The Role of Securities Lending in Well-Functioning Markets

Abstract

Securities lending markets contribute to well-functioning markets in important ways. The main vector for this contribution is that lending markets aid in efficient price discovery for assets. Asymmetries in the ability of investors to express opinions on the value of assets, in particular for low valuations, are reduced. This is particularly relevant for assets where breadth of ownership is limited, the case of the current environment. We argue that an asset owner’s stock lending activities are the result of an interplay between three separate objectives – contributing to wellfunctioning markets through an efficient stock lending market, generating income from the portfolio inventory, and ensuring that the relationship with corporates and exercising voting rights as a responsible investor is maintained. In this note, we describe how we approach this interplay of objectives as a large, long-term investor. We first analyse how securities lending markets help in price discovery. We then consider the incentive structures and risks for stock borrowers, and highlight the important role that regulatory policy plays in that incentive structure. We conclude with a discussion of our approach to managing the lender’s separate objectives.