The key to profitable lending
The key to making money from securities lending ultimately lies in the stocks you hold.
Typically a UK pension fund will hold a majority of its assets in UK equities where supply can at times be greater than demand. Equities held in lesser developed countries with illiquid markets typically command a higher price when borrowed.
Initially a broker (the borrower) will approach the custodian (the lender) holding the pension fund’s assets and request the loan of a set amoun t of stocks in a given market. If the fund holds them and is willing to lend, the broker gives the client collateral, typically in the form of cash or government bonds, government debt or letters of credit, amounting to an industry-wide average of 105% in developed markets, and upto 115% or greater in very illiquid markets, of the face value of the stocks, to secure the loan. On its return, all dividends that arise from the stocks while in the hands of the broker are paid to the client.
In the case of a lender accepting non-cash collateral, a fee would be charged on the life of the loan, which would vary from market to market. With cash collateral, a margin called a rebate is initiated. For example, the lender, if the overnight rate is 5.52%, would charge 4.52%, so the 100 basis points difference would be the fee. The pension fund makes money from that fee, which is split between the custodian and the pension fund client. The degree of the split, be it 60/40 or 70/30 can vary and is individual to the agreement between client and custodian.