Question

when lending and burrowing meet together , why collateral agreement between the two become importance?

Answer 1

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Securities borrowing and lending is growing globally and in the Hong Kong market. It is an institutional business, requiring sophisticated systems and expertise. Some overseas clearing houses provide centralised securities lending services, but in Hong Kong there is less room for a centralised service.

Introduction

There has been renewed discussion in the Hong Kong market recently on the possibility of expanding the securities borrowing and lending (SBL) facility provided by Hong Kong Securities Clearing Company (HKSCC), a subsidiary of HKEx. However, commentators have differing perceptions of the value of such service, and indeed different understandings of what SBL entails. This article seeks to clarify some of these perceptions.

The article firstly describes SBL, as practiced in international markets and in Hong Kong. It summarises the experience of HKEx in operating a stock borrowing programme for settlement coverage. The article also considers the experience of overseas clearing houses and other institutions in providing centralised SBL services. Finally, the relevance of international experience to Hong Kong is discussed.

1. What is securities borrowing and lending2 ?

Securities lending is the temporary transfer of securities on a collateralised basis. In many markets it is an important activity, contributing to greater liquidity, narrower spreads and improved risk management. Most SBL activity takes place on the over-the-counter (OTC) market, hence statistics on volumes are not readily available. However, it is believed that the balance of securities on loan globally exceeds US$1.7 trillion, representing 10 to 12 per cent of lendable assets, and that lending activities generate an annual US$3.2 billion of revenue for lenders and agents3 .

Most SBL activity is between large sophisticated institutions. The institutions follow conventions of practice that have developed over the years and are now embodied in codes such as the Stock Borrowing and Lending Code, developed by the UK Securities Lending and Repo Committee. The International Securities Lending Association has developed standard market agreements, such as the Global Master Securities Lending Agreement, or GMSLA.

Securities lending

"Securities lending" is a misleading term because in legal terms the securities are not actually lent. In fact, the securities are sold to the "borrower" under an agreement for subsequent reacquisition of equivalent securities. The original securities may be sold onward by the borrower to third parties. Hence, absolute title passes over both the securities lent and the collateral received. The economic benefits associated with ownership such as dividends belong in the first place to the borrower (who is the legal owner), but are "manufactured" back to the lender by the borrower making equivalent payments to him. The lender surrenders the rights of ownership such as voting rights. However, if the lender wishes to vote on securities on loan, he has the contractual right to recall equivalent securities from the borrower to do so.

In jurisdictions with stamp duty, such as Hong Kong and the UK, there are provisions in the legislation to exempt SBL transactions from such duty.

Most SBL transactions are against collateral, which can be in the form of cash, securities or other assets. The eligible collateral will be agreed between the parties at the outset, including the initial margin, the maintenance margin, and concentration limits (ie to ensure that the collateral can be liquidated in need). The collateral is often held by a Tri Party Agent, to whom the borrower pays a fee. This agent, usually a large custodian bank or international central securities depository, will receive the eligible collateral from the borrower and hold it to the account of the lender. The Tri Party Agent will mark the collateral to market, distributing the information to lender and borrower.

SBL fees paid by the borrower to the lender vary according to the
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