It’s fair to Vanguard has been one of the more vocal buy-side supporters of securities lending this year.

The US asset management giant has publicly announced plans to allow some of its largest ETFs to engage in the practice.

Experts at the fund house have also been doing their best to allay investors’ stock loan fears by publishing detailed research about the associated risks and potential benefits.

There could be a few reasons behind the firm’s active approach.

Vanguard’s analysts themselves admit that securities lending is often misunderstood and still considered by some to be relatively opaque.

This doesn’t sit well with shareholders and board members who are increasingly demanding greater transparency across every area of the business.

Secondly, a low rate environment has heightened the search for yield.

If, therefore, lending securities makes sense from a risk perspective and generates a few basis points to help beat a benchmark or cover expenses, why sit on the sidelines?

Another reason for the increased focus could be something of a push back on further potential regulation.

This summer the FSB sharpened its focus on securities lending in a bid to address systemic risks in the funds sector.

Investment trade body SIFMA responded by saying that securities lending is already subject to a range of existing and pending regulations that adequately address any risks.

Vanguard also has competition factors to consider.  Rival BlackRock, which made nearly $500m from securities lending in 2015, has been loosening some of its funds’ lending restrictions.

When combined, it is thought BlackRock and Vanguard own 5% of most major companies on the planet - meaning they have plenty of securities to supply to willing borrowers that would otherwise be sitting idle.

“Our securities-lending program is value-oriented,” Jane Wagner, global head of Vanguard's securities lending program told Global Investor/ISF at the RMA’s securities lending event in Florida last week.

“It generates revenue by lending limited amounts of select, hard-to-borrow securities that are in high demand.”

By doing so, Wagner explains that the percentage amounts of securities on loan in Vanguard funds is far lower than most other lending programs and therefore limits risk in the program. 

Based on certain factors, Vanguard will use either their direct lending program or an agent lender. 

“For our direct lending program, we know our portfolios well and can fill borrow orders effectively,” Wagner explains, adding that their direct lending approach returns 100% of the lending fee revenue less expenses to fund investors.

The firm does use agents where the agent may have a presence in certain local markets where the particular security trades.  

When this happens, it’s crucial that the agent shares the company's value-oriented and risk-adverse philosophy.

“There are nuances in terms of location and fund type,” Wagner adds. 

“An agent lender model might work for an Irish UCITS fund, for example,  while our direct lending program may work for a mutual fund. We strike a good balance between both agency and direct models.”

Regulation

Aside from the FSB's closer attention, the securities lending market has been subject to a vast amount of rules following the 2008 global financial crisis.

On the lending side, agent banks are being forced to hold more capital against indemnified loans. There are also single counterparty credit limits to contend with, which place a quantitative limit on an exposure to one firm.  

Meanwhile on the borrowing side, demand is being constrained by shrinking investment bank balance sheets. All the above has changed supply, demand, pricing, participation levels, operations, technology and risk management. 

As a result, Wagner adds that it has become crucial to understand not only the regulation impacting Vanguard itself, but also the various capital rules impacting banks.

“While beneficial owners face intense regulation governing how we move and hold assets, we are just as aware of the changes agent lenders and borrowing community face. It's crucial to know the influencing factors at play."