The Hidden Cost of Lending Your Shares: Forthcoming Research Could Change How Investors Think About Securities Lending

The Hidden Cost of Lending Your Shares: Forthcoming Research Could Change How Investors Think About Securities Lending

For years, securities lending has looked like easy money for asset owners.

An investor owns shares. A short seller wants to borrow them. The investor lends the shares and collects a fee.

But forthcoming research by Iro Tasitsiomi raises a provocative question:

What if the fee investors receive for lending their shares isn't always enough to compensate them for the risks and costs they are taking on?

In her work-in-progress paper, "On the Economics of Fee Sufficiency in Securities Lending," Tasitsiomi develops a framework for determining when the economics of lending actually make sense for an asset owner.

The central insight is deceptively simple: an investor gets paid only on the shares it lends, but a potential price effect associated with lending could affect the value of its entire position.

The Fee May Not Tell the Whole Story

Imagine an investor owns $10 million of a stock and lends out $1 million worth of those shares. The investor receives a lending fee on the $1 million.

But if lending contributes to downward pressure on the stock, the potential economic impact isn't confined to the $1 million that was lent. The investor still owns the other $9 million.

That creates a fundamental asymmetry at the heart of securities lending.

Tasitsiomi's research asks a different question from simply determining the market rate for borrowing a stock.

Instead, it asks:

What level of compensation is sufficient for the incremental costs and risks that this particular owner's lending decision creates or avoids?

That distinction could have major implications for institutional investors, pension funds, asset managers and other large securities owners.

A New Way to Think About the Right Lending Fee

In "On the Economics of Fee Sufficiency in Securities Lending," which Tasitsiomi is currently developing, she proposes a minimum-fee framework designed to determine the compensation an asset owner should require before lending shares.

The framework goes well beyond the advertised lending rate.

It considers potential lending-attributable price impact, counterparty and collateral-related costs, operational expenses, recall costs and the portion of lending revenue retained by a lending agent.

The result is essentially an economic hurdle rate.

If the actual securities-lending fee exceeds the hurdle, lending may provide sufficient compensation.

If the fee falls below it, the owner may be better off retaining the shares.

Why "Lend Everything" May Not Make Sense

One of the most interesting implications of Tasitsiomi's work is that securities owners may not want to apply the same lending policy across an entire portfolio.

A stock with abundant lending supply and little short-selling activity is economically different from a stock where borrow is extremely scarce and short sellers are aggressively competing for shares.

Her analysis examines this distinction using a point-in-time U.S.-equity sample constructed as an Interactive Brokers-based proxy for the Russell 3000, matched with market, short-sale, short-interest and SEC filing data.

The preliminary analysis indicates that, under the reference timing assumptions, observed fees clear the proposed compensation hurdle for ample-supply, low-short-activity securities across the economically meaningful scenarios examined.

But tight-supply securities and stocks facing event risk are considerably more sensitive to the assumptions.

That suggests that the economics of securities lending can vary dramatically from one security to another.

The Investor Could Be Taking Risk on More Than It Lends

This is where Tasitsiomi's framework becomes particularly compelling.

Suppose an asset owner has a large position in a stock but lends only a fraction of it.

The lending fee applies to the shares actually lent.

But if the lending decision has an effect on the stock's price, the economic consequences could extend across the owner's entire position.

The investor's revenue is concentrated on the borrowed shares, while a potential price effect can extend to everything the investor owns.

That is one of the central economic problems Tasitsiomi is attempting to quantify.

The Future Could Be Security by Security

Rather than prescribing a simple binary rule — lend or don't lend — the forthcoming research proposes a more granular approach.

Asset owners could determine a required fee based on the specific security, the quantity being considered for lending, market conditions, short activity, supply constraints and the costs and risks associated with the transaction.

A highly liquid stock with abundant borrow availability might have a relatively low hurdle.

A hard-to-borrow stock with elevated short interest and a major corporate event approaching could require substantially greater compensation.

The result is a potentially more sophisticated securities-lending strategy:

Don't simply ask whether someone wants to borrow your shares. Ask what price makes it worth your while.

A Potential New Framework for Securities Lending

The implications could be significant for institutions that generate revenue by lending portfolio securities.

For a large portfolio, even small differences in lending economics can become meaningful when applied across billions of dollars of assets.

Tasitsiomi's work therefore reframes securities lending as an optimization problem rather than simply a source of incremental portfolio income.

The objective isn't necessarily to maximize the number of shares being lent.

It is to maximize the risk-adjusted economics of lending.

That could mean lending aggressively when fees clearly compensate the owner, demanding higher fees when risks increase, and withholding inventory when the economics no longer justify the transaction.

The broader message of Iro Tasitsiomi's forthcoming paper, "On the Economics of Fee Sufficiency in Securities Lending," is striking:

The right question may not be whether a stock can be lent profitably. It may be whether the lending fee is high enough to compensate the owner for everything that lending can change.

As securities lending becomes increasingly sophisticated, that distinction could force asset owners to rethink one of the industry's most established sources of portfolio revenue.

The days of simply asking "What's the borrow fee?" may be giving way to a much more consequential question:

"What's the minimum price I should demand for putting my shares into the lending market?"

This article is based on work in progress by Iro Tasitsiomi, "On the Economics of Fee Sufficiency in Securities Lending." The paper is not yet publicly released and remains under development.