Securities borrowing and lending is growing globally and
in the Hong Kong market. It is an institutional business,
requiring sophisticated systems and expertise. Some overseas
clearing houses provide centralised securities lending services,
but in Hong Kong there is less room for a centralised service.
There has been renewed discussion in the Hong Kong market
recently on the possibility of expanding the securities borrowing
and lending (SBL) facility provided by Hong Kong Securities
Clearing Company (HKSCC), a subsidiary of HKEx. However, commentators
have differing perceptions of the value of such service, and
indeed different understandings of what SBL entails. This
article seeks to clarify some of these perceptions.
The article firstly describes SBL, as practiced in international
markets and in Hong Kong. It summarises the experience of
HKEx in operating a stock borrowing programme for settlement
coverage. The article also considers the experience of overseas
clearing houses and other institutions in providing centralised
SBL services. Finally, the relevance of international experience
to Hong Kong is discussed.
1. What is securities borrowing
and lending2 ?
Securities lending is the temporary transfer of securities
on a collateralised basis. In many markets it is an important
activity, contributing to greater liquidity, narrower spreads
and improved risk management. Most SBL activity takes place
on the over-the-counter (OTC) market, hence statistics on
volumes are not readily available. However, it is believed
that the balance of securities on loan globally exceeds US$1.7
trillion, representing 10 to 12 per cent of lendable assets,
and that lending activities generate an annual US$3.2 billion
of revenue for lenders and agents3 .
Most SBL activity is between large sophisticated institutions.
The institutions follow conventions of practice that have
developed over the years and are now embodied in codes such
as the Stock Borrowing and Lending Code, developed by the
UK Securities Lending and Repo Committee. The International
Securities Lending Association has developed standard market
agreements, such as the Global Master Securities Lending Agreement,
"Securities lending" is a misleading term because
in legal terms the securities are not actually lent. In fact,
the securities are sold to the "borrower" under
an agreement for subsequent reacquisition of equivalent securities.
The original securities may be sold onward by the borrower
to third parties. Hence, absolute title passes over both the
securities lent and the collateral received. The economic
benefits associated with ownership such as dividends belong
in the first place to the borrower (who is the legal owner),
but are "manufactured" back to the lender by the
borrower making equivalent payments to him. The lender surrenders
the rights of ownership such as voting rights. However, if
the lender wishes to vote on securities on loan, he has the
contractual right to recall equivalent securities from the
borrower to do so.
In jurisdictions with stamp duty, such as Hong Kong and the
UK, there are provisions in the legislation to exempt SBL
transactions from such duty.
Most SBL transactions are against collateral, which can be
in the form of cash, securities or other assets. The eligible
collateral will be agreed between the parties at the outset,
including the initial margin, the maintenance margin, and
concentration limits (ie to ensure that the collateral can
be liquidated in need). The collateral is often held by a
Tri Party Agent, to whom the borrower pays a fee. This agent,
usually a large custodian bank or international central securities
depository, will receive the eligible collateral from the
borrower and hold it to the account of the lender. The Tri
Party Agent will mark the collateral to market, distributing
the information to lender and borrower.
SBL fees paid by the borrower to the lender vary according
to the nature of the securities lent. For example, typical
fees in the UK market in December 2003 ranged from 6 to 100
basis points on a per annum basis for UK FTSE 100 equities,
10 to 400 basis points for UK FTSE 250 equities, and 3 to
13 basis points for non-index-linked gilts (government securities),
with most transactions being concluded at the lower end of
these ranges. Other factors such as the creditworthiness of
the borrower, the duration of the loan, and the type of collateral
will also affect the fee. Loan transactions are normally larger
than US$250,000, although specialist agencies can pool smaller
Where the lender receives cash collateral, he will reinvest
it, earning the spread between the reinvestment rate and the
agreed rebate rate which he pays to the borrower.
Repos and buy-backs
In addition to securities lending transactions, described
above, there are also the somewhat similar sale and repurchase
agreements and buy/sell backs.
Sale and repurchase agreements, or repos, involve one party
agreeing to sell securities to another against a transfer
of cash, with a simultaneous agreement to repurchase the same
or equivalent securities at a specific price on an agreed
date in the future. The resale price will reflect the original
sale price together with accrued interest at the repo rate.
