Securities lending - Frequently Asked Questions (FAQ) - Full document compilation brochure for download
- What are fee rates for securities lending transactions in B3?
Securities lenders earn a freely negotiated fee for lending securities. The fee is paid to lenders net of withholding income tax.A borrower is required to pay both the lender’s fee and a transaction fee owed to B3. Currently, this transaction fee is charged at a rate of 0.25% per annum calculated over the loan amount, i.e., the financial value of the borrower’s open interest position, provided a minimum R$10.00 fee applies. Where the automatic securities lending program is activated (further details below), the transaction fee is charged at 0.50% per annum and no minimum fee applies.
- How do we calculate and payout the lending fees?
Payment for the loan is calculated in form of a fee rate calculated as follows: rate of interest to the borrower x number of securities x average quote for the security.
The fee rate is calculated on compounded basis of a 252 business days count convention. The lending fee may be agreed upon accrual and payment on predefined cash flow periods before the loan expiration or accrue for a lump sum payment at the end of the loan.
The average quote for a security is determined at the time the loan agreement is registered, and it is established based on the the average quote at the close of the prior trading session as of the loan registration date.
Where the average quote has to be adjusted to account for payouts or other corporate action events (e.g., cash distributions in the form of interest on capital’ equity or dividends, etc.), the base average quote for adjustment will be the last date the security trade “cum rights”.
- Are there limits established for time-to-maturity and settlement period?
Securities loans may be agreed for a specified term as short as one day and there is no requisite maximum term to maturity.
In addition, while lender and borrower may freely negotiate time to maturity, time- to-settlement must be at least T+1 (where “T” means the transaction date).
However, where the automatic securities lending program is activated, it is possible for the borrower to promptly return equivalent securities settling the transaction at “T+0”.
- Is it possible to renegotiate the lending fee during the life of the agreement?
Yes, a fee renegotiation is permitted at any time, as long as lender and the borrower are able and agree to renew the contract, settling the old one and assigning for a new one.
- What types of standard settlement arrangements are available for securities lending agreements?
There are two types of standard settlement arrangements, which are related to the contract term and right of early return or recall (if any), as follows:
- Returnable: For loans that include an early return option, settlement may take place sooner than anticipated if the borrower chooses to return equivalent securities to the lender earlier
- Returnable/recallable: For loans that include both an early return option and a recall option, settlement may take place sooner than anticipated either because the borrower chooses to exercise the early return option, or otherwise because the lender recalls equivalent securities from the borrower.
Early return by the borrower may be executed up to 7:00 p.m and including one business day prior to the expiration date. In this case, the borrower shall fully or partially settle the contract by 8:00 p.m.
On the expiration date of the contract or on the expiration date of the request for early settlement by the lender, full or partial settlement shall be executed by 8:00 p.m
Early settlement by the lender follows the procedure above:
- For requests made up to 9:30 a.m the borrower must execute settlement of the contract by 8:00 p.m. of T+2 from the request date; and
- For requests made after 9:30 a.m. the borrower must execute settlement by 8:00 p.m. of T+3 from the request date.
- Do securities lenders retain rights to payouts or other corporate action events?
Strictly speaking, when a security is loaned, the title and the ownership are transferred to the borrower, such that the issuer will not be making direct payments to the lender. However, the borrower refunds the lender (and the securities lending system is programmed to process the refund) for payouts, at the same amounts and dates as cash distributions are paid out by the issuer. This means that at the payment date set by the issuer, the system will credit the lender for the payout amount (as adjusted to account for any withholding tax charges).
Based on the premise of making the lender “whole” for any corporate action event, in the case of cash distributions (e.g., interest on capital, dividends), the lender retains right to be paid cash in the equivalent of any payouts, as if the securities were not on loan.
Where a corporate action event affects the number of outstanding securities of the issuer (e.g., bonus stock distributions, stock splits, reverse splits), the number of securities delivered to the lender at the end of the loan will have been adjusted to account for the effects of the relevant corporate action event.
However, the voting rights inherent in shares on loan are not retained by a lender; rather, they are transferred to the borrower along with the title and ownership.
- What is automatic BTC?
Automatic BTC means the compulsory loan of securities utilizing the securities lending service (BTC), triggered by the clearinghouse to deal with delivery failure detected after the end of the securities delivery period. It is one of the mechanisms used by the clearinghouse to mitigate liquidity risk associated with securities delivery in spot transactions.
Thus, in the event of failed delivery by a short seller of cash market equity securities, the automatic securities lending program is activated to track unfilled loan orders whose features as to size and loan term adequately accommodate the short seller’s delivery obligation.
Where more than one such loan order is outstanding, the system selects those which offer lower lending fee rates.
Thus, a short seller in default of its obligation to deliver securities will take a borrowing position in like securities so as to deliver them to the buyer, consummating the original trade.
From this standpoint, securities lending plays a major part in the efficient functioning of settlement processes and the securities markets.
