What is Fully Paid Securities Lending? - 2023

Updated March 20, 2023

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Definition:

Fully Paid Securities Lending (aka: FPSL) is a common type of securities lending where customers can earn passive income by giving their broker permission to lend out stocks that they’ve fully purchased (aka: not on margin).

🤔 Understanding Fully Paid Securities Lending

Fully Paid Securities Lending may sound complicated, but the goal is pretty simple: profit off of an existing security (like a stock in your portfolio) by loaning it. When customers agree to participate in FPSL, they give their broker permission to lend out shares that they have fully purchased (read: not on margin). From there, brokers lend those shares to other financial institutions and market participants (think: funds, brokers, banks, proprietary trading firms) who want to borrow them for different reasons — usually, to facilitate short sales, but also to settle trades or support more sophisticated trading strategies. The borrowers pay brokers a fee, and brokers share a fraction of that fee with customers. While securities lending typically happens between institutions, customers can indirectly profit. FYI: securities that are in short supply (aka: “hard-to-borrow” stocks) are more likely to be borrowed and command higher loan fees.

Example

Let’s say you’re a long-term investor in Meow Enterprises, with $1K worth of fully-paid Meow shares. You decide you want to earn some passive income, so you give your broker permission to lend out your Meow shares. Your broker makes the loan to an institutional investor, earning a 10% annualized fee of $100 — and gives you a 12% cut of that $100 fee. You would earn $1 every month that the loan was active.

Takeaway

Fully paid securities lending is kind of like renting out your house...

While renting your house earns you income on an asset you already own, you can still sell your house or move back in. Similarly, securities lending earns you passive income on stocks you already hold, and you can sell them or recall them any time.

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Tell me more…

What are the benefits of FPSL for customers?
What are the tradeoffs of FPSL for customers?
Do I still own my shares if I participate in FPSL?
How do I participate in fully paid securities lending?

What are the benefits of FPSL for customers?

While brokers are typically the biggest gainers in FPSL, customers who participate earn an extra source of passive income. Zooming out: securities lending as a whole provides liquidity to markets and facilitates short-selling.

Keep in mind that securities lending is demand-driven: Widely available securities that are not frequently bet against (“shorted”), like most S&P 500 stocks, earn lenders less. Securities that are in short supply (aka: “hard-to-borrows”) are more lucrative for lenders than easier-to-borrow securities. For example, Tesla circa 2018 commanded a higher loan fee than Google or Microsoft — at the time, many investors were shorting Tesla, which meant there was a greater demand for borrowed Tesla shares to satisfy delivery obligations and facilitate short positions.

What are the tradeoffs of FPSL for customers?

There are three key tradeoffs to earning passive income through FPSL. First, customers lose the right to participate in shareholder voting on loaned securities during the borrowing period. Second, any dividends they earn on those loaned securities are paid as cash instead of dividends and are taxed as ordinary income, which could carry a higher tax rate. Third, customers lose SIPC insurance for the securities that are out on loan. That means that if their broker goes out of business, SIPC will not cover the value of those lost securities.

To make up for the loss of SIPC insurance, brokers generally hold collateral (usually cash) that is at least equal to the value of the loaned securities. This collateral is held at a third party financial institution to hedge the risk of default.

Do I still own my shares if I participate in FPSL?

Kind of. You can sell your shares or recall the loan at any time. But when a security is loaned, ownership of that security is temporarily transferred to the borrower. This means the borrower gets shareholder voting rights and SIPC insurance for those shares.

However, you still have economic control over them (confusing, we know). For example: the loaned shares are still visible in your account, and you can sell them or terminate the loan any time.

On the backend, your broker would return the collateral to the borrower, and the borrower would return the shares to the broker (but that all happens behind-the-scenes).

How do I participate in fully paid securities lending?

If your broker offers an FPSL product, you need to actively agree if you want to participate. Eligibility criteria varies by broker. Many broker-dealers require customers to have hundreds of thousands of dollars in their portfolios to participate. Others have more flexible eligibility criteria (think: less than $10K).

It’s also important to keep in mind that different brokers have different split rates, or the percentage of loan fees received by the broker from borrowers that the broker shares with its customers (after the clearing broker that facilitated the lending process takes its portion of the fees). There’s a range: some brokers split the fees they receive 50-50 with their customers, while some don’t share anything.