Most repos are governed by a master agreement, the ISMA/TPMA43
Global Master Repurchase Agreement, or GMRA.
Buy/sell backs are similar in economic terms to repos, but
structured as a sale and simultaneous purchase of securities,
with the purchase agreed for a future settlement date. The
price of the forward purchase is typically agreed with reference
to repo rates.
Lenders and intermediaries
Because of the complexity of SBL transactions and the narrow
margins that users expect, SBL has become a volume business.
Specialised agents invest in the systems and knowhow needed
to conduct SBL operations, and then leverage their investment
by pooling the securities of a number of owners. Agents and
owners then split the revenues arising from SBL transactions.
Agents include asset managers, particularly in Europe, and
custodian banks (who can leverage their custody business and
have the advantage of being able to manage cash collateral
efficiently). There are also specialist third party agents.
There are principal intermediaries who assume principal risk,
offer credit intermediation, and take positions in the securities
they borrow. These are broker dealers, specialist intermediaries
and prime brokers. Broker dealers need to borrow securities
for market-making, to support proprietory trading, and on
behalf of clients. Prime brokers serve the needs of hedge
funds and other alternative investment vehicles, to which
they provide SBL services alongside financing, execution,
custody and reporting.
The value added by such intermediaries is to bridge the gap
in cases where the lender does not wish to take on credit
exposure to the borrower (eg a pension fund owner and a hedge
fund borrower). Principal intermediaries also take on liquidity
risk, borrowing from lenders on an open basis - ie allowing
the lender to recall the securities - and lending to borrowers
on a term basis.
Beneficial owners who have securities portfolios of sufficient
size to make securities lending worthwhile include pension
funds, insurance companies, mutual funds and endowments.
Borrowers generally borrow securities in order (a) to cover
a short position (settlement coverage, naked shorting, market
making, arbitrage), (b) to support a financing transaction
motivated by the desire to lend cash, and to transfer ownership
temporarily to the advantage of both lender and borrower (tax
arbitrage, dividend reinvestment plan arbitrage).
Settlement coverage was historically the origin of securities
lending activity. For less liquid securities such as corporate
bonds and equities with limited free float, settlement coverage
remains today a large part of borrowing demand. Borrowing
to cover settlement is vital to the settlement process. This
has led some securities depositories into the automated securities
lending business whereby customers make their securities available
to be lent by the depository automatically.
Naked shorting is the short selling of securities without
any corresponding long position. Commentators suggest that
it is a comparatively rare strategy.
Market-makers need to be able to borrow securities in order
to execute buy orders and to make tight two-way prices. They
need automated communication channels with securities lenders
in order to operate. In less liquid securities, market-makers
may need special arrangements with lenders such as guaranteed
Arbitrage involves hedged long and short positions, and often
involves securities lending. For example, convertible bond
arbitrage involves buying a convertible bond and simultaneously
selling the underlying equities short and borrowing to cover
the short sale.
Securities loan negotiation takes place between two parties
whose credit departments have approved one another. Traditionally,
negotiation took place on the phone, but nowadays the negotiation
process may be automated, either bilaterally or multilaterally
via an electronic platform such as EquiLend (see below), or
SecFinex which offers electronic SBL services in Europe.
Following negotiation, the transaction must be confirmed
by written or electronic means if possible on the day of the
trade. The details include, contract and settlement dates,
detail of loaned securities, identities of lender and borrower,
acceptable collateral and margin percentage, term and rates,
bank and settlement account details of lender and borrower.
Material changes during the period of the transaction, such
as collateral substitution, are agreed between the parties
as they occur. The loan may be for a fixed term or, more usually,
open or "at call". Lenders can sell securities which
are on open loan because they can usually recall the securities
from the borrower within the market settlement period.
Where the borrower expects to need securities at a future
date, the lender may put the securities on hold for him ("icing"
the securities). The lender receives no fee for icing, but
if another borrower makes a firm bid for the securities, the
first borrower has 30 minutes to decide whether to take the
securities at that time or release them.
Securities lenders need to settle in a shorter time than
the settlement period of the market concerned. Settlement
is normally through the lender's custodian bank, with which
the lender will have agreed a schedule of settlement times.
