Guide to Share Lending
Share lending is when investment firms loan shares to borrowers as a way to collect additional revenue on stocks they already hold. This produces another revenue stream on equities that would otherwise sit untraded in their portfolios.
The borrowers of the shares are often short sellers, who give collateral in the form of cash or other securities to the lenders.
What Is Share Lending?
Share lending is very much as it sounds: Institutions lend out shares of stock to other investors in order to generate more revenue.
The lenders tend to be pension funds, mutual funds, sovereign wealth funds, and exchange-traded fund (ETF) providers, since these types of firms tend to be long-term holders of equities.
Brokerages can also practice securities lending with shares in retail investors’ brokerage accounts. Share lending can help such firms keep management fees down for their clients.
Share lending is also known as securities lending, as the practice can extend beyond equities to bonds and commodities. Securities lending has become more popular in recent years as increased competition in the brokerage space drove down management fees to near-zero, and investment firms sought other sources of revenue. Worldwide revenue from securities lending totaled $9.89 billion during 2022.
Share lending is also useful to investors who are shorting stock, because those investors need to borrow shares in order to open their positions.
Critics argue that the practice comes at the expense of fund investors, since investment firms forgo their voting rights when they loan out shares. They might also try to own stocks that are easier to rent out.
Other concerns about share lending include a lack of transparency, and an increase in counterparty risk. That said, because short-sellers often use margin trading as a way to increase their potential returns, they’re likely used to assuming risk.
How Securities Lending Works
Here’s a deeper breakdown of how share lending works:
1. Institutional investors use in-house or third-party agents to match their shares with borrowers. Such agents receive a cut of the fee generated by the loan.
2. The fee is agreed upon in advance and typically tied to how much demand there is for the lent-out security on the market.
3. The institutional investor or lender often reinvests the collateral in order to collect additional interest or income while their shares are out on loan.
4. Borrowers tend to be other banks, hedge funds, or broker-dealers, and sometimes include other lending agents. When the borrower is done using the shares, they return them back to the lender.
5. If the collateral posted was in the form of cash, a percentage of the revenue earned from reinvesting is sometimes given back to the borrower.
Retail investors should learn whether their brokerage offers securities lending or share-lending programs. If you have a margin account at a brokerage or with a specific investing platform, there’s a good chance that you may be eligible or given access to a share-lending program. But you’ll need to ask your specific brokerage for details.
For some dividend stocks, investors could get some form of payment from the borrower, rather than the dividend itself. This payment may be taxed at a higher rate than a dividend payout.
Share Lending and Short Selling
In order to short a stock, investors usually first borrow shares. They then sell these shares to another investor or trader, with the hope that when or if the stock’s price falls, the short seller can buy them back and pocket the difference, before returning the loaned shares.
In share lending, a share can only be loaned out once — but when the borrower is a short seller, they can sell it, and the new buyer can lend it again. This is why the short stock float — the percentage of the share float that is shorted — can rise above 100% in a stock.
The fee generated by lending out shares depends on their availability. A small number of stocks tend to account for a large proportion of revenue in securities lending.
Criticism of Securities Lending
The lack of transparency in securities lending is a concern for many investors — both retail, and institutional.
The Dark Side of Share Lending
In December 2019, Japan’s Government Pension Investment Fund, among the world’s largest, announced that it would halt stock lending, saying the practice is not in line with its goals as a long-term investor. They further cited a lack of transparency regarding the identity of the individuals or entities borrowing the loaned securities, as well as their motivations for borrowing.
This became a bigger concern for investors after the “cum-ex” scandal in Germany, where borrowed shares were allegedly used in a tax evasion scheme.
Voting Rights Transferred
Another one of the biggest criticisms of share lending is that shareholder voting rights attached to the actual stock are transferred to the borrower.
This practice challenges the traditional model, in which institutional investors vote and push for change in companies in order to maximize shareholder value for their investors. Money managers can recall shares in order to cast a vote in an upcoming shareholder meeting. But there are concerns that they don’t, and it’s unclear how often they do.
