Securities financing transactions for ETFs

Tax deductions

Securities financing transaction is an arrangement under which a holder of securities/cash agrees to provide its securities/cash to a borrower for a specified period of time. The borrower will pay a fee for the securities/cash and will return the securities/cash to the lender after the specified period of time.

In order to protect the interests of the lender over the securities/cash lent, the borrower will generally be expected to provide collateral in the form of cash or other securities as agreed by the lender. The value of the collateral is expected to be marked to market daily and at least equal to or in excess of the value of the securities lent to cover the risk of default of the borrower.

Where an ETF engages in securities financing transactions, the ETF will be the lender whereby a certain amount of its portfolio holdings is lent out to third parties.

An ETF may earn additional income in lending out its securities/cash for a fee which may be used to offset a portion of its operating costs (such as management fees). This may also cause a passive ETF to reduce its tracking differences under certain market conditions.

Key risks associated with securities financing transactions

Investing in ETFs that engage in securities financing transactions involves certain risks which includes the following:

  • Risk of failure to return the securities lent: The borrower may default on its obligation and fails to return the securities/cash lent in a timely manner or at all.
  • Risk of delay in the return of securities/cash lent: Any delay in the return of securities/cash lent may restrict the ability of the fund to meet delivery or payment obligations arising from redemption request and may trigger claims.
  • Market risk: If the borrower defaults, there is a risk that the collateral held by the ETF may be realised at a value lower than the value of the securities/cash lent. This may be due to adverse market movements in the value of the collateral, intra-day increase in the value of the securities/cash lent, a deterioration in the credit rating of the collateral issuer, default or insolvency of the collateral issuer or the illiquidity of the market in which the collateral is traded.
  • Operational risk: Securities financing transactions entail operational risks such as settlement failure or delays in the settlement of instructions.
  • Risk of not achieving its objective: There can be no assurance that the objective sought to be obtained from use of securities financing transactions (such as to increase return for the ETF and/or to reduce tracking error of a passive ETF) will be achieved.

Investors should carefully read the risk factors relating to securities financing transactions as disclosed in the offering documents. If in doubt, they should consult professional advisors.

Website disclosure

To enhance the level of transparency in view of the nature of ETFs, where securities financing transaction undertaken by a physical ETF exceeds 50% of its total net asset value (NAV), the ETF should make available, at a minimum, the following information through the ETF’s own website or other acceptable channels on an ongoing basis to investors (updated monthly):

  • Summary of policy regarding the ETF’s use of the securities financing transactions and its risk management policy in relation to securities financing transactions , including haircut policy, selection criteria for counterparties, collateral policy etc;
  • Information on the counterparties of each type of securities financing transactions and their relevant exposures;
  • Amount of securities on loan as a proportion of the ETF’s total lendable assets and NAV;
  • Net return to the ETF relating to each type of securities financing transactions (at least over the past 12 months);
  • Collateral information, preferably pictorial presentation by way of pie charts, showing a breakdown by asset type, e.g. equity, bond and cash and cash equivalents;
  • Top 10 largest collateral issuers across all securities financing transactions with details on the amounts of collateral received by the ETF; and
  • Fee split (in percentage terms) between the ETF and the ETF manager/any other operating parties on the income derived from the securities financing transactions.

For details on the ETFs that engage in securities financing transactions, please refer to the relevant offering documents.

As investors, you should assess whether the product is suitable for you in light of your investment objectives, understand the amount of expenditure required to make the investment and check if the investment match with your risk tolerance. If in doubt, please consult professional advisors for details.