In most settlement systems, securities loans are settled free
of payment, with collateral taken separately, often through
another system and even in another country or time zone. This
gives rise to "daylight exposure" during the period
when the lent securities have been delivered but the collateral
has not yet been received. To avoid this, lenders will often
ask for collateral to be delivered in advance, ie before they
release the lent securities.
Where redelivery fails, lenders would normally recover costs
such as interest arising or the expense of buying the securities
in on the open market. To minimise the impact of fails, consideration
can be given to breaking a large transaction into smaller
parts so that a partial failure does not impact the whole
Under securities lending, the lender is to be "made
whole" for any corporate event, such as dividend or bonus
issue - by the borrower making equivalent payments to the
lender, eg by manufacture of dividends. However, the right
to vote cannot be manufactured.
Lenders manage risk primarily through the use of collateral
and netting. Many of the large losses related to securities
lending over the years have been related to the reinvestment
of cash collateral. Taking securities as collateral avoids
reinvestment risk, however the lender is exposed to the risk
of incorrect pricing of the securities, and to liquidity risk
when he seeks to realise his collateral. There is also the
risk of incongruency of collateral and lent portfolios, ie
the lent securities may rise in price while the collateral
Given that participants will often have numerous transactions
outstanding with a counterpart, netting is important. The
master agreement will provide for netting of obligations in
case of default, thus saving participants from the need to
settle each of their transactions gross. However, care is
needed to ensure the efficacy of netting provisions in the
jurisdictions in which the SBL transactions take place.
2. Securities borrowing and lending in
Since the introduction of the exemption from stamp duty for
properly executed SBL transactions, Hong Kong has emerged
as a regional SBL centre. The Pan-Asian Securities Lending
Association (PASLA) was founded in Hong Kong in 1995, and
now has 33 members, 16 of whom are represented in Hong Kong.
Although Japan is the largest regional SBL market and the
oldest-established, since Hong Kong is the regional headquarters
for many financial firms, it is easy for borrowers and lenders
to meet there and resolve any issues; moreover, the credibility
of counterparties in Hong Kong is high.
The SBL business in Hong Kong has a similar profile to the
business globally, as described in the preceding section.
The major Hong Kong-based agent lenders operate their SBL
business through a 24-hour global booking system via their
offices in different time zones. They pool securities from
investors such as US or European pension funds, and insurance
companies, and lend to borrowers who are mainly the major
brokers and investment banks. These parties in turn may be
borrowing for their own account, or more often on behalf of
their clients, such as hedge funds or smaller brokers, on
whose behalf they accept counterparty risk. Thus smaller borrowers,
to whom the lenders' fund clients would not want to be exposed,
can nonetheless participate in SBL transactions. Some lenders
take collateral only in US dollars.
Fees for a large deal are typically around 25 basis points,
the agent lender and the client (stock owner) sharing the
fee in perhaps a 7:3 ratio. Deals are rarely below US$100,000,
but sometimes smaller deals will be done in less liquid stock
(ie for which there is little available for lending) at higher
The Hong Kong regulatory regime, which includes restrictions
on short selling (including criminal sanctions), and stamp
duty for which exemption has to be claimed by filing the stock
lending agreement with the Inland Revenue Department, is not
particularly convenient for the industry, but the players
have generally adapted to it.
3. HKSCC's Stock Borrowing Programme for
In 1999, HKSCC introduced a facility whereby it can borrow
stock from participants to fulfil HKSCC's settlement obligation
to participants with long continuous net settlement (CNS)
positions. However, this facility is not much used. It is
understood that this is because the settlement efficiency
of the Central Clearing and Settlement System (CCASS) on T+2
is already over 99 per cent, hence demand for stock loans
to cover unsettled long positions is low. The loan period
is also very short, one to two days, hence the related lending
fee would be negligible in relation to the administrative
work involved. A fixed borrowing fee of 4 per cent on a per
annum basis is paid by HKSCC to the lender. HKSCC does not
pass through the collateral to the lender. These latter arrangements
may not be very attractive to some Participants.
In accordance with CCASS Rule 3503, HKSCC may at any time
effect a compulsory stock borrowing transaction in order to
(i) meet the aggregate of HKSCC's delivery obligations to
participants which have not been satisfied as a result of
a participant's failure to deliver eligible securities to
HKSCC on T+2, or (ii) replace HKSCC's stock borrowing under
any transaction under (i). Such transactions are governed
by the Compulsory Stock Borrowing and Lending Regulations
which comprise Appendix 6 of the CCASS Operational Procedures.
