Securities Lending Doesn’t Deserve Bad Press, Says Expert

One of the most common criticisms against this practice is that when pension funds or other investors lend securities to hedge funds that use the securities for short selling, it can drive down the value of the security.

“This is a familiar story. We’ve heard it a number of times in the press,” said Rule. However, he pointed out that academic research shows that short-selling is good for the market. “If you eliminate the ability of people to go short, you reduce market efficiency.”

He also noted that only a small percentage of short sales are a bet that a share price will fall. Rather, many short sales are undertaken as a hedge against other positions, said Rule, speaking at the one-day summit, hosted by Canadian Investment Review—Benefits Canada’s sister publication—together with CIBC Mellon, Northern Trust Investor Services, RBC Dexia Investor Services and State Street.

Securities lending refers to the lending of securities by one party—often an institutional investor—to another, such as a hedge fund. The borrower provides the lender with collateral in the form of cash or securities. In return for lending the securities, the lender receives a fee or the ability to re-invest cash collateral and keep a portion of the proceeds. The borrower is obligated to return the securities either on demand or at the end of an agreed term.

More and more institutional investors are turning to securities lending as a means of enhancing returns and offsetting costs. Rule cited an estimate by London-based Spitalfields Advisors that US$6 trillion worth of securities were on loan worldwide in 2007.

Another traditional criticism against securities lending is that some hedge funds borrow stocks in order to obtain shareholder votes and influence the fortunes of the underlying company in their own favour, rather than in the interests of shareholders. Rule said that instances of this practice are exaggerated. “We think there’s a lot more hot air than evidence around this subject,” he said. He added that there is a growing consensus in the market that this is “unacceptable behaviour” and that ISLA is engaging regulators to curtail the practice. And he reminded the audience that securities lenders have the option to recall the loaned securities when important shareholder votes arise.

Rule also answered common concerns that lending securities is a risky endeavour and said: “securities lending is designed to be a low-risk business.” He mentioned that lenders may choose to take risks in the re-investment of cash collateral, but that this is a separate issue from the risks associated with securities lending itself.

Please visit BenefitsCanada.com in the coming weeks for more comprehensive coverage of the Securities Lending Summit.

To comment on this story, email don.bisch@rci.rogers.com.