I can’t seem to remember the term for this operation… basically, you give your broker access to the stocks you have long when a short seller is looking to borrow the same stocks to short. The short seller pays an interest rate to borrow the stocks (usually less than 1% for liquid ones) and you earn some of the borrowing cost.
I suppose there’s a risk in doing this as well… either you can no longer exit your positions at will or the borrower could default but I’m not sure. Anyone know the term for this?
As igor555 said, you’re lending your stock through your margin account to a potential short seller. However, the cost of borrow / negative rebate goes to your broker, not to you. That is how brokers make money. It’s also in the margin agreement. http://www.investopedia.com/ask/answers/05/shortsalebenefit.asp
If at some point you lent out shares but want to sell the underlying, you can contact your broker and they’ll “give” you back shares from inventory, and then you can sell.
Is the term you’re looking for Securities Lending?
…doesn’t have to be a margin account, works with cash accounts too. Your broker will take shares you’ve fully paid for and lend them out. Most brokers should/will share the interest earned on the loan with you but may charge a fee or profit split for the service. Specifics will vary based on broker and what you agree to.
There are desks specifically dedicated to these kinds of trades from the brokerage side.
Occasionally on heavily shorted issues, the brokerage firm may be willing to share some of that rebate with you. So like if cost of borrow is 40% and they can’t pull together enough borrow on their own, they might reach out to you if you have a bunch of stock to lend and offer to give you the 20% rebate. But in most cases, they keep everything so you don’t get anything for lending out your shares. As STL noted, unless borrow is so tight, it probably happens all the time and you just don’t know it.
Interestingly for 2013, I noticed on my 1099 from Interactive Brokers a small, ~$40, other income line item which I think is this payment. The explanation for this box was Shows substitute payments in lieu of dividends or tax-exempt interest received by your broker on your behalf as a result of a loan of your securities
Whether and how it happens depends more on the specific agreement with your broker rather than borrow availability. Just check with your broker, they’ll tell you the arrangement.
There are other implications - might not be loaned out in a retirement account, giving up voting rights/dividends, etc.
My understanding was that brokers retained the right to lend out your shares without your knowledge and keep the interest, but assume the risk of getting those shares back to you if you call them to sell.
Presumably not all brokers are like that and you can negotiate alternatives with them if you have an attractive enough account size and trading volume.
Give me some rope here, but what if your broker goes bust after lending your shares to someone who also went bust ?
Isn’t there an additional credit risk for you than compared with a brokerage arrangement where no lending of your securities is involved and you remain technically in possession of your securities the whole time ?
I don’t know for sure, but I think you would be close to first in line in a liquidation, like employees and suppliers. Investing in securities entails risk. Presumably the rights are burried in the fine print of the broker and/or custodian agreement, and they will argue that you get cheaper commissions (even if by only $0.01) by implicitly giving them this right.
Again, account rules may vary by broker and client, but I suspect that lending out client shares without their knowledge or pre-approval is fairly common, and many retail investors don’t even know this is happening (and if it makes no material difference to them outside of the occasional broke broker-dealer, maybe it doesn’t matter that much).
Aren’t accounts covered by some deposit insurance scheme for the broker going bust? I’m pretty sure they are in Canada, and I imagine such assurances exist south of the border too.
There is some SIPC insurance in the US, up to a certain point, and this would presumably cover broke dealers lending out shares they can’t buy back. Similar to FDIC insurance.
From the wikipedia article on SIPC:
“The SIPC fund, which constitutes an insurance program… is designed to protect the customers of brokers or dealers subject to the SIPA from loss in case of financial failure of the member. The fund is supported by assessments upon its members. If the fund should become inadequate, the SIPA authorizes borrowing against the U.S. Treasury.”
The stock has to be in a margin account with a debit balance and is limited to 140% of the debit, my manager has double checked this with our stock loan dept.
“In the United States, rehypothecation of collateral by broker-dealers is limited to 140% of the loan amount to a client, under Rule 15c3-3 of the SEC.”
this is accurate. Some firms allow lending of securities in type cash as well. One tax risk is if you are to be paid a dividend and your shares are currently being lent. You will receive a substitute payment which is not going to be considered a qualified payment, but rather misc income that will be taxed at your marginal tax rate.
Why would you borrow a stock you are long to someone
that is going to bet against that stock in effort to depress
the price of that stock? Would not be smart right?