INTM552050 - Hybrids: hybrid transfers (Chapter 4): conditions to be satisfied: condition A - what are stock lending arrangements

In a commercial stock lending transaction (see CFM74100) there is normally a party that has a need of securities (for example, in order to deliver securities to satisfy a sales contract it has previously entered into). The original holder of the securities transfers them to the stock borrower, but no price is specified. However, the stock borrower is obliged to transfer back those securities (or identical securities) at a later date.

In the interim, the stock borrower lodges collateral with the stock lender and will normally pay a fee to the stock lender, sometimes by allowing the stock lender to retain part of the return on the collateral (a collateral rebate). For example, where the collateral is a security the stock lender may be allowed to retain any interest payments in the interim.

If there is no collateral, this may be a sign of an uncommercial arrangement that is possibly tax driven.

Where the collateral is cash, a stock loan can be very similar to a repo in its economic effects. The stock lender transfers securities and gets them back at a later date. When it transfers the securities, the stock lender gets the cash collateral, which it can use in its business. It pays over an interest return on the cash collateral and returns the cash principle at the end. In this example, the stock lender is in the same position as the in-substance borrower in a repo.

This type of arrangement is unlikely to satisfy the dual treatment condition, as the amount paid over in respect of the cash collateral is interest and is less likely than the price differential on a repo to give rise to a mismatch.

In stock lending, as with repos, a transaction may extend over a dividend or interest record date. The stock borrower will typically be obliged to make a substitute payment to the stock lender. A payment may also arise from the lender to the borrower on the securities posted as collateral. The stock lender would normally pay this over to the stock borrower, so substitute payments could flow in both directions, although they could be netted.