Securities Lending: Generating Income From Your Investment Portfolio

Securities lending is a transaction in which the owner of shares or bonds temporarily transfers them to a borrower — typically a short seller or broker-dealer — in return for collateral and a lending fee. The lender continues to receive economic benefit equivalent to any income paid by the securities (dividends or coupon), and retains the right to recall the securities at short notice. For institutional investors and, increasingly, for sophisticated individuals through fund vehicles, securities lending generates a genuine incremental return from assets that would otherwise sit idle.

Why Borrowers Want Your Securities

The primary driver of securities lending demand is short selling: an investor who believes a security will fall in price must first borrow it before selling it short, then buy it back later to return it. To borrow the security, the short seller pays a lending fee to the securities lender.

Other motivations include:

• Settlement: failing to deliver: If a market participant has sold securities it cannot deliver on the settlement date, it may borrow the security to make delivery, returning it once its own stock arrives.
• Regulatory and collateral purposes: Some financial institutions borrow high-quality government bonds to use as collateral for other transactions, such as repurchase agreements or derivatives margining.

The demand for specific securities varies considerably. Heavily shorted stocks — those targeted by short sellers — command significantly higher lending fees than securities with low borrowing demand.

Lending Fee Economics

Securities lending fees are driven by supply and demand for the specific security:

• General collateral (GC) securities: Blue-chip shares and government bonds for which there is broad supply available command very low fees — typically 0.05–0.1% per annum.
• Warm securities: Mid-cap stocks or those with moderate short interest command fees of 0.1–1% per annum.
• Special securities: Heavily shorted stocks, stocks subject to takeover speculation, or thinly traded securities can command fees of 1–10% or even higher per annum. In extreme cases (GameStop in early 2021, for example), certain stocks briefly commanded borrow rates in excess of 100% annualised.

The average fee across a diversified equity portfolio is typically in the range of 0.05–0.5% per annum, depending on the composition and the demand for short selling in the securities held.

The Custodian Bank Intermediary Model

In most securities lending programmes, the lender does not deal directly with the short seller. Instead:

1. A custodian bank (such as State Street, BNY Mellon, J.P. Morgan, or Northern Trust) acts as the lending agent.
2. The custodian matches available securities against borrower demand from its network of broker-dealer clients.
3. The custodian receives the gross lending fee and retains a share (typically 15–30%) as its compensation, passing the remainder to the asset owner.

This intermediary structure means the lender does not bear direct counterparty risk against the borrower — the custodian and the collateral arrangements provide multiple layers of protection.

Collateral Arrangements

Every securities loan is secured by collateral posted by the borrower, typically valued at 102–105% of the market value of the securities lent. This overcollateralisation provides a buffer against borrower default.

Collateral types accepted include:

• Cash (most common in the US): Cash collateral is reinvested in short-term money market instruments, generating additional income (the "reinvestment spread"). Cash collateral programmes require careful management — reinvesting in instruments that are too long-duration or too credit-risky has historically caused losses in some programmes.
• Government bonds: High-quality sovereign bonds (gilts, US Treasuries, German Bunds) are the most common non-cash collateral in European markets. No reinvestment risk is involved; the income is solely from the lending fee.
• Letters of credit: Less common; used in some institutional arrangements.
• Other securities: Some programmes accept equities as collateral, though this requires careful correlation analysis.

Rehypothecation Risk

Rehypothecation refers to the lender's right to use the collateral it has received for its own purposes. In cash collateral programmes, the custodian typically reinvests the cash — which is a form of rehypothecation. In non-cash collateral programmes, whether the lender can use the collateral itself is governed by the specific securities lending agreement.

Rehypothecation introduces counterparty credit risk: if the custodian or reinvestment vehicle defaults while holding the collateral, recovering the original securities or their equivalent may be complex and time-consuming. Following the Lehman Brothers collapse in 2008 — in which rehypothecated collateral became entangled in the insolvency process — market practice tightened significantly, with many programmes moving to segregated collateral accounts.

Investors in securities lending programmes should understand whether collateral is segregated or subject to rehypothecation, and what happens in the event of a custodian failure.

Recall Rights

The lender retains the right to recall securities at short notice — typically one to three business days. If you decide to sell a security currently on loan, the custodian will recall it so that delivery can be made to the buyer.

In practice, most recall requests are fulfilled without difficulty — the borrower either returns the securities promptly or sources them elsewhere. However, in very heavily shorted stocks where borrow supply is tight, recall can take longer, potentially delaying settlement of a sale. This is a relatively rare occurrence but one that investors should be aware of.

Dividends: Tax Complication

When securities are on loan during an ex-dividend date, the legal ownership of the shares has temporarily transferred to the borrower. The borrower receives the actual dividend; they are contractually obliged to pay the lender an equivalent "manufactured dividend" (also called a dividend equivalent payment).

The manufactured dividend is economically identical to the actual dividend — the lender receives the same amount. However, the tax treatment may differ:

• Actual dividends from UK companies are taxed under dividend tax rules (with the £500 dividend allowance for 2026/27, then 8.75% at basic rate, 33.75% at higher rate, or 39.35% at additional rate).
• Manufactured dividend payments are treated as ordinary income by HMRC rather than as dividends — meaning they do not benefit from the dividend allowance and are subject to income tax at marginal rates.

This distinction can meaningfully affect the net return from securities lending for higher-rate and additional-rate taxpayers, particularly on large equity portfolios with substantial dividend income. In ISA or SIPP wrappers, this distinction is irrelevant.

Securities Lending in ETFs: iShares and Beyond

Most large ETF providers engage in securities lending within their funds, using the incremental income to reduce fund costs and improve tracking difference (the gap between the ETF's performance and its benchmark).

BlackRock iShares, for example, is one of the world's largest securities lending agents through its ETF range. iShares ETFs lend up to 100% of assets within UCITS constraints (though in practice lending levels are lower), with the income split 62.5% to the fund and 37.5% retained by BlackRock as lending agent. This income reduces the effective cost of holding the ETF, contributing to iShares' competitive total expense ratios.

Investors in ETFs do not bear the securities lending risk directly — it sits within the fund — but they should understand that the fund's risk profile includes this activity. ETF providers publish transparency reports detailing lending levels, collateral types, and income generated.

Under UCITS regulations, collateral accepted in securities lending must meet quality standards: high liquidity, low correlation with the borrower (counterparty), and sufficient diversification. Cash collateral must be reinvested in specified money market instruments.

Individual Portfolio Lending Programmes

Some prime brokers and custodians offer securities lending programmes directly to HNW individuals holding significant portfolios (typically £5m+ in securities). Under these arrangements, the investor's own custody account is enrolled in a lending programme, with income credited directly.

Key questions for investors considering direct participation:

• What percentage of the lending income is shared with the investor (vs retained by the custodian)?
• What collateral types are accepted and how is it held?
• What are the tax implications of manufactured dividend receipts in your specific circumstances?
• What protections apply in the event of a custodian failure?

Securities lending involves risks including counterparty default, collateral valuation risk, and tax treatment differences for manufactured dividend payments. This guide is for informational purposes only and does not constitute financial or tax advice. The value of investments can fall as well as rise. Tax rules are subject to change; seek qualified professional advice for your specific circumstances.

How Global Investments Can Help

Global Investments can advise HNW investors on whether participation in a securities lending programme is appropriate for their portfolio and tax circumstances. We can assess the economics of specific lending programmes, including the income share, collateral terms, and risks relative to alternatives, and provide guidance on how to structure lending activities to optimise the net outcome. Contact our investment team to discuss securities lending as an element of your portfolio income strategy.