How does lending shares become a yield business, and how did it lose money in 2008?
Every short position has a lender on the other side, quietly running what looks like the safest business in finance: renting out assets you were going to hold anyway, against over-collateralisation, with daily marks. In 2008 it produced some of the largest losses of the crisis — and not for the reason most people assume.
The revenue side
The beneficial owner earns the borrow fee (or, in cash-collateral markets, the spread between what the collateral earns and the rebate paid away), and splits it with the agent lender, typically 70–85% to the owner. Globally, securities lending revenue to beneficial owners has run on the order of $10 billion a year in recent years.
A worked example. A $10 billion index fund lends 8% of assets on average — $800 million — at a blended 30 basis point fee, keeping 80%:
$800,000,000 × 0.0030 × 0.80 = $1,920,000 a year ≈ 1.9 basis points on total assets.
On a fund with a 3–5 basis point expense ratio, that is a material contribution. Funds holding names in heavy demand — small caps, recent IPOs, crowded shorts — can earn many times more.
The risks, ordered by how much money they have actually cost
1. Collateral reinvestment risk — by far the largest
Here is the structural point almost nobody states plainly: in cash-collateral markets, a securities lending program is two businesses stapled together.
- Business one: renting out shares for a fee. Low risk, over-collateralised, marked daily.
- Business two: investing the cash collateral to earn the rebate you owe. That is a short-term fixed income portfolio, and it carries whatever credit and liquidity risk you put in it.
The temptation is obvious. Reach for a few extra basis points in the reinvestment pool and the lending program's revenue improves — until the reinvestment pool is exactly where the risk was hiding.
What happened in 2008. Many cash-collateral pools held asset-backed commercial paper, structured investment vehicle paper and floating-rate notes. When those instruments fell in value or stopped trading altogether, and borrowers simultaneously returned securities and demanded their cash back, the pools could not liquidate at par. The mismatch was the loss.
The documented extreme case is AIG. Its insurance subsidiaries lent securities and reinvested the cash collateral in residential mortgage-backed securities — a long-dated, illiquid asset funded by an obligation repayable on demand. When borrowers returned securities in 2008 and asked for their cash, AIG could not sell the RMBS anywhere near par. The Federal Reserve's Maiden Lane II facility, created in December 2008, purchased roughly $20.5 billion of RMBS out of AIG's securities lending portfolio. Several large custodian banks also faced investor litigation over cash-collateral pool losses in the same period.
Read the causation carefully: the losses came from the reinvestment, not from the lending, and not from the short sellers. Non-cash collateral markets — where the borrower posts government bonds and simply pays a fee — do not run business two at all, and therefore did not have this problem.
2. Borrower default
Mitigated by 102–105% over-collateralisation, daily marks and agent-lender indemnification. Historically a small source of loss, even through 2008.
3. Recall and opportunity risk
A lent security must be recalled before it can be sold. In a fast-moving market that is a delay the lender did not plan for.
4. Governance
Lent shares carry no vote for the lender. Institutions with stewardship obligations face a real trade-off between lending revenue and the ability to vote, and many recall around contentious meetings. That is the same recall pressure a short seller experiences from the other end of the chain — now visible from both sides.
Try it now
- Open the most recent annual report of the iShares Russell 2000 ETF (IWM), published on the fund's iShares page and filed with the SEC, and find the securities lending disclosures: income earned, the split with the agent, and the collateral policy.
- Check whether the collateral is cash or non-cash, and if cash, what the reinvestment guidelines permit. That paragraph is where the 2008 risk lived.
- Compare the lending income to the fund's net expense ratio, which is below with the fund's total assets. It is written as a decimal fraction, so 0.00030 is 0.03%. Divide the year's lending income by the fund's net assets to turn it into a rate, then divide that rate by the expense ratio: you have measured how much of the fund's running cost is paid for by the short sellers who borrow from it.