Everyone knows that hedge funds may short securities to enhance their returns. This is the simple act of borrowing them and selling them at a higher price. Then buying them back at a lower price (hopefully). Where do the prime brokers get the securities to lend to the funds? They have securities lending desks; can lend out securities in custody from other funds or even retail accounts. Let's look at the desk. It negotiates with investors to have access to its holdings. Why would an institutional investor do this? They can generate extra revenue for better returns or to offset expenses with their bank. The investor should consider the following:
There are five program structures: agency discretionary, client directed, auctions, exclusives and principal. Agency discretionary is where the investor uses a third party (like a prime broker) to handle the details such as sourcing transactions and record-keeping. Client directed is when the investor handle transactions on its own and using its custodian to facilitate loans and/of cash collateral transactions. The last three are agreements with a borrower to give access to their portfolio for a fee, price or period of time.
The investor has to decide on the loan type. The most common loan is open where the loan can be closed at any time and the fee renegotiated. The term loan is for a specific period of time with a fixed fee. A general collateral loan is used for securities that are not popular with the borrowing funds and a specials loans is used for securities with a high demand i.e. those with a high short interest.
The investor has to set parameters for is lending program. An example would be setting a limit on the amount of securities on loan to borrower(s) as a percentage of the portfolio or market value. Restrictions can be made on the security or client level.
The investor decides what types of collateral to take from the borrower. They may take other securities or cash. The decision should take into account the size of the lending program, liquidity, ownership/control, transparency and risk levels. They can place the collateral in a separate managed account, commingled account with other lenders, external investment account with another fund manager or "self-invest" where the investor controls the assets.
The source for this article can be accessed here.
Informative post. Thank you. A bank is a business, and like any other business they are in it for a profit. Why provide fixed rates to customers? To make a profit of course. They do this by forming an opinion of the interest rate cycle. If interest rates are trending up, banks will be hesitant to offer fixed rates for a long period of time as they could land up out of the money.
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