In accordance with the Compulsory Stock Borrowing and Lending
Regulations, CCASS Participants which wish to lend their securities
in return for income deposit the securities into their stock
lending account, whereupon they become available for lending
to HKSCC. Once a borrowing request is matched with the eligible
securities in the stock lending account, the relevant securities
are debited from that Participant's stock lending account
and credited to HKSCC's account in CCASS. The loan has no
fixed term, but can be recalled by the lender at any time
with five business days' notice.
4. Overseas experience of centralised securities
borrowing & lending services
A number of overseas central securities depositories have
introduced securities borrowing and lending services, not
only to cover settlement failure, as in Hong Kong, but in
some cases also for strategic purposes.
In some less mature markets, such as Korea, the depository
has managed to capture a major share of the local SBL market.
However, in more mature markets, such as Singapore, the larger
industry players are already catered for. These players mostly
have global operations and seek counterparties who have a
global offering; moreover, they have global integrated systems
and standard practices. The local depository, which only has
local stocks to offer and cannot necessarily conform with
global practice, may not be an attractive counterparty. Hence
in mature markets the depository may obtain at best only a
marginal segment of smaller players. Nonetheless, in some
very large markets, depositories with a sophisticated offering
such as Crestco or Euroclear appear to have developed a successful
Selected examples of centralised SBL services are described
Singapore Exchange (SGX)
The main objective of SGX's SBL programme is to improve liquidity
of the stocks traded on the SGX. The programme was launched
in January 2002 by SGX's subsidiary, Central Depository (CDP).
The account structure of CDP is the foundation of the SBL
programme. The stocks from a large number of direct securities
accounts provide a steady supply to the lending pool.
CDP acts as the principal to both borrowers and lenders.
The borrowers and lenders remain mutually anonymous. CDP collects
collateral from the borrowers but does not pass it on the
lenders. For cash collateral provided by the borrowers, CDP
will pass back the interest to them at a lower rate.
The direct securities account holders are the major lenders.
Currently, about 6,000 direct securities account holders have
signed up to lend out their stocks. They can specify to lend
out (1) all stocks, (2) specific stocks only, or (3) specific
stocks with maximum quantities only. The stocks remain in
the accounts of the potential lenders. CDP uses a separate
system to keep track of the lending pool. Stock movements
are only required for executed SBL loans and recalls.
SGX brokers are the major borrowers. A majority of them have
participated in the programme. Most of their loans are on
second- and third-liners for retail trades. The loan sizes
are usually small with average of 60,000 to 70,000 shares
per transaction. The custodians seldom participate because
they have their own lending desks and are not interested in
the small deals.
The 200 stocks with the highest transaction volumes are eligible
for the programme, and the minimum borrowing size is 1,000
units. Fees are fixed - borrowers pay 6 per cent and lenders
get 4 per cent. CDP has implemented various risks management
measures on the price risks and concentration risks for the
outstanding loans and the collateral. However, it is up to
the borrowing brokers to monitor the risks of their clients.
The transaction volume of the SBL programme has been low.
It is difficult to attract investors to participate. Borrowers
see the programme as a complement to the OTC market. They
will usually obtain large loans for blue chips through the
OTC market and small loans or loans for second- or third-liners
from CDP. It is difficult for CDP to compete with the OTC
market on the pricing and services. Short-selling activity
is not robust in Singapore, which is a further reason for
the low demand for SBL loans.
Crestco is the central securities depository for the UK securities
market and Irish equities. Through the CREST system, Crestco
provides electronic real-time settlement for corporate and
government securities, particularly those traded on the London
Stock Exchange (LSE), Irish Stock Exchange and virt-x. In
2002, Crestco was merged with Euroclear.
CREST provides stock lending and collateral transfer functions
through three services - Stock Loan, Delivery By Value (DBV)
and, since 2001, Repo. The functionality allows two parties
to transact with each other as principal or agent; CREST itself
is never a counterparty to any loan or repo transaction. Crestco
does not mandate that stock loan transactions be used for
any particular purpose. Stock loans may be used for the following
activities, among others: fails management, short selling,
dividend arbitrage and equity financing. One advantage of
the CREST system is that since collateral is available within
the system, loans can be settled against cash intra-day and
the cash can be exchanged if desired for a package of DBV
securities overnight. During April 2004, CREST had a daily
average of GBP65 billion of open lending equities, and GBP76
billion of open lending gilts (UK Government securities).
