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A mutual fund or exchange traded fund (ETF) aims to earn returns for investors by buying and selling stocks or other investments. But a fund manager can also earn modest amounts of income to increase overall fund/ETF returns with a strategy called securities lending. This article explains how securities lending works and how it benefits investors. It also highlights the safeguards and policies RBC Global Asset Management (RBC GAM) has put in place to protect investors’ capital.

What is securities lending?

  • Securities lending occurs when a fund lends some of its eligible securities to another trusted financial institution. The fund charges a fee for the loan, with the terms outlined in a Securities Lending Agreement. The fund receives collateral from the borrower in exchange for the loan.
  • The lending of securities has been in practice for over four decades around the world by banks, asset management firms, pension plans, other financial institutions and central banks.
  • With a series of checks and balances (described further on) to protect a fund’s assets, securities lending can be a low-risk strategy that can add up to five basis points to a fund’s performance on some mandates.
  • Securities lending in Canadian mutual funds and ETFs occurs within a regulated framework.

Who borrows the securities and why?

  • RBC GAM lends securities to a broad global network of reputable, well-established and credit-worthy brokers, investment dealers and other financial institutions.
  • The loaning of securities does not impact a fund’s investment-management process.
  • The period of time a security is on loan can vary depending on the purpose of the loan, the supply and demand dynamics of the security and market conditions.
  • Reasons for borrowing securities can include:
    • When a security is needed temporarily, it may be cheaper to borrow it than to buy it on the open market.
    • Some short-term investment strategies (e.g. short selling, arbitrage trading and hedging) rely on using borrowed securities to generate additional returns.
    • To minimize a company’s tax obligations by borrowing dividend-paying securities – the borrower would have its desired exposure to stock while the dividends would be retained by the lender.

Is securities lending common in the finance industry?

  • Yes, securities lending is a common industry practice. Since 2001, the Canadian Securities Administrators (CSA) have allowed mutual funds to lend securities.
  • The practice of securities lending is considered to be an essential component of a healthy and efficient marketplace, leading to increased liquidity of securities and an opportunity for fund investors to earn additional income.

What are the checks and balances to protect a fund’s assets?

  • RBC GAM’s securities-lending arrangements are subject to the lending guidelines mandated by the Office of the Superintendent of Financial Institutions as well as mutual fund regulations.
  • RBC GAM lends a fund’s securities only to well-capitalized, highly rated borrowers who meet our stringent credit and risk limits. We draw on RBC’s deep expertise in credit analysis and risk management to oversee every loan.
  • There are specific guidelines on the types of collateral we accept from borrowers to secure the loan. This includes high-quality federal and provincial government bonds as well as sovereign debt from other approved countries. The value of the collateral we receive from the borrower will always exceed the market value of the securities we loan.
  • The borrower must return the loaned securities to the fund on demand.
  • RBC Investor Services Trust is the custodian and securities-lending agent for all RBC GAM mutual funds and RBC ETFs. To protect investors, it guarantees all loans the funds make.

How do RBC GAM investors benefit from securities lending?

  • A fund earns income on the securities it lends out. In addition, the fund also continues to earn the return on any securities that are lent out.
  • Together, these sources of revenue can increase the fund’s overall return – usually in the range of 1–5 basis points depending on the demand of the security.

The bottom line is that with appropriate checks and balances in place, securities lending can be a relatively safe, low-risk strategy that can reward investors with incremental fund performance.

Disclosure

Last reviewed: January 1, 2023

This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided. Information obtained from third parties is believed to be reliable but RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.



All opinions and estimates contained in this report constitute RBC GAM’s judgment as of the indicated date of the information, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates and market conditions are subject to change.
Return estimates are for illustrative purposes only and are not a prediction of returns. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.