International Securities Lending

Securities lending is growing fast. Its rapid expansion in recent years looks set to continue as this exciting process proves its value by producing generous profits.

In contrast to the procedures described in some other chapters of this publication, stock lending in UK domestic securities still takes place in a relatively closely regulated environment. The main reason for this is the peculiarity to the UK of the competing market maker system for dealing in securities.

Securities lending in the German market has been developing slowly due to various market and regulatory constraints. Significant market changes in 1990 and 1991 have altered the securities lending landscape in Germany, making it an acceptable transaction form as in more progressive markets. In this chapter, the authors trace the development of securities lending in Germany prior to the ‘breakthrough’ years, analyse the current situation and discuss the adjustments necessary to make securities lending a fully developed financial vehicle in the German market in the future.

In recent years the French market has been one of the fastest growing markets in terms of securities lending.

The Japan Securities Finance Co. was founded in 1950 as an institution specialising in securities finance. It was licensed in 1956 as a securities finance company according to the Securities and Exchange Law. It then began lending operations directed at securities companies, individuals and corporations with emphasis on loan transactions.

Thus far, we have focused on international securities lending on a country-by-country basis, or from a micro perspective. Included in our discussions have been various issues which affect our businesses across the board. Information involving settlement procedures, transactions costs, tax, legal and regulatory concerns, implications of cross-currency, cross-border and cross-cultural trading and the problem of dealing in several time zones affect all of us regardless of venue. The very specific information included throughout this text will prove invaluable as your trading operation springboards you into the global market for fixed income and equity securities lending and position financing.

Although securities lending programmes give scope for enhancing the performance of an investment portfolio, inevitably that enhancement is not risk free. This needs to be borne in mind in particular by those who lend securities owned by others (such as trustees or managers of pension and other investment funds and custodians) because a failure to address these risks could result in claims against them by the owners of the securities.

In order to fully appreciate the concept of global custody it is useful to consider the many varied financial instruments available to an investor in only one market such as Japan or the UK. These include equities in all configurations, fixed income securities with variable and fixed coupons, a myriad of derivative products including securities options and currency options, ‘baskets’ of securities based on a particular index, and unit trusts.

A grim statistic is often cited whenever specialists in international securities gather. The figure is that 40 per cent of all transactions in global markets fail to settle on the contractual date; some pundits put the percentage even higher. While the exact number may be difficult to verify, what can be readily determined is that many of these failures are due to the inability of the seller to deliver the securities to the buyer by the trade’s settlement date.

The purpose of securities clearance and settlement is to administer the exchange of money and securities between parties to a securities trade. Clearance is the process of determining accountability for the exchange of assets and establishes obligations for securities and funds due. Settlement is the completion of a trade wherein securities and, depending on the system, the corresponding funds are delivered and credited to the appropriate accounts. Each trade has two sides: a securities side and a cash side. The securities side concerns the transfer of securities and is the traditional activity of a clearance system. The cash side concerns the transfer of funds corresponding to the securities trade.

The description following is a general guideline in order to obtain an overview of the taxation of securities lending transactions in various countries. Before the initiation of any specific transactions, further detailed expertise should be requested from competent consultants. This overview has been compiled by our Frankfurt office under the guidance of Jürgen Jung with the support of our offices in London, New York, Paris and Tokyo. It complies with the status of tax regulations as of August 1991.