Securities lending is a well-established practice, in which the owner of securities temporarily loans them to a counterparty in return for a fee. UBS ETFs participate in securities lending to generate additional revenues, thereby reducing the net cost to investors.
Securities lending is a transaction between the beneficial owner of some securities, for example an ETF, and a borrower, which is often a bank or a broker. It is a common and well-established practice that increases liquidity and the efficiency of capital markets.
In a securities loan, the owner (lender) transfers the ownership rights of securities such as stocks or bonds to the borrower for a defined or undefined period of time. In exchange, the borrower puts up collateral, which is typically other securities they own, and pays an agreed fee for the duration of the loan. Furthermore, all entitlements such as coupons or dividends paid on the securities while on loan are passed on to the lender as a substitute payment. Upon termination of the securities lending agreement, the borrower is obliged to return “equivalent” securities, that is the same type and number of securities as the ones he/she borrowed.
Frequently, a lending agent or principal is employed by the lender to facilitate the transaction. When the borrower returns the securities to the lender, the lender regains full ownership rights over them.
Securities lending provides the lenders of securities with a relatively low-risk yield enhancement to their portfolio. Lending out securities for a short period gives a fund that owns stocks in, for example, a tech giant, the opportunity to generate fees and interest on stocks that it plans to hold in the portfolio long-term. This revenue is reflected in the net asset value (NAV) of the fund, which can increase investors’ returns.
The reasons why a borrower needs to borrow securities vary, but generally securities are needed to fulfill delivery obligations, support market-making activities, or implement investment strategies through derivatives transactions.
Securities lending transactions are subject to numerous regulations such as the UCITS Directive for EU investment funds or the FINMA Ordinance on Collective Investment Schemes (CISO-FINMA) for Swiss-domiciled funds. Thanks to comprehensive safety mechanisms and regulators engaged in various jurisdictions, the risks involved in securities lending are relatively low.
For funds that allow securities lending, the borrower is required to provide highly liquid collateral with a high credit rating. The collateral is typically worth 105% or more of the market value of the securities lent out at any time. In addition, contracts for securities lending typically state that the owner has the right to recall securities lent out at any time without notice.
A number of selected, physically replicated UBS equity ETFs domiciled in Switzerland, Ireland, and Luxembourg engage in securities lending. Fixed income ETFs, precious metal ETFs or ETFs with an environmental, social, and corporate governance (ESG) focus do not engage in the securities lending program. Furthermore, ETFs with “NSL” in their name, which stands for non-securities-lending fund, are also excluded from securities lending.
The objective of securities lending is to reduce investors' net costs through additional revenues, which typically range from 1 to 20 basis points (bps), depending on the index. Lending is done via a lending agent or a principal, who facilitates the transaction between the borrowing and lending parties. For Luxembourg- and Ireland-domiciled ETFs, State Street Bank International GmbH, Munich, Germany, and State Street Bank and Trust Company act as lending agents. For Switzerland-domiciled ETFs, UBS Switzerland AG acts as the sole borrower (principal) to the lending program and guarantees all contractual duties.
Securities lending transactions of UBS ETFs set up in Luxemburg or Ireland are over-collateralized to a minimum of 105%, except for US Treasuries. For US Treasuries a margin surplus of at least 2% is maintained so that the value of collateral held is at least 102% of the value of the lent securities. For Swiss-domiciled ETFs, an additional haircut of up to 8% is also being applied. According to EU and Swiss directives, ETFs are allowed to lend out up to 100% of their assets. However, actual lending rates for UBS ETFs have been considerably lower and are capped at 50% (or at 25% for a strategy tracking the Euro Stoxx 50 index) of the net asset value of an ETF.
To minimize risks for UBS ETFs, borrowers are carefully selected and monitored daily. Before borrowers receive the securities, they must provide the ETF – via the lending agent or principal – with collateral to secure their obligations. The collateral is then transferred to a separate custody or collateral account that is ring-fenced from the ETF’s balance sheet.
UBS ETFs also have the right to terminate securities on demand and on a daily basis. A daily mark-to-market valuation of loans and collateral ensures that the value of the collateral posted by the borrower is always adjusted to the correct level. Securities lending ceases when it is terminated by the ETF or the borrower's demand is satisfied. The collateral held is returned to the borrower only after the securities have been returned.
Should the borrower not return the securities lent out in accordance with the contract, the collateral may be sold in favor of the UBS ETF as it already acquired ownership of the collateral when it was transferred. This helps to protect the value of the fund’s total assets.
If implemented diligently, ETFs can benefit from securities lending by generating additional income that can help offset management fees and enhance overall investor returns. It is important that the practice is underpinned by robust risk management strategies, ensuring that high-quality collateral is secured to protect against potential counterparty risks. As such, ETFs can enhance portfolio efficiency while maintaining their appeal as low-cost, diversified investment options.
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