- What is a non-standard securities lending agreement?
A non-standard securities lending agreement differs from a standard form agreement in that while presenting similar features, it also contains provisions designed for market makers and stabilization agents to implement block trading strategies.
- What is the credit risk undertaken by securities lenders?
B3 acts as central counterparty in securities lending transactions and the clearinghouse manages outstanding positions. There are no links between the investors who borrow securities and investors who lend securities.
Loans are made against collateral in order to protect the lender against possible default by the borrower on its obligation to pay the lending fee and return equivalent securities at the end of the loan. B3 requires the borrowers to post collateral right before taking any borrowing position so as to ensure a successful outcome for securities loans.
- What level of collateral is required from a securities borrower?
At the outset of a loan, the borrower is required to post collateral for 100% of the principal amount of the loan (value of the loaned securities) plus an amount to cover potential exposure to future fluctuations in the market price of the security. The value of such additional amount, called margin interval, depends on the outcome of risk assessments made by B3, which take into account stress scenarios estimated to the relevant security. The margin interval, which generally ranges between 15% and 100% of the principal, represents the prospective price fluctuation of the security over two consecutive trading sessions.
Clearing agents admitted as participants of B3 bear co-responsibility with customer borrowers for loan settlement. At the clearing agent discretion, this may lead the clearing agent to require additional collateral from a customer borrower.
Before taking a loan position, the lender must have placed the securities in custody at B3’s Central Securities Depository.
Similarly, before taking a borrowing position, the borrower must have post the required collateral (pre-margining system). During the life of the loan, daily margin calls may be made as a result of mark-to-market adjustments to the value of the loan. For example, if the market price for the security rises, the borrower will be required to make an additional margin deposit.
- What is the calculation method used in determining margin requirements?
B3 uses a proprietary risk management methodology. Stress testing is the key risk management tool and an integral part of margin methodology.
Chapter V, section 2 of the B3 manual provides a description of the criteria for determining margin requirements and adjusting the value of assets posted as collateral.
- What are the financial assets accepted as eligible collateral?
The collateral margin deposit to the clearinghouse must be made in local currency and may also happen using the deposit of the following assets or instruments at the clearing house’s discretion:
- Brazilian government bonds
- Financial gold;
- ETF quotas and the equities of companies listed on B3
- Corporate securities;
- Securities traded in the international markets
- Bank letters of credit;
- Profits from forward contract trading;
- Other assets or financial instruments;
B3 calculates the value of assets posted as collateral on a daily basis. In doing so, it determines fair market value (in BRL – brazilian local currency) and applies a discount factor assigned on the basis of risks (market, credit, liquidity and other risk factors) associated with the specific asset, as well as taking into account material costs potentially incurred in the collateral execution.
- How is the collateral management process implemented?
The registration of a loan identifies the borrower and the lender at the beneficial owner level, which to a degree contrasts to practice in some major international markets, where beneficial ownership identification takes place at the level of the intermediary firm (brokerage firm, clearing agent).
Similarly to the transaction registration process, the post of collateral process requires identifying the final investor. Assets deposited as collateral are registered in the name of the final investor and kept segregated from the assets of B3.
- What happens if the borrower fails to return a security at maturity or when called?
In this event, the borrower will be required to pay a 0.20% daily fine, plus twice the lending fee (which will be paid to the lender).
The borrower that does not return the securities upon the contract’s expiration must regularize the situation by 8:00 p.m. of T+1 of the contract’s expiration date. Once this deadline has passed, on T+2 of the contract’s expiration date a buy-in order shall be issued in favor of the lender, in the non-regularized quantity.
Ultimately, as central counterparty clearinghouse, B3 is responsible for ensuring a successful outcome for securities loans, with the lender being paid the lending fee and returned equivalent securities at the end of the loan (or, in the extreme, being compensated for them). For this purpose, the equities clearinghouse may proceed to seize collateral posted by the borrower. Moreover, in the extreme, the equities clearinghouse would resort toother levels of its safeguard structure.
- Are there concentration limits for positions in loaned securities?
Yes. Concentration limits are defined by B3, for stocks in instance, each of the different criteria set forth below, as a percentage of the free float of a listed security:
- Total number of open interest positions in the market – 20% (standard limit);
- Total number of registered open interest positions by category of participant of B3 markets (e.g., intermediary firms licensed as clearing agents) – 6.5%;
- Total number of registered open interest positions by investor – 3%.
- What documents are required to operate a securities lending transaction?
There is a one-off requirement for first-time lenders, borrowers and intermediaries that wish to do business on the securities lending market operated by B3, to sign certain documents (pursuant to rules on transactions and to operating procedures within the scope of the securities lending facility), as follows:
Instrument of adherence as participant of the Securities Lending Facility (BTC) – required from intermediary firms (broker-dealers, custodians)
Instrument of consent for registration of transactions in the BTC System – required from lenders and borrowers (to be kept on file by the relevant borrowing brokers and lending agents)