As seen in Europe several years ago, the number of impactful US beneficial owners in securities lending is shrinking. This phenomenon is being driven in the asset management world primarily by the growth in AUM of the largest asset managers. A reduction in the number of US clients with large, diverse, lendable portfolios that can meet borrower requirements means that agent lenders must use their lendable securities wisely. Beneficial owners that partner with agent lenders best suited for their needs are more likely to see positive results across revenues and client service going forward.
Dodd-Frank and Basel III rules imposed new capital requirements on securities borrowers, and this has reduced the securities borrowing business that banks are able to conduct. While ’40 Act funds were subject to limitations on the amount of securities that could be lent prior to 2010, concepts like the Leverage Ratio and Liquidity Coverage Ratio did not yet exist. Now, borrowers are forced to be more thoughtful about the types of lenders they borrow from, and this has had a direct impact on their daily business.
An important part of the borrower decision matrix today is the lender impact on risk-weighted assets (RWA), for which ’40 Act funds may have a 100% weighting. The RWA of other lenders, for example US pensions and Sovereign Wealth Funds, is generally much lower, and will depend on a variety of factors, including the ability of a bank to net transactions and whether a bank uses a standardized or advanced risk calculation. On balance, borrowing from ’40 Act funds may be more expensive to banks than borrowing from other types of entities.
In response to these pressures on bank risk and capital measures, some ’40 Act funds and their agent lenders have invested in trading strategies and operations to make it easier for banks to borrow. Some options mitigate how bank capital cost calculations flow through to the balance sheet, while others reduce operational burdens and lower settlement fails. Some strategies are applicable throughout the market for all beneficial owners while others are specific to certain client segments.
US Basel III Endgame rules may have been postponed for now, but beneficial owners, agent lenders and bank borrowers must still work to identify the best combination of balance sheet mitigation and operational strategies that make securities lending as frictionless as possible. Finadium is currently tracking ten options, some of which are being used in practice while others are in discussion (see Exhibit 1). This level of experimentation and innovation is new for the market. Agent lenders that are participating at the front lines of change may be poised to deliver strong returns for clients going forward.
’40 Act Funds – the biggest managers lead the market
The largest asset managers have a dominant share of ’40 Act fund securities lending revenues, according to public data. Filings on the Securities and Exchange Commission’s (SEC) EDGAR system show that from 2022 to 2024, the top 10 ’40 Act complexes earned 80-84% of ’40 Act fund securities lending revenues, compared to the universe of lending mutual funds and ETFs (see Exhibit 2). In 2024, EquiLend, a securities lending technology and data provider, reported that beneficial owners earned $9.64 billion in 2024. The top 10 US ’40 Act managers earned 21% of the total while all US ’40 Act funds earned 26%.
Each year contains its own variations and there are suggestions that the market share of the top 10 ’40 Act managers will be more concentrated in 2025 than 2024. Last year’s data included a temporary revenue drop by a top 10 manager due to a program change; otherwise, the top 10 ’40 Act funds would have earned 86% of all ’40 Act revenues. The amount of hard to borrow securities in the market also matters, and panelists at the 2024 Finadium Investors in Securities Lending conference said that the year had seen an unusually low level of specials. In a typical year, the availability of hard to borrows lead the market, and the largest fund managers and agent lenders have the most diversified portfolios.
Some of the concentration of the top funds is simply due to the assets of the largest managers, but another reason is that the largest managers are investing to facilitate borrower access to inventory, manage corporate actions, and more easily process the transfer of loans vs. collateral. If the cost of risk-weighted assets (RWA) is the same across all managers, then operational efficiencies can make a difference in which firm a borrower chooses.
For Agent Lenders, a tighter market with changing client terms
Scale in agency lending attracts borrowers who can be confident that inventory is accessible, and loans will not be recalled on short notice. For that reason, agents must ensure they have the supply that borrowers want, but this is not always doable. Agent lenders have an incentive to maintain a diversity of clients and portfolios. This helps agents to more likely be a first call for borrowers.
A contracting ’40 Act fund space impacts the agent lenders most reliant on mutual fund and ETF customers. Two custodial agents have elected to fully outsource their agency lending business. Bank-affiliated agents that seem now to be the bedrock of the business may find a few years from now that a merger or outsourcing makes the best sense from the perspective of client aggregation and investments in operations and technology. This is not the time for agent lenders to be complacent as bank capital requirements and fixed costs reach into the revenue profile of their beneficial owner clients.
The potential for agent lender consolidation is particularly important in US equity securities lending where a lack of deep specials and uncompetitive operations in 2024 left some agents unable to generate enough revenue for reinvestment into the business. It is unknown if this situation will persist or if international markets like Taiwan and Brazil can make up the difference, but in the short term, a lack of intrinsic value revenue combined with fewer large clients means that market winners must have the right relationships and inventory to succeed.
At the same time, we observe agent lenders responding to beneficial owner requests for proposals with new terms, including offers of bank-indemnified, insurance-indemnified and non-indemnified lending. Along with this are new price points, with the cost of indemnification becoming more transparent. This information has come as a surprise to some beneficial owners who have learned to always expect bank indemnification as a bundled offering but are now finding that market conditions have shifted.
Navigating the agency lending market for beneficial owners
Beneficial owners lending through an agent or considering a hybrid model want to know that their agent is in the business for the long haul. While nothing is certain in today’s capital markets industry, partnering with an agent that is committed and is investing in their business is an important prerequisite to agent lender selection. An early due diligence question in 2025 is to ask what progress agents have made in the last year and where they expect their product development efforts to be heading over the next 18 months. This will provide good comparative information on where each agent stands.
A focus on global lending is a further area of interest. Securities lending is an international market, and the ability of an agent to lend around the world from their own desks can support client revenues, borrower demand, and consolidated regulatory reporting. As new markets in Asia continue to open up, beneficial owners should look to ensure that their custodied assets can be utilized.
Clients should also determine if their agent lender is focused on their specific client type, whether a regulated fund, insurance company, pension or sovereign wealth fund. While the basics of agency lending are similar across providers, substantial differentiation has occurred behind the scenes in responding to regulatory requirements. For ’40 Act funds, this includes calculating Qualified Dividend Income and considering the impact of collateral acceptance criteria under the Securities and Exchange Commission’s Rule 15c3-3. These details speed up communications between client and agent and are often already built in to the agent’s technology stack, resulting in a better overall client experience. Not every client has these types of regulations overseeing their businesses, but for those that do, the differentiation can be important.
According to Fidelity Agency Lending’s Justin Aldridge, “Fidelity Agency Lending is deeply committed to the agent lending business with clients who value aligning with an agent lender dedicated to providing the best outcomes for their stakeholders. Our attractive assets and substantial scale uniquely position us in the market as we support the securities lending goals of different clients like asset managers, pensions, insurance companies and sovereign wealth funds. As the pool of significant lenders contracts, we believe that partnering with a dedicated agent may lead to market-leading revenue and service gains.” The ability of an agent lender to clarify how, why and when their services add value is a topic that beneficial owners may want to consider more closely in their lending relationships going forward.
This article was commissioned by Fidelity Agency Lending, a division of Fidelity Capital Markets. For more information about Fidelity Agency Lending, please visit https://capitalmarkets.fidelity.com/fidelity-agency-lending.
Fidelity Agency Lending® is a part of Fidelity Capital MarketsSM, a division of National Financial Services LLC, a member of NYSE, SIPC. Clearing, custody or other brokerage services may be provided by National Financial Services LLC, or Fidelity Brokerage Services LLC.
Finadium is an independent entity and is not affiliated with Fidelity Investments.