Stock lending for ETFs
Stock lending is an arrangement under which a holder of securities agrees to provide its securities to a borrower for a specified period of time. The borrower will pay a fee for the securities and will return the securities to the lender after the specified period of time.
In order to protect the interests of the lender over the securities 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 a physical ETF (exchange traded fund) engages in stock lending activities, the ETF will be the lender whereby a certain amount of its portfolio holdings is lent out to third parties.
A physical ETF may earn additional income in lending out its securities for a fee which may be used to offset a portion of its operating costs (such as management fees). This may also cause the ETF to reduce its tracking differences under certain market conditions.
Key risks associated with stock lending activities
Investing in ETFs that engage in stock lending activities 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 lent in a timely manner or at all.
- Risk of delay in the return of securities lent: Any delay in the return of securities 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 lent. This may be due to adverse market movements in the value of the collateral, intra-day increase in the value of the securities 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 lending activities 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 stock lending (such as to increase return for the ETF and/or to reduce its tracking error) will be achieved.
Investors should carefully read the risk factors relating to stock lending as disclosed in the offering documents. If in doubt, they should consult professional advisors.
To enhance the level of transparency in view of the nature of ETFs, physical ETFs which engage in stock lending activities are generally expected to make available, at a minimum, the following information on the ETFs’ websites on an ongoing basis to investors:
- Summary of stock lending policy of the ETF and its risk management policy in relation to stock lending, including haircut policy, selection criteria for stock lending counterparties, collateral policy etc;
- Information on the securities lending counterparties and their relevant exposures (updated daily);
- Amount of securities on loan (including exact amount and as percentage of the ETF’s NAV) and level of collaterisation (updated daily);
- Net return to the ETF (at least over the past 12 months) (updated monthly);
- Collateral information, preferably pictorial presentation by way of pie charts, showing the following (updated weekly):
- A breakdown by asset type, eg equity, bond and cash and cash equivalents;
- For equity, further breakdown by eg primary listing (ie stock exchange), index constituents; and sector;
- For bonds, further breakdown by eg types of bonds, countries of issuers/guarantors, and credit rating;
- Top 10 holdings in the collateral (including name, percentage, type, primary listing for equities, credit rating, country of issuers) (updated weekly); and
- Fee split between the ETF and stock lending agent/the ETF manager/any other operating parties on the income derived from the stock lending transactions.
For details on the ETFs that engage in stock lending activities, please refer 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.