A Hidden Problem
Another concern is that share lending programs incentivize money managers to own stocks that are popular to borrow, but may underperform. A 2017 paper entitled “Distortions Caused By Lending Fee Retention,” updated in July 2022, found that mutual funds that practice securities lending tend to overweight high-fee stocks which then underperform versus funds that do not rent out shares.
Pros and Cons of Share Lending
There are numerous pros and cons to share lending.
Pros
The most obvious upside for investors is that they may be able to open up an additional revenue stream to increase their returns by lending their shares. Along the same lines, share lending can also help investors turn otherwise dormant investments into return-boosters, under the right circumstances.
Also, lending shares allows for investors to lend their shares to short-sellers — thereby greasing the wheels of the market and allowing short-sellers to do their work. It adds liquidity to the market, in other words.
Cons
One downside to share lending is that retail investors should take note that securities that have been loaned are not protected by the Securities Investor Protection Corporation (SIPC). The SIPC, however, does protect the cash collateral received for the loaned securities for up to $250,000.
There can also be negative tax consequences when lending out shares of stock. You don’t receive dividends for the stocks you’ve loaned out, but you do get Payment in Lieu that’s equal to the value of the dividends paid on loan shares. Unfortunately, though, these payments are taxed at your marginal tax rate, not the more favorable dividend rate.
Another concern is the increase in counterparty risk (similar to credit risk). Let’s say a short seller’s wager goes sour. If the shorted stock rallies enough, the short seller could default and there’s a risk that the collateral posted to the lender isn’t enough to cover the cost of the shares on loan.
Finally, there may be additional and special criteria that investors need to meet in order to qualify for share-lending programs. This will depend on individual brokerages or platforms, however. And a final note: If you use a platform that allows you to buy or trade fractional shares, those fractional shares may not be eligible for share lending, either.
|
Pros and Cons of Share Lending |
|
|---|---|
| Pros | Cons |
| Potential to earn more revenue | Lack of SIPC protection |
| Allows investors to boost returns from dormant investments | Increased counterparty risk (the borrower may default) |
| Adds liquidity to short-seller market | You’re taxed at the marginal rate on payments in lieu of dividends |
| Investors may need to qualify | |
The Takeaway
Share lending or securities lending is a potential source of revenue for institutional investors and brokerage firms, who rent out shares that otherwise would have sat idly in portfolios. The practice has ramped up in recent years as management and brokerage fees have shrunk dramatically due to competition and the popularity of index investing.
There are pros and cons, however, as there’s always a risk that a borrower could default. That’s offset, naturally, by the chance to earn additional revenue and boost your ultimate returns. But there are no guarantees.
If you’re interested in investing in stocks, you can start building your portfolio with SoFi Invest. When you open an Active Invest account, you can start trading stocks online with SoFi Invest’s secure, streamlined platform today. And you may qualify for share lending, which could bring in some income.
FAQ
What are the risks of share lending?
Some of the biggest risks of share lending are counterparty risk (or, the risk that a borrower will default and not be able to return your shares); the fact that you may lose SIPC protection on your shares; and that you may need to qualify in order to actually lend shares.
What exactly happens when you lend shares?
When you lend shares, ownership is temporarily transferred to a borrower, who transfers other shares or investments to the lender as collateral. The borrower also pays the lender a fee for the privilege of borrowing their shares.
Does share lending save money?
It doesn’t necessarily save money, but it can be a way to earn more money or drive more revenue from your owned investments. By lending out shares, you can garner fees from borrowers, amounting to a boost to your overall return.
For members enrolled in the Apex Fully Paid Securities Lending Program, securities are lent based on the Master Securities Lending Agreement. Members are eligible to receive a monthly payment if Apex lends out any securities. The payment is a percentage of the total net proceeds earned, which is subject to change. There are risks with share lending, for a detailed review of those risks please review the Important Disclosure. Members may opt out of the Securities Lending Program at any time by sending us a message via chat.
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