In the realm of investments and portfolio management, a Fully Paid Securities Lending Program offers an intriguing opportunity for investors. This program allows shareholders to earn additional income by lending out their fully paid securities to other market participants, typically short sellers. But as with any financial instrument or strategy, there are both advantages and disadvantages to consider. In this blog, we’ll explore the pros and cons of the Fully Paid Securities Lending Program.
Fully Paid Securities Lending Program Pros And Cons
Pros
- Additional Income Stream: The primary allure of such programs is the opportunity to earn extra income. Lenders receive a lending fee, which is a portion of the interest charged to the borrower.
- Retain Ownership Benefits: Even though you’ve lent out your securities, you still typically retain benefits like receiving dividends and retaining voting rights. The broker or lending agent often provides “payment in lieu” of dividends to the lender.
- Collateral: Borrowers provide collateral, usually cash or other securities, which typically exceeds the value of the lent securities. This acts as a safety net for the lender in case the borrower defaults.
- Low Risk: Given that the loans are over-collateralized and brokers monitor the value of the lent securities versus the collateral daily, the risk to the lender is minimal.
- Flexibility: Many programs allow you to terminate your participation or recall your securities with little to no notice, giving you flexibility with your investments.
Cons
- Tax Implications: The “payment in lieu” of dividends is not qualified as a dividend and is therefore taxed at the regular income rate instead of the potentially lower dividend rate. This can have negative tax implications for the lender.
- Opportunity Cost: If the stock price appreciates significantly while it’s out on loan, the lender might miss out on selling the stock at that high price, especially if there’s a delay in recalling the security.
- Potential for Reinvestment Risk: The cash collateral provided by borrowers will typically be reinvested by the lending agent. If this reinvestment earns less than the borrowing fee, the lender can face reinvestment risk.
- Counterparty Risk: While minimized, there’s still a risk that the borrower or the institution facilitating the lending program defaults or goes bankrupt.
- Complexity and Understanding: Not all investors fully grasp the intricacies of securities lending, which can lead to misunderstandings or mismanagement.
- Lack of Standardization: Terms and conditions can vary between brokers and lending programs, making it essential for investors to scrutinize the specifics of any program they consider.
Conclusion
Fully Paid Securities Lending Programs can provide an attractive way for investors to enhance their returns. However, as with all financial decisions, it’s crucial to weigh the potential benefits against the risks. Before participating, it’s advisable to consult with a financial advisor or tax professional to understand the program’s nuances and the potential impact on one’s individual situation.
