Scrip-lending is the term used to describe the practice of lending out shares and other securities typically held in a unit trust fund, exchange traded fund or retirement fund.
Fund managers rent out securities they are sure will hold for the period of the loan in return for a fee. This fee generates additional income for the fund and keeps the ongoing management fees down.
Index-tracking funds typically hold certain shares for long periods while they are in the index and are therefore more likely to be involved in scrip-lending than active fund managers.
The borrowers are typically fund managers who want to short sell those securities – sell them in the market and then buy them back later at a cheaper price in order to return them to the lender.
If your fund is involved in securities lending, the extent to which it is must be disclosed on the minimum disclosure document or fund fact sheet – your fund should not be making secret profits.
Scrip lending is limited to a maximum of 50% of the underlying assets of a fund.
Ownership transfers
Another important issue is that when your fund lends out securities, the ownership title transfers to the borrower along with any voting rights on those securities.
This means that your fund is not able to attend the company’s annual general meeting and vote on resolutions around executive pay, or engage the company management on issues that have an impact on society or climate change.
Securities lending is not without risks. If the borrower is involved in short selling, the strategy may not pan out as expected.
This is why the loan must be backed by collateral - other securities such as shares, bonds or cash to the lender and the risks must be assessed. The trustee that holds the funds’ securities must assess the risks and be comfortable with the loan agreement.
While the shares or bonds are on loan, the dividends and interest will be paid to the borrower, but the scrip-lending agreement typically obliges the borrower to pay these over to the lender as interest.
The effect of this transaction is that dividends paid by the shares may become interest for tax purposes when they are paid over to you.
