Borrowing stock for the purpose of satisfying settlement obligations occurs in over 40 markets worldwide solidifying its position as a feature of every developed and many developing markets. Indeed, some index providers have stock lending/borrowing as a qualifying criterion for ‘developed market’ status.
Stock borrowing can be considered a somewhat opaque support mechanism for efficient market operations. Its historical roots lie in the transfer of assets between securities firms to avoid settlement failures. Especially critical in the days of certificated settlement, this operational aspect has had several revivals over the past dozen years, first driven by the regulatory desire to reduce the systemic risk of increased fails and naked short sales in the immediate aftermath of the Lehman default, and then again over the past decade as many markets reduced their domestic settlement cycles.
Borrowing is not an end-objective, rather it is part of a wider transaction or purpose. For example, market makers’ ability to borrow as opposed to buy shares enables them to provide timely liquidity to investors. As long as there are market makers, stock borrowing will be a critical part of their toolkit. In addition to support for market making, it is a part of everyday capital markets life including merger and acquisition deals, algorithmic trading, arbitrage across indices and ETFs as well as outright directional trading.
