lending Program Works
Potential Risks
As with all investment activities, securities lending bears risk. Here are some of the key risks and mitigants typically used to control the risk.
Figure 2: Risk & Mitigation
Governance
The State Street Global Advisors Securities Lending Committee (Committee) oversees and comprehensively reviews performance and effectiveness of the State Street Global Advisors Global securities lending programs.
The Committee evaluates the performance of the State Street Global Advisors securities lending agents. It also reviews and challenges State Street Global Advisors’ global securities lending programs against industry standards and performance, current risk appetite levels, and current market conditions.
In addition, the securities lending program for each participating fund is reviewed, approved and overseen by the respective fund boards.
About the Lending Agent: State Street Bank and Trust Company
State Street Bank and Trust Company (SSBT), which has been appointed as lending agent, is one of the world’s most experienced lending agents, providing both custodial and third-party lending services covering more than 30 international markets. SSBT operates through entities within the State Street group of companies (which are affiliates of State Street Global Advisors). SSBT has been providing securities lending services since 1974, and now operates from trading desks based in London, Boston, Hong Kong, Toronto and Sydney.
This international presence provides local expertise and 24-hour access to the securities lending markets. SSBT offers considerable depth of inventory and market presence, thus attracting high credit-quality borrowers and providing insights into the level of demand for securities.
SSBT employs a number of safeguards for clients engaged in securities lending, including:
- Indemnifying clients against borrower default
- Monitoring the daily activity of the borrowers
- Maintaining liquid collateral with appropriate margins
- Ensuring collateral diversification
Indemnification
SSBT provides a borrower default indemnity as part of the contractual agreement as lending agent for the funds. If a borrower defaults, and fails to return a lent security to a fund, SSBT will liquidate the collateral held and repurchase the lent security in the market with the proceeds. Should those proceeds be insufficient to replace the security and all associated cash flows due to the fund, SSBT will cover the difference. Should the security not be available for purchase, SSBT will credit the fund an amount of cash equal to the market value of securities and associated cash flows due.
Approved Borrowers
State Street Global Advisors has a dual review and approval process for borrowers in the securities lending program. Counterparties are reviewed and approved by the State Street Global Advisors Counterparty Risk Management (SSGA CRM) team and the lending agent, State Street Bank and Trust (SSBT). Both quantitative and fundamental approaches are leveraged in evaluation of borrowers. Borrowers are also subject to a continuous monitoring regime to identify developments that may impact the creditworthiness of a borrower. Generally, it is State Street Global Advisors’ practice to approve the largest and strongest participants in any market.
Collateral
Forms of acceptable collateral are limited to:
- Government securities whose long-term debt ratings are at or above A- (or a rating equivalent) by two or more internationally recognized rating agencies.
- Select equity securities that are traded on a regulated market that operates regularly and are officially recognized and open to the public
- Select Supranational Bonds
The collateral amount is marked to market daily. If collateral levels are insufficient for a particular loan, the borrower is required to provide more collateral. If the loan is over-collateralised, the lending agent may return some of the collateral to the borrower. Collateralisation levels are frequently negotiated between 102–110%. This is often above the contractual minimums and based on the liquidity, price volatility, and currency of individual instruments.
Lending Limits
The percentage out on loan will depend on the type of fund and securities held:
- Maximum of 95% on loan for a single security on a per-fund basis.
- The aggregate outstanding value of loaned securities for any fund in the ETF range shall not exceed 70% of its total net asset value for fixed income ETFs and 40% for equity ETFs.
Securities Lending Revenue and Costs
Various fees may be assessed to operate a securities lending program including revenue sharing fee-splits, cash collateral management fees, administrative and operational fees. However, SPDR simplifies this and only assesses a single fee-split. A fee-split is a form of revenue sharing whereby the agent lender retains a portion of the program revenue, and covers all operating costs and expenses associated with executing the program and providing the indemnification. State Street Global Advisors as investment manager does not receive compensation for overseeing the lending program, and all revenues arising from securities lending in respect of an ETF, net of the fee-split, are returned to the fund.
The funds enrolled in the securities lending program receive 75% of the gross securities lending revenue, while the lending agent receives 25%. These revenues are paid net to the fund on a monthly basis.
Revenues from securities lending vary between funds and overtime based on many factors. Some of the key factors include: market demand for specific securities held by a fund, design of the lending program including specific risk controls, general market conditions for interest rates and collateral, and efficient execution of the program by the lending agent.
Securities Lending Report
The Securities Lending Report is regularly updated and is available to download here.
SPDR ETFs Engaged in Securities Lending
SPDR ETFs engaged in securities lending as of 27 October 2023: