Investors are concerned about loaning out stocks, arguing the income generated by securities lending is unlikely to offset the risks, especially in market downturns. One concern for investors is the quality of collateral an ETF accepts when it lends out its holdings. Although ETF providers typically receive stocks or cash that, when exchanged, are worth more than the securities loaned out, some worry this would not be enough in times of market stress.
Another concern for investors is whether cash or securities are best for collateral. In Europe, asset managers typically take securities as collateral and charge a fee. In the US, cash is often used as collateral, with the ETF provider then investing that cash to try to make a higher return rather than receiving a fee. There are also risks that the counterparty goes bankrupt, losing the ETF’s stocks on the way.
Even so, the benefits of securities lending outweigh the risks for investors. FT sources said that many of the largest ETF providers have strict policies in place to protect investors, including requirements for over-collateralisation. Providers typically also offer an indemnity that means that if the borrower goes bust, the asset manager will guarantee to buy back the securities that have been lost.
Investors who want to avoid ETFs that engage in securities lending may find their options limited. According to Morningstar, about 30% of ETFs based in Europe lend out securities, while almost 71% of US ETFs have a stock lending program, and it’s recommended that investors practice due diligence.