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Preet Banerjee, B.Sc., FMA, DMS is a former stockbroker and financial advisor in Toronto. Information on this site is for entertainment purposes ONLY. Always seek individual professional advice before making any financial decisions.

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The Risks Of Securities Lending

August 5th, 2009 • Related • Filed Under
                                                         
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Yesterday’s post indicated that the reason the db x-trackers DJ Euro Stoxx 50 Index ETF was able to charge a 0.00% MER was due in part to the revenues it collects on lending out securities to short-sellers. Below is a short list of risks involved in securities lending* (taken on by the unitholder, which is important to note).

  1. Credit / Counterparty risk – the short seller defaults on returning the securities they borrowed
  2. Market risk – Adverse or abrupt movements in the underlying security’s price (which can affect the short sellers’ ability to return the security)
  3. Cash Re-investment risk – when the cash collateral is invested in something that falls in value
  4. Foreign Exchange risk – when the collateral is denominated in a different currency than the security being lent
  5. Legal risk – the enforceability of the contract between the fund and short seller, especially if the companies operate in different countries
  6. Mismatch risk – risk of differing price movement behaviour of the collateral and the securities on loan
  7. Recall risk – risk of delayed return of securities when requested by the fund
  8. Operational risk – inadequate technology or infrastructure to facilitate securities lending properly and competently
  9. Settlement risk – if the securities are not returned at the same time that the collateral is given back, there is risk borne in what is known as “daylight” exposure

It should also be noted that there are numerous controls and protocols that are in place to deal with these risks, but given that the total dollar volume of securities on loan in 2007 reached $5.5 Trillion (USD), more attention needs to be paid by regulators. Additionally, the retail investor may or not be participating in the securities lending taking place in their investment funds, but they are most certainly taking part in the risks involved.

*Source: RBC Dexia Investor Services – Demistifying Securities Lending, July 2009

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There Are 5 Responses So Far. »

  1. Comment by as on 6 August 2009:

    “Daylight” exposure?? Like a high UV index?

  2. Comment by Preet on 6 August 2009:

    @as – lol, I suppose you could use the VIX as a proxy for how badly you could get burnt by daylight exposure in this case… :)

  3. Pingback by This and That: The $10 life and more… | Canadian Capitalist on 6 August 2009:

    [...] Securities lending is a prevalent practice among ETF vendors. In this post, Preet listed the risks involved in securities lending. [...]

  4. Comment by Roy Zimmerhansl on 10 August 2009:

    This article gives a good headline listing of issues, and suggests that there “controls and protocols to deal with these risks”. For a more detailed discussion on securities lending for ETFs go to http://www.indexuniverse.com/blog/4970-etfs-and-securities-lending.html

  5. Comment by Preet on 10 August 2009:

    @Roy Zimmerhansl – thanks for the link, great article.

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