Equilend was established in the US in 2001 by a group of
major financial services firms to develop a centralised system
for securities lending. The system was launched in June 2002,
and has seen daily volumes of US$2.5 billion per day with
US$1 trillion of securities available for lending. Equilend's
sole purpose is SBL facilitation. In 2003, Equilend established
a subsidiary in London, Equilend Europe, which is authorised
by the Financial Services Authority to operate as an alternative
trading system in the UK.
The Equilend platform is an open, global, standards-based
system that enables lenders and borrowers of securities to
transact with one another via a secure hub. This removes the
need for participants to maintain point-to-point connections
with one another, and replaces manual processes with automation.
The platform is a web-based using XML standards for communication
(Equilend's Securities Lending Markup Language, SLML, a new
open-standards protocol created for the securities industry).
The Options Clearing Corporation
The Options Clearing Corporation (OCC) is the clearing house
for listed equity options in the US. In 1993, the OCC introduced
the Hedge System which allows its clearing members to borrow
and loan securities with listed options contracts and selected
exchange traded funds. The stock loan programme aims to reduce
OCC margin requirements by reflecting the real risks of their
inter-market hedged positions.
In the Hedge System, OCC clearing members can create hedge
stock loan/borrow positions. The terms and rebate of the stock
loan are negotiated between borrowers and lenders. Details
of loans are sent to the Depository Trust Company (DTC) using
special OCC codes. Cash and securities are transferred through
DTC. Members can also instruct OCC to automatically allocate
hedge positions against either equity or index stock positions
for margin offset. Each business evening, OCC marks to market
each outstanding stock loan/borrow position and reports the
information to participants daily. The transactions are guaranteed
Clearstream, part of the Deutsche Boerse Group, offers settlement
and custody services on over 150,000 bonds and equities to
the German, Luxembourg and international markets. As one service
of the custody business, global securities financing service
is provided via its Central Securities Depository and International
Clearstream offers securities lending services - including
automated securities lending and borrowing service which automatically
detects the loan requirement of a borrower and the loan supply
from the lender. Collateral of the borrower will be blocked
and pledged directly in favour of Clearstream as the guarantor.
The loan securities will then be transferred to the borrower.
The strategic securities lending (SSL) service is a pro-active
service supporting the longer-term trading strategies of borrowers.
SSL lenders and borrowers are required to open an account
in and sign agreed terms with Clearstream Banking for SSL
transactions. Borrowers have to send an enquiry to the SSL
Service Desk in London to check the availability of the securities.
Once initiated, the proposed transaction details are agreed
and confirmed by the SSL Operations Unit in Luxembourg which
will transfer the securities and collateral to the appropriate
accounts. Clearstream also provides a case-by-case lending
service. It provides collateral management services - including
tripartite repo service and tripartite securities lending
Clearstream is the second largest provider of tri-party securities
financing in the world. According to the tri-party securities
financing industry survey by Global Custodian, Clearstream
processed US$104 billion of assets daily in 2004.
Euroclear, established in 1968, is an International Central
Securities Depository based in Europe and also provides Central
Securities Depository services to a number of domestic markets
in Europe. Euroclear offers securities lending and borrowing
services through the Euroclear Bank and also through its wholly-owned
subsidiary Crestco (see above).
Euroclear Bank's securities lending service targets loan
demand to avoid settlement failures. Securities are generally
eligible for lending if regulations in the jurisdiction of
issue permit the lending and borrowing of securities. Currently,
the securities available include 32 currencies, debt in 26
markets and equities in 15 markets.
The service is an integrated component of the settlement
process. Clients must explicitly subscribe to the service
by completing various enrolment forms. Borrowers must complete
credit documentation with Euroclear Bank. There are three
types of SBL transactions: automatic instructions, opportunity
borrowing and requested recall. Lenders' positions are aggregated
into an anonymous lending pool from which securities are allocated
to borrowers on a pro rata basis. Euroclear Bank acts as the
counterparty of borrowers and lenders. Furthermore, Euroclear
Bank monitors and guarantees the return of lent securities,
related entitlements paid by issuers and payment of lending
Korea Securities Depository (KSD)
The KSD introduced SBL services in 1997. It provides intermediary
services such as trade intermediation, matching, delivery
and return, management of rights deriving from loaned securities
and collateral management.
