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How securities lending works: the basics and process

Securities lending is an essential practice in the financial markets, especially in Singapore. It involves the temporary transfer of securities from one party to another, with the understanding that the borrower will return them at a future date. The lender receives a fee for this service, known as “lending fees.” Securities lending is crucial in maintaining market liquidity and providing short-selling opportunities for investors. This article will discuss how securities lending works in Singapore, focusing on the steps involved in the process.

Securities lending agreement

The first step in securities lending in Singapore is the agreement between two parties – the lender and the borrower. This agreement outlines the terms and conditions of the transaction, including details such as the type of securities, lending fees, duration of the loan, and collateral requirements. In Singapore, these agreements are typically overseen by the Securities Industry Council (SIC), which sets out guidelines for fair and transparent practices.

The lender sets the lending terms, including the minimum lending fee and acceptable collateral. On the other hand, borrowers must meet specific eligibility requirements, including a credit check and providing adequate collateral. Some of the commonly accepted collateral include cash, government securities, and high-quality corporate bonds.

It is essential to note that the lender retains all voting rights and entitlements related to the securities during the loan term. Also, both parties must agree on any changes made to the initial agreement.

Securities transfer

Once the agreement is in place, the next step is transferring the securities from the lender to the borrower. This process involves updating ownership records and notifying relevant parties, such as the Central Depository (CDP) in Singapore. The CDP acts as a central securities depository, holding and maintaining records of all securities traded in Singapore.

The transfer of securities is usually done through electronic book-entry systems, eliminating the need for physical certificates. This process ensures efficiency and protection during the transaction. Lenders can monitor their holdings and receive updates on corporate actions or dividends during the loan period.

The transfer of securities does not change the ownership. The borrower only has temporary ownership and must return the securities at the end of the loan period. It is also essential to have proper documentation and record-keeping during this step to avoid disputes or discrepancies.

Collateral management

Collateral is a crucial aspect of securities lending, as it acts as security for the lender against potential default by the borrower. In Singapore, lenders are required to hold collateral that is at least equal to the market value of the lent securities. The collateral is marked-to-market daily, with adjustments to maintain its value relative to the loaned securities.

The lender has the right to request additional collateral if there is a significant change in the market value of the lent securities. In such cases, the borrower must provide other collateral or return some of the borrowed securities. This process ensures that lenders are protected from any potential market risks.

Borrowers also have the right to substitute collateral during the loan period, subject to approval from the lender. This flexibility allows borrowers to use their preferred securities as collateral while providing lenders adequate protection.

Lending fees

Lending fees are a crucial aspect of securities lending, as they provide income for the lender. In Singapore, lenders can negotiate the lending fee with the borrower and set a minimum acceptable rate. The agreed-upon fee is usually a percentage of the market value of the lent securities and is payable at the end of the loan period.

The lender can earn additional income by lending out securities not fully utilised in their portfolio. This practice, known as “over-lending,” allows lenders to earn more income while managing their risk exposure effectively.

It is worth noting that the lending fee can change during the loan period, depending on market conditions. This aspect provides flexibility for both parties, as they can adjust their terms accordingly.

Return of securities

At the end of the agreed loan period, the borrower must return the borrowed securities to the lender. The CDP facilitates this process by transferring ownership to the lender and updating records accordingly. If there are any corporate actions or dividends during the loan period, they will be forwarded to the lender.

If a borrower fails to return the borrowed securities at the end of the loan period, the lender can recall them immediately. In such instances, the borrower must repay or replace the lent securities within a specified time frame. Failure to do so may result in penalties and legal action.

It is essential to have proper documentation, including a return confirmation, to ensure a smooth and transparent return process. This step also includes the settlement of lending fees and collateral adjustments.

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