Securities lending

Securities loans / lending  used to cover short-selling activities. In this case, when short sellers make a trade, they are obligated to deliver the stock sold to the buyer and must therefore borrow the security from another party. To mitigate the risk of the loan, the borrower gives the lender cash collateral that is generally higher than the market value of the securities.  The borrowed security and related collateral are then returned to their respective owners once the short seller buys back the stock in the open market, thus unwinding the loan.In addition to the exchange of collateral, a fee called a rebate rate is assessed for each securities loan. The cost is expressed as an interest rate paid on the value of the cash collateral based on a  funding rate like LIBOR.

Other factors that influence rebate rates are the duration and re-pricing frequency of the loan.  Open loans are marked-to-market daily to allow rates to move as the funding rate moves, or as the supply and demand of the security changes.

Term loans rates are fixed at the beginning of the loan and are established for a set period
of time.   Rebate rates may be positive or negative, indicating which participant is responsible for paying interest on the cash collateral outstanding.

Trade flow
Lender → Custodian → Prime Broker → Borrower
Borrower → Rime Broker → Custodian → Lender
(Shares / Collateral / Rebate)
Rebate (+ ve) paid to borrower
Rebate (- ve) paid to lender

Custodian → A financial institution that has the legal responsibility for a customer’s securities. This implies management as well as safekeeping.

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