The KSD was the first institution to offer SBL services in
Korea and thus had an advantage over other service providers.
The market has grown steadily, and in 2003, the KSD captured
a record 80 per cent share of the Korean SBL market, with
a monthly average volume of KRW538 billion (US$450 million).
The main purposes of securities borrowing include supporting
trading strategies, avoiding fails in securities delivery
and providing inventory for various financial strategies.
The KSD commenced repo agent service for foreign institutional
investors from 2000. However, the business is not very successful
because foreign investors still have many barriers to participate
the domestic repo market such as differences in language,
time and telecommunication method.
Taiwan Stock Exchange (TSEC)
The TSEC launched an SBL system on 30 June 2003. As of 15
March 2004 (about nine months after launch), 248 SBL transactions
had been conducted with transaction value of NT$27 billion
(US$800 million). The SBL system is targeted at qualified
Participants can only borrow securities for strategic trading.
According to the TSEC's Operation Rules, permissible trading
strategies include hedging, arbitraging and exercising contracts.
Before placing an order, a borrower should indicate the purpose
of the transaction and prove ownership of the derivatives
to the broker.
The TSEC provides three kinds of SBL transactions - fixed-rate
transaction, competitive auction transaction and negotiated
transaction. The exchange provides a matching system for fixed-rate
and competitive auction transactions. After matching, the
order details will be passed to the Taiwan Securities Central
Depository (TSCD), a subsidiary of the TSEC. Accordingly,
TSCD will transfer the securities from the lender account
to the borrower account. The borrower returns the securities
by notifying its securities dealer which in turn notifies
the exchange. The borrower should deposit collateral to the
exchange. For negotiated transactions, borrowers and lenders
will agree the securities, collateral, related fees and beneficial
owners of the securities. The exchange will not provide guarantee
to this type of transaction. Details of the negotiated transactions
will be sent to the exchange which will inform TSCD to process.
The SBL transactions are mainly fixed-rate transactions (57
per cent) and competitive transactions (42 per cent). Only
one per cent of transactions are negotiated transactions.
SBL facilitates a variety of transactions in the market,
and so is an important support for market liquidity. It is
a complex business with an involved transaction process. Before
executing a transaction, the borrower has to assess the creditworthiness
of the lender, and then negotiate the terms and sign an agreement
with him. The borrower then has to take delivery of the securities,
deposit collateral, deposit further collateral if called upon
to do so by the lender, make the lender whole for any dividends
or other benefits arising from the underlying securities,
and finally return borrowed securities on the due date while
at the same time taking delivery of the returned collateral.
Because of its complexity, SBL is typically conducted among
large global players who have the systems, the creditworthiness
and the specialised skills to conduct such operations. SBL
is nowadays a volume business conducted mostly at low margins
with a high level of automation. It is dominated by global
intermediaries, who aggregate the borrowing and lending demand
of their clients.
In Hong Kong, the SBL industry has been established for almost
10 years, and operates along the lines described above. The
major global lending agents are represented in Hong Kong and
conduct much of their regional lending from the territory.
Their clients are the major securities firms, which in turn
represent the borrowers such as hedge funds and second-tier
securities firms. The major players operate through global
transaction systems in accordance with international practice
on a highly competitive basis. These players occupy the market
space; there would be less room for a centralised service.
1Article prepared for October 2004 issue of Hong Kong Exchanges
and Clearing (HKEx)'s journal Exchange. Matthew Harrison and
Ada Choi are in HKEx's Research & Planning Department.
2 This section is largely based upon An Introduction to Securities
Lending, a paper commissioned by the UK Securities Lending
and Repo Committee and other bodies, © Mark C.Faulkner.
3Technology Key as Sec Lending Moves Upstream, Securities
Industry News, 24 February 2003.
4The UK-based International Securities Market Association
(ISMA) and the US-based Public Markets Association (TPMA).
5Based mainly on information gathered from the respective
institutions' websites, viewed during August and September
2004, supplemented by discussion with personnel of certain