Murray Bender: RBC Investor & Treasury Services is pleased to present insights on the future of asset and payment services across the globe. Today’s podcast features Kyle Kolasingh, Associate Director of Securities Finance at RBC Investor & Treasury Services, addressing some of the concerns that beneficial owners may have about securities lending. Thanks for joining us, Kyle.
Kyle Kolasingh: I’m pleased to be here today, Murray.
Murray Bender: To start, Kyle, can you provide a simple definition of securities lending for our listeners?
Kyle Kolasingh: Sure. In its simplest form, securities lending is a portfolio optimizing tool used by beneficial owners to earn incremental revenue on their long assets in a relatively low-risk setting. It is essentially the act of temporarily transferring or loaning an exchange-traded asset, such as bonds, equities, or ETFs, to another party for a fee. Every day, beneficial owners, such as sovereign wealth funds, central banks, asset owners, and asset managers, participate in a $30 trillion market, realizing on the benefits of securities lending by adding additional returns to their portfolios.
Now I say securities lending is a low-risk investment tool because transactions are always collateralized and usually indemnified by agent lenders. That indemnification covers collateral shortfall in the event of a borrower default scenario. Now because of this fact, on a risk-adjusted basis, the returns can be quite significant in comparison to other means of enhancing returns within one’s portfolio. Securities lending has been in practice for over 50 years and is an important aspect of the global financial system. This is something which is often overlooked or otherwise unknown.
Murray Bender: So, Kyle, you mentioned the importance of securities lending to the financial system. What impact does securities lending have on the financial markets?
Kyle Kolasingh: The impact of securities lending on the global financial ecosystem is actually quite far-reaching. The industry plays a vital role in promoting liquidity, supporting financing and collateral optimization strategies, and enhancing overall price discovery. And this is really just to name a few. Central banks globally, such as the Bank of England and the Bank of Canada, have acknowledged the importance of securities lending in financial markets, especially when it comes to increasing market liquidity and efficiency.
In periods of market volatility, as we saw in 2020, the securities lending market was vital in supporting the broader financial market with liquidity. At its core, securities lending enables the effective buying and selling of securities every day. Market makers will borrow assets in the lending market to ensure their inventory can meet investor demand.
Also, the securities lending market allows investors to borrow securities to be used in various financing strategies. An example would be borrowing securities to be used as collateral in the repo market to then raise cash. Another significant impact to the financial markets is the ability of institutional investors to borrow securities to execute on collateral optimization strategies. This is used for swaps or other structured derivative products.
At the end of the day, the impact is numerous and these are only just a few examples of how securities lending contributes to the financial system, and ultimately benefits investors globally.
Murray Bender: How do you address some of the concerns that beneficial owners may have around short selling, which has been in the news lately, and is often associated with securities lending?
Kyle Kolasingh: Yes. Those concerns are understandable. Historically, short selling has suffered from negative press and media coverage rather than highlighting how it can support the efficient operating of financial markets, benefitting all stakeholders collectively.
Price discovery is important. As with most aspects of life, the ability for both sides to be expressed effectively can be mutually beneficial. In this context, when both sides of the market are allowed to effectively execute the mechanism of price discovery, it is much more efficient.
This is another contributing facet to the healthy functioning of the financial system acknowledged by central banks around the world. More recently, there have also been numerous discussions on how short selling benefits the financial community by uncovering problematic companies who may be misleading investors, or in some cases even uncovering fraud. In this lens, short selling can facilitate more efficiently the incorporation of negative information into market prices, this too contributing to a much more resilient system overall.
That said, it’s important to note that securities lending does in fact go beyond short selling, and includes other market facilities, such as market making, funding, prime brokerage, and collateral optimization. In reality, short selling is not the most significant driver of activity in today’s lending market.
Murray Bender: How do you accommodate the potential requirement of beneficial owners to incorporate environmental, social and governance factors into their securities lending programs?
Kyle Kolasingh: ESG is undeniably an increasingly important aspect to the financial community today. And it can be effectively implemented in various forms and fashions, regardless if a portfolio lends or not.
In fact, the processes and protocols in place to accommodate such mandates have existed within securities lending for some time now. It all boils down to the ability to tailor and structure a securities lending program to meet a beneficial owner’s investment methodology.
For example, with regards to governance or corporate engagement, the ability to exercise a proxy vote is not inhibited by securities lending. It does, however, require consideration and discussion with your agent lender. Beneficial owners typically can take two courses of action: either selectively requesting a recall of a lent position to vote or mandating their agent lender to monitor for events in the market, thereby proactively ensuring positions are recalled.
The latter is usually taken when all votes are exercised, and it’s quite limited in practice. Essentially beneficial owners do not need to give up their proxy vote when lending securities. Another aspect can be looking at collateral selection. In a similar fashion, securities lending programs can be tailored to accommodate collateral exceptions, if that element exists within one’s ESG mandate.
But these examples are at a micro level. If you take a step back and look at the broader picture, one can argue that securities lending is a proponent of ESG by promoting sustainable capital markets. And this is through some of the impacts previously mentioned: liquidity, price discovery, which has been broadly acknowledged in supporting the healthy functioning of financial markets today.
Simply put, ESG and securities lending can absolutely coexist and they are not mutually exclusive.
Murray Bender: Finally, Kyle, as an agent lender, what do you say to beneficial owners who may be apprehensive about lending their securities?
Kyle Kolasingh: The apprehension is understandable, especially when it may be a lesser understood product. But like any area of the investment spectrum, it is all about understanding how securities lending works and how the associated risks are effectively managed.
Ultimately, securities lending works in the background of one’s portfolio and can be structured to coexist with various investment strategies. Securities lending is also not a one-size-fits-all approach. It can be scaled, it can be tailored, and it can be structured to suit. Understanding the risks, what they are, how they are mitigated, and managed on a daily basis, is key as well.
I would also remind beneficial owners that securities lending is a mature, resilient market practice that has persisted through macroeconomic events, such as credit shocks, sovereign bond crisis, and now the pandemic. And lastly, I would remind beneficial owners that your agent lenders should be your partner and work with you to ensure you not only understand the benefits but you understand the nuances and the results of a securities lending program. And also, to work with you in consultation, to craft a program that suits your risk appetite and your investment goals.
Murray Bender: Thanks for helping to demystify this whole area of securities lending, Kyle. We really appreciate your time.
Kyle Kolasingh: Thank you for the opportunity, Murray.
Murray Bender: Today’s podcast has been brought to you by RBC Investor & Treasury Services. We hope you found it useful. For additional insights on the future of asset and payment services, including our previous podcasts, visit rbcits.com/insights. I’m Murray Bender. Thanks for listening.
This content is provided for general information and does not constitute financial, tax, legal, or accounting advice, and should not be relied upon in that regard. Neither RBC Investor & Treasury Services nor its affiliates accepts any liability for loss or damage arising from use of the information in this podcast.