Securities lending is becoming a popular way for investors in Singapore to earn extra revenue with their existing assets. As an individual investor, becoming a securities lender in the city may be more challenging compared to institutional investors, as it is an activity that requires a significant amount of capital and operational infrastructure. Nevertheless, there are ways that individual investors can participate in securities lending.
In this article, we look at what securities lending is, how it works, and its appeal to investors. We will also explain some of the risks involved in the activity and present some ways you can minimise them. If you are interested in securities lending in Singapore, this will provide a good foundation of knowledge on your journey to becoming a securities lender.
What is securities lending?
Securities lending is a process by which investors lend securities, such as stocks or bonds, to other investors or financial institutions for a period in exchange for collateral. The borrower agrees to return the securities to the lender later, along with any agreed-upon and accrued interest or fee.
How does securities lending work?
Securities lending typically works when a market participant wants to borrow securities – either to short sell or to settle a trade. Some assets are in higher demand than others in the market, and lenders will have an easier time loaning them out.
Brokers, custodian banks, and securities lending agents facilitate the lending process, and they match lenders to borrowers. They negotiate the terms of the loan, including the interest fee, custody fee, and other operational charges to be paid by the borrower to the lender.
The borrower borrows the securities by providing collateral, such as cash or other securities, to the lender. This collateral is typically worth more than the value of the borrowed securities to minimise the chances of the borrower defaulting on the loan. The facilitator then transfers the securities to the borrower’s account, while the lender maintains legal ownership of the securities.
The borrower can then use the borrowed securities for a specified period as outlined in their contract terms, and this typically ranges from a few days to a few months. After this time, the borrower pays an interest or a fee to the lender, and the lender returns the collateral to the borrower.
Is securities lending legal in Singapore?
Securities lending is legal in Singapore. The Monetary Authority of Singapore (MAS) is the country’s central bank and financial regulator, and it permits securities lending activities in Singapore under certain conditions. More details can be found on their official website, which updates regularly.
What is the appeal of being a securities lender?
There are many benefits of being a securities lender, including the potential for profit which can lead to additional income, the contribution to market efficiency, risk management, and having an improved portfolio performance. Let’s go through each one in turn.
One of the primary benefits of being a securities lender is the ability to generate additional income should the asset be in high demand from market participants. By lending out securities to other investors, lenders can earn an interest, which can supplement their investment returns.
Contribution to market efficiency
Lenders can also contribute to market efficiency by improving it with securities lending. When they loan their securities, they facilitate short selling and other trading activities. Short selling, in particular, can help identify overvalued securities and prevent market bubbles from forming.
During times of market downturn, securities lenders can choose to loan the security and earn income on it while waiting for market conditions to improve. This can help them reduce the losses they incur while they ride out market uncertainties.
Improved portfolio performance
Finally, securities lending can improve a trader’s overall portfolio performance when a trader decides to loan out securities they are not currently using. This is because other market participants can put those securities into use and generate revenue. This can improve the lender’s overall portfolio performance.
What are the risks involved in securities lending?
Nevertheless, there are risks involved in securities trading, and they include counterparty risk, collateral risk, market risk, and legal and regulatory risk. Below, we look at them in more detail and provide tips on how you can minimise these risks.
For every asset you lend, there will be a borrower, who is your counterparty. Counterparty risk is the risk of the borrower defaulting on the loan and failing to return the securities to the lender. When this happens, the lender will lose their securities. To lower the chances of this happening, you should make sure the borrower always provides a collateral that can cover the value of the borrowed securities.
Collateral risk is the risk that the value of the collateral provided by the borrower declines in value, leading to it not being able to cover the value of the borrowed securities. Collateral risk is present usually for non-cash collateral, such as other forms of securities, as they can decline in value depending on market conditions. To minimise this risk, you should accept collateral in the form of cash, or you should carefully consider the securities presented as collateral by staying up to date with the market conditions of the assets.
Market risk is the risk of the market fluctuating, causing the value of the securities to decline during the loan period. If the value of the securities falls, the borrower may not be able to provide sufficient collateral to cover the loss. This results in a loss for the lender too. To limit market risk, you should keep a close eye on the market of the securities you loan, and you should diversify the securities you loan so that one market’s downturn will not cause you to lose a large sum of money.
Legal and regulatory risk
Finally, the MAS regulates securities lending in Singapore. Changes to regulations they pass may impact the legality and profitability of securities lending activities. Therefore, you should always keep an eye on the local regulations and laws to ensure that you understand what you are doing.
How to be a securities lender in Singapore
If you are an individual investor looking to become a securities lender in Singapore, you can do so by joining a lending programme facilitated by a broker, a custodian bank, or through a securities lending agent. One of the most common ways to do this is through a broker, where you can loan out your existing assets in an investment account to earn extra income.
Working with a broker
As an individual investor, you can open an account with a broker that offers securities lending. When you fulfil their minimum account balance requirements and other eligibility criteria, you will be able to participate in the scheme should you sign up for it. Once you activate your account, you can choose which securities you want to loan depending on its demand from market participants. When you work with a broker, you will not need to have a large amount of capital, as your broker will likely pool your assets together with